Using Discipline During Periods of Market Volatility

Last Week’s Reminder: Volatility is a Fact of Life for Investors

Volatility spiked for stock markets around the world last week. Higher in the volatility in the U.S. meant that indices such as the S&P 500 US stock index fell as much as 11.8% from its peak of 2,872.87 on January 26, 2018. The last time stocks had a correction, a decline greater than 10% from a peak, was two years ago in February 2016.

With stocks climbing steadily higher over the last two years, it is easy to forget that stocks can also go downA historical study that goes back to 1930 by Bank of America Merrill Lynch1 found that a 5%+ pullback happens about three-times a year, 10%+ corrections occur about once a year, and 15% downturns come every two years.

The Roller Coaster Ride is Not Over

The stock market is on a roller coaster ride.  After a steady climb over the last two years, the roller coaster fell, correcting by more than 10% from its peak.  Ups and downs may be more frequent in 2018 as the stock market figures out how to interpret developments.

Many of the reasons cited for why stock markets corrected last week were also the same ones used to explain its rise. The reasons include inflation or pricing power, Jerome Powell as the new Fed Chairman overseeing interest rates, a strong job market, tax cuts and fiscal spending.

Optimists view a strong job market as support for continued economic growth. Pessimists view a tight job market means that the Fed may be more aggressive in increasing interesting rates in order to stem the risk of the economy overheating.

Optimists see inflation as a sign of pricing power, the ability for businesses to raise prices, which is good for profits. Pessimists see inflation driving up interest rates, raising the cost to finance business and a threat to growth.

Optimists believe tax cuts will boost profits and would dub the increase in fiscal spending as stimulus spending. Pessimists see tax cuts as moves that increase the budget deficit and would label fiscal spending as deficit spending that would increase our national indebtedness. President Trump’s proposed budget for 2019 calls for more spending on infrastructure and other projects that would add $7 trillion to the federal deficit over the next 10 years. More borrowing means that the US Treasury will issue more bonds to finance its spending. The law of supply and demand says that more supply should lower the price of bonds, which translates into higher interest rates.

We Are Cautiously Optimistic

We continue to be cautiously optimistic about the current investment environment. We are optimistic because business and economic fundamentals are solid. Earnings are improving, businesses have good access to capital for growth, the job market is strong, and the tax cut should boost business profits and increase disposable income for families. Interest rates remain low, and we believe global central banks will continue to maintain their easy money policies until they believe inflationary pressures are apparent. Continue reading

Six Ways to Make Your Money & Your Impact Go Further Before End of 2017

Before I get into the six ways to make your money and your impact go further, consider current talks regarding tax reform. They can influence your money and your impact. The last major overhaul in taxes was in 1986, 31 … Continue reading

5 Simple Ways to Improve Cybersecurity & Protect Yourself Against Identity Theft

Cybersecurity is one of the biggest challenges of modern times. Identity theft is one of the outcomes that you want to avoid. It can be a huge drain on time and money. No time is better than now to update your passwords and check your credit reports. Recent news on the theft of personal information seem to get worse and worse, and it may be the tip of the iceberg. With over 140 million people affected by the breach at Equifax, odds are good that you or someone you know is someone where their name, address, birthday, Social Security and driver’s license numbers may have been exposed. There have been other breaches of varying degrees at government institutions such as the SEC and Office of Personnel Management, and other companies such as Anthem, JP Morgan Chase, Target and Yahoo.

Identity theft can do as much if not more damage to your personal finances than a market correction. At least history shows that investments tend to bounce back over time. A stolen debit card may result in someone drawing money from your bank account. A stolen identity can mean thieves opening accounts as you and running credit card balances in your name. Identity theft can cost you money that you may recover, but lost of countless hours that you won’t recover.

Use Strong Passwords

There are several simple things to protect yourself from identity theft. First, update your passwords and make this a regular practice. Use passwords that are difficult to guess. They should be lengthy and contain special characters and numbers. Try creating a unique phrase that few would guess. I use a password manager to help me keep track of all my passwords, which are not easy to remember and are different for every website. Personally, I have been satisfied using Lastpass as my password manager. It took me a couple of days to get used to it. Click here for the Wirecutter’s review of password managers. Wirecutter’s favorites include Lastpass, 1Password and Dashlane.

Setup Account Monitors and Alerts

Second, monitor your financial accounts and get alerts for transactions on your accounts. I use eMoney, the personal financial management tool that I mentioned last month. It simplifies the process to watch all our accounts. I have made eMoney available for free to everyone that works with Candent. eMoney will also help you get organized and enable you to see progress towards your investment goals. It can send you alerts about changes to your account balances. I also use a more granular approach. I signed up to receive alerts from my bank and credit card companies. In my experience, this service has been always free. I get alerts for transactions and changes to my account balance. Yes, I may be extreme. Did I say I take this very seriously?

