News & Views

Out of Hock

There is an old saying regarding personal debt. “The lender remembers things the borrower forgets.” Try not to take on either of these roles, that of the lender or the borrower. Easier said than done. If you have children – even adult children, you often become their bank. Many of us have needy relatives. Sometimes we’re the ones in need and look for loans from family members.

Is this just the nature of things? If so, nature has a way of coming back and biting us. Controlling spending is critical. Debt has become a habit that is hard to break for many of us. Here are the figures for consumer debt in the U.S. for 2014.

U.S. household consumer debt profile:

• Average credit card debt: $15,611
• Average mortgage debt: $155,192
• Average student loan debt: $32,264

In total, American consumers owe:

• $11.74 trillion in debt
  • An increase of 3.3% from last year
• $882.6 billion in credit card debt
• $8.14 trillion in mortgages
• $1.13 trillion in student loans
  • An increase of 8% from last year

Younger Workers

If you’re a millennial, you’ve probably amassed some student loan debt. Although you’re working, saving strikes you as an often impossibly difficult task. You’re not alone. The savings rate for workers under 35 according to Moody’s Analytics was a negative 1.4% in 2014.

That lack of savings sets a pattern that has long range implications for millennial workers. If you don’t start savings habits early, you’re financially less likely to be secure in the future…often regardless of your earning potential. Much of the reason is simply the math behind the power of compound interest. The earlier you begin saving, the more powerful compounding becomes. To paraphrase an old Rolling Stones classic, “time is on your side”, but only if you start early enough in your career to let the dollars grow. If you start late, you never catch up.

One often used example of the how compounding works to your advantage involves two twin brothers. Let’s call them Jackson and Scott. Both went to work for the very same company at 25 years of age and worked until they were 55. At 55, they both opted to retire early. The brothers, however, has very different savings habits.
Jackson began funding his 401k immediately from his date of hire. Each year, he contributed $5,000. Over his working life he averaged a fairly modest 7% return. When he took early retirement he had amassed $467,304.

Scott was a bit different. At 25, he couldn’t think much about saving for the future, let alone retirement. It seemed too far off and there were more important needs like a “nice ride” and weekends. Scott didn’t do anything for 10 years. At 35, he came to the realization that he’d better begin saving. To catch up with his brother Jackson, he decided to double his contribution to $10,000 instead of the $5,000 Jackson continued to contribute. Scott did this for the next 20 years.

Like his brother, he also earned an average of 7% each year on the contribution. Each brother earns the same 7% return, but the totals are not the same at the end of their 30 year career.

Jackson had $467,304. Scott ended up with $399,955. Starting the savings habit earlier gave Jackson a 17% advantage.

Thrift Plan Withdrawal Strategies

Building wealth can often be thought of in having three phases. The first is the accumulation phase. The second is the preservation phase, which entails keeping what you’ve built. The third is the harvesting phase. It’s this harvesting phase that we often don’t give enough thought to until it’s upon us.

Several strategies can provide retirement income streams in retirement. Here is one of the most popular. Take a portion of your TSP in equal payments. Let’s say you retire at 66 and you’re under FERS. You have decided to begin taking Social Security. You’ve gone on to the Social Security Administration website (www.ssa.gov) and determined that your Social Security benefits will not be enough to cover your needs. You could decide to take a portion of your TSP in equal payments during your first 2 or 3 years of retirement to augment your FERS pension and your Social Security.

Another strategy might be to increase the size of your equal payments and forgo taking your Social Security until perhaps age 68 or 70. For example, if your full Social Security retirement age is 66, between age 66 and age 70, Social Security benefits increase 8% a year. That’s an excellent guaranteed return on your money.

Another option of an income stream, although often not as attractive as equal payments, is choosing to annuitize a portion of your TSP. That way you have steady predictable income each month. Each of these options provides the income stream that can augment both your FERS pension and your Social Security.

Ad you prepare for retirement, you may want to consider a “bucket strategy” for your total retirement portfolio. Here is how it works. Each of the four buckets is composed of different assets. The objective is to provide income over a long period of time with good growth potential.

The first bucket is the most important because it will sustain you for the first 2 to 5 years of your retirement. It’s made up of cash, short term treasuries and CD’s, and perhaps money market accounts. This bucket is used to cover your basic needs. If you retire at a particularly bad time economically like 2008 or 2009, this bucket sustains you until markets improve.

The remaining buckets are composed of increasingly aggressive assets. Each of these buckets grows in both aggressiveness and maturity. Bucket 2 begins to meet your needs 3 to 6 years after you retire. It’s composed of investments grade bonds, longer CDs and a sprinkling of well rated blue chips with good dividends.

Bucket 3 shouldn’t be accessed for 5 years. To keep it inexpensive, it’s composed of an S& P 500 index, a broadly based international stock index fund, and a broadly based U.S. or world bond fund.

The final bucket, bucket 4, swings for the fences. This is the most aggressive because your time lines are a long way out. In this bucket, you might have an index of small cap stocks, emerging markets, and a global bond bund typically 10 or more years. Increasingly, people are realizing that this simple strategy has the potential for providing for long term needs.