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Personal Finance

This guide gathers together useful resources relating to money management.

The Three-Legged Stool

Prior to the 20th Century retirement as a concept did not exist for most people.  You worked until you couldn't, and then you died shortly thereafter.  Sadly that is still the case for a large percentage of humanity.  What makes a comfortable retirement feasible for people in the middle class is implementing a plan, when you are still relatively young, that sets up at least three income streams after you stop working.  The metaphor of a three-legged stool is used to illustrate this concept because you need at least three legs for a stool to be stable. Of course, a stool can have four legs and so can a retirement, but three is the necessary minimum.

The typical three-legged retirement plan for someone starting out in a career today would be:

1) 401(k) or 403(b) account with pre-tax dollars and employer matching contributions

2) Roth IRA with after-tax dollars

3) Social Security

Not everyone has to do it exactly this way.  Below are some examples of workable strategies.  The main element of a successful strategy is establishing and starting to fund the three legs by age 30.

Variations of a Three-Legged Retirement Strategy
a public school teacher a federal government employee a small business owner

1) teacher's pension
2) mutual fund
3) social security

1) thrift savings plan
2) traditional IRA
3) social security

1) tax-deferred variable annuity
2) exchange traded funds
3) social security

How Not to Outlive Your Savings

Problem = It is hard to know when you have saved enough to retire because the future could place unlimited demands on your finite savings.

Three Sensible Strategies:

1) Diversify widely and sensibly beyond the mainstream U.S. stock market.

2) When you retire adopt a flexible distribution system based on your portfolio value rather than a fixed inflation-adjusted budget set at the start of your retirement.  In other words, you will need to tighten your belt when inflation is high and investment returns are low but then loosen your belt when those numbers improve.

3) Before you retire, save considerably more money than you think you will need.

When you make the decision to retire you cannot predict inflation rates or market fluctuations.  So what is considered a safe amount to withdraw from your retirement savings without depleting them and running out of money?

Most financial advisors will say 4%.  So one million dollars in savings would give you a safe retirement income of $40,000 annually.  If that seems low remember that typical assumptions are that by that time you have retired all of your debts (including a mortgage), will collect social security, and will be enrolled in Medicare.  People also generally become less materialistic and acquisitive as they age.  So you can retire comfortably even with savings less than one million dollars.

We know that power of compound interest dramatically rewards people who are able to start saving in their twenties.  But that power diminishes over time.

Recent research suggests that: "Once the average earner reaches their 50s, substantially increasing sustainable retirement resources by saving more has a significantly smaller impact than working long does." (Scott, Shoven, and Slavov)