Asymmetrical Information - Megan McArdle

03.19.13

Ask the Blogger: Worried Savers Edition

You ask, I answer

Dear Blogger:

I'm wrapping up a doctoral degree in the physical sciences and heading to an industrial job in a few months. My grad school years have been spent in one of the highest cost-of-living parts of the States, so my individual savings aren't in great (mid four-digits), but I'm mid-twenties and thankfully debt-free (no student loans, never carry a credit card balance, car bought with cash, etc.) My new job will be both in a much lower cost of living state and a significant step up in salary at a little under $100,00/year base + signing bonus + potential annual bonus, dependent on company performance and my personal success or failure. The company offers a 401k with a mixed match (I put in 6%, they fractionally escalate until they've matched 4%) and discounted stock for employees. Health and dental carry a modest deductible but the coverage is good.

I've gotten by for a little under a decade as an undergrad on scholarships and lab assistant support and then as a grad student on fellowships and TA appointments; now that I'm slogging through my dissertation I'm starting to dream about how to structure my finances once I actually have finances to think about. I've been in school longer than most so I know I'm behind in starting major retirement savings, but the emergency fund will have to be bumped up first. Industrial research jobs are growing less stable than they once were, so I'm wary of locking myself too much into the company's system beyond what I need to get the match. I'm also likely renting for the first few years as I'm not sure if I'll be settling at that particular site long enough to merit binding myself with a mortgage to the local real estate environment. If you were in my shoes and starting your first outside-of-school job, how would you allocate things for the first few years?

-Almost a PhD


Dear AP:

Congratulations on making it through grad school, finding a job, and thinking about your finances in advance, rather than after you’ve realized that $100,000 won’t go quite as far as you thought when you were living on Ramen and Cheez-Its.

You’ve got your priorities roughly correct, but even before you start thinking about an emergency fund, I recommend that you start thinking about a budget. How much are you willing to spend on rent, food, and so forth? It will be more than you spend now, but how much more? How much do you want to spend on a vacation? How about new clothes? Set a budget before you go shopping for these things, which will help you hit your savings goals. Right now you’re in an enviable position: you have a big income coming, but you are used to a very small one. If you keep your lifestyle upgrades on the low side for a few years, you’ll find that at the end of it all, you’ll have enough for a better car and a downpayment on a house anywhere you want to live. Of course, you don’t have to live exactly like a grad student—there’s nothing wrong with buying a nice television and taking yourself on vacation to celebrate your graduation. But if you plug most of that signing bonus into your emergency fund, and budget for only modest improvements in your rent and dining-out budget, you’ll give yourself a great foundation for your thirties.

You’re quite right that you shouldn’t buy a house immediately, and no only because you don’t know if you’ll want to transfer. It takes at least a year of living in a new city before you know what sort of amenities you’ll care about, and what neighborhoods you like.

After you’ve got that settled, you should have three savings goals:

1. An emergency fund with at least six months worth of expenses. (You will note doubt have already realized that the lower you keep your fixed expenses, the less you will have to save in this account.)
2. A retirement account with 15% of your annual income. Don’t worry about “locking yourself in” to your employer’s system; a 401(k) account is your property, and you will take it with you when you go. It can be rolled into your new 401(k), or an IRA.
3. Sinking funds for car repairs, and the things that you will no doubt want to buy with your newfound wealth: vacations, furniture, electronics, a better car, a downpayment on a house.

If you do this, you will have a great deal of financial freedom to advance your career—and up your consumption.


Dear Blogger:

I'm 52 and have less than $100k in various 401k, IRA, and other retirement vehicles.

All my life I've had, well, a "bad relationship with money," but over the past few years have started to change that. I've been in debt all my working life, but my $6k Visa debt will be paid off by late summer and I'll start putting the payment amounts into savings to build my emergency fund (which I've never had).

I have no assets nor other liabilities. I'm single.
Better late than never for all this, but it means I can't easily make up for lost time in my retirement funds. I'm saving 7% of my salary (which is matched or partly matched up to 5%) but don't want to do much more now, because I want to focus on my consumer debt and emergency fund.

But I worry about my retirement. Experts harp on saving as much as possible starting as early as possible, but that isn't always going to happen, for one reason ir another. Do you have any words of advice for me? I'm betting I'm not the only late baby boomer in this situation.
Thanks!


Behind the 8 ball



Dear BTB:

You are not the only late Boomer in this situation, but take heart: it’s not too late. True story: a 65-year old guy who owned a truck stop in Kentucky basically saw his business destroyed by a new interstate that took all the traffic from his road. With almost no savings, he picked up and decided to see what he could do with his one remaining asset: a great recipe for fried chicken. Decades later, Colonel Sanders is a household name, and millions of us enjoy his Kentucky Fried Chicken.

Which is not to say that we all get to be Colonel Sanders. But it is never too late to rescue yourself from what seems like certain disaster. You’ve done the most important thing: just like Colonel Sanders, you’ve decided to do what you can to keep moving rather than giving up. Congratulations on deciding to get debt free and give yourself an emergency fund.

However, it is a little harder if you start late. I’m probably not going to surprise you by telling you that it’s unlikely you’ll be able to retire at 62, or even 65, on the assets you have now. You need more work years to build up your nest egg.


That said, let me ease your undoubted panic a little: you already have more in retirement assets than most people. It’s not enough—particularly if you’re used to a nice income. But in 21st century America, even retired people with no assets at all generally have shelter, enough to eat, and some decent free entertainment options, unless they have far bigger mental or behavioral problems than “a bad relationship with money”—which describes most of the population, frankly.

So don’t panic. Seriously: don’t panic. Don’t lie awake at nights worrying. You’re going to be fine. You just need a plan.

Here’s what that plan looks like: first, pay off that consumer debt, which has usurious interest rates. Second, get yourself an emergency fund of three months of expenses so you don't have to go back into consumer debt. And then third, figure out how you can live on 75% of your income, while plowing 25% into retirement savings. Not necessarily all in a 401(k)—older workers should also have a decent cash nest egg, what with the state of the economy.   That will make up for a smaller emergency fund--though only tap it if you get laid off! But you really need to be putting a way a big chunk of your income, both to bump your savings, and to lower what you’re used to living on—and will therefore need to replace in retirement.

I know this probably won’t be easy; it may mean downgrading the car and the house, or looking for side projects to help you make more money. But if you put away a solid 25% for the next 15 years, you should be able to finance a decent, if not lavish, retirement with no problem.


Dear Blogger:

Here's a personal finance question for you. For reasons sort of dumb and complicated, my decent-sized Roth IRA is now almost entirely sitting in a money market account. I'm fairly young (30+ years until retirement) and I know that I need to get these funds back into (mostly) equities in order to take advantage of my lengthy investment horizon. My problem is that dumping this money into an index fund, which is what I'll almost definitely do with it, makes me feel like I'm leaving myself vulnerable to losing a bundle on any downward swing in the markets, which these days seems like it's always right around the corner. I know that I'm talking myself into the cardinal mistake of thinking I can "time the market", but for the past few years I just haven't been able to stomach the idea of throwing my nest egg into the market when there always seems to be some big, imminent, dangerous event (Euro crisis, debt ceiling standoff, fiscal cliff, sequestration, the ongoing mystery about how healthy the US banks actually are) threatening to cause a repeat of 2008. What should I do?

Crisis Watcher

Dear CW:

Repeat after me: I cannot time the market. I cannot time the market. I cannot time the market.

Seriously. The average returns of guys who spend all day, every day watching the market are perilously low—barely enough to cover their costs. You will not do better, what with having a day job. Yes, you might lose money in any crisis, but you have decades to make it up—and in the crisis, if you keep reliably plugging away, you’ll buy cheap, getting higher returns.

Put your money in index funds and forget about it for thirty years. You’ll thank me—and yourself—later. Much, much later.

Ask the blogger runs Tuesday afternoons. Mail your questions to mcmeganmoney@gmail.com