Take Control Over Your Credit Reports

Third, sign up for services to track your credit report and for a security freeze with the credit reporting agencies. The three big ones are Equifax, Transunion, and Experian. Click here for the Federal Trade Commission’s webpage for free credit reports. For a security freeze on your credit report, you will need to contact the three credit agencies directly. A freeze limits the ability of someone to pull your credit information. It is not foolproof, but it is better than nothing. At the very least, you made it harder for someone to steal your identity.

Be Careful With Your Personal Information

Fourth, be more mindful of personal information that you share with someone. You may be surprised by how much information about your is already out there. If you think about it, what you give for the convenience or enjoyment you get in using many of the apps on your phone, for example, is your personal information that gets used for advertising. Just think, advertising is one of the more legitimate uses.

Be on Alert of Scams

Fifth, be aware of phone scams and otherwise. Don’t give out your personal information over the phone or some website unless you are confident that the person on the other side is trustworthy. I would not respond when a caller says they are from the IRS, Medicare, some credit card company, etc. Instead, I ask for the caller’s name and a reference number for the call so I could follow-up by calling a number that I believe is valid. Moreover, the IRS and Medicare have the policy to send letters regarding information, not to call people. Click here for an IRS post on how to spot a suspicious call and here for more alerts from the National Council on Aging. Other popular phone scams include those from callers seeking help to retrieve money or some asset. Some callers prey on the elderly by posing as grandchildren seeking financial assistance from grandparents.

There are more things you can do to protect yourself. I will save those for a later note. You are always welcome to contact me if you want to discuss what these ideas.

Outlook Post 2016 Presidential Election

The Trump victory keeps us in the bizarro world that I described in the July Quarterly Client Letter. Expect the unexpected is the lesson for 2016. Who would have thought that the UK would vote in favor of leaving the European Union in June? Who would have thought that many developed countries would have negative interest rates? Who would have predicted 12- or 6-months ago that the US would be saying President Trump in 2017?

Greater Conviction for a Lower Expected Returns

The election results gives me greater conviction in my investment outlook. I expect more days of large market gains and declines. Expected returns over the next 10 years will be lower than historical averages. I expect average annuals gains for US stocks to be between 4% and 7% over the next 10 years. The historical average since 1926 around 10%.  Returns for US bonds should be be between 1% and 3% versus 6.2% over the last 20 years.

Time to Review Outlook for Investment Goals

Investors should revisit the outlook for their investment goals using more conservative return expectations. Many retirement or financial planning calculators use as expectations the optimistic historical averages. If returns are lower than their historical norm, many people may be in for an unpleasant surprise. Their investment portfolio may not be able to support their retirement plans or run out of money.

2 Reasons for Lower Expected Returns: Greater Uncertainty & High Valuations

Two reasons for lower expected returns are greater market uncertainty and high valuations. A vote for Trump was a vote for change for many voters. With change comes uncertainty. Will President-elect Trump will with Congress? How will he change healthcare, trade or tax policies? Until they have more clarity, I look for investors and companies to be more conservative with their investments. This implies less risk taking and less willingness to pay up for their investments.

Greater investor uncertainty adds to larger market swings. US stock futures tumbled 5% overnight as a Trump victory seemed more likely. Stocks then opened the next day on a down note only to rebound and be up over 1% for much of the morning after election.  Large market swings will be more common until uncertainty subsides. Uncertainty also makes it more difficult for stock valuations to increase beyond current levels. At 25x, the price-to-earnings of the S&P 500 is above its historical norm of 16x but below periods such as 1999 when it was over 30x.

Position for the Long-Run

Predicting daily moves in the market with any consistency is a near impossible task. My years conducting investment research taught me that it is better to focus on the long-term. Your portfolio should reflect your financial goals, the priority of those goals, your risk tolerance and time horizon.  The approach that I think is most applicable in the current environment is to cast wide net. Holding an appropriate amount of broad assets will increase the chances of capturing market gains. It will also reduce risk through diversification.  It is also important to emphasize lower cost investments. Lower costs will help maximize your returns in an otherwise low return environment.

Plan Ahead to Increase College Financial Aid

College is one of the biggest investments that a family will make for its children. Four years of college can run upwards of a quarter of a million dollars at a private school and roughly half at a public institution. The reality is that two-thirds of families do not pay the full amount. They receive financial aid in the form of grants and scholarships. With some planning, more families can qualify or increase their financial aid package.

Most colleges determine eligibility for financial aid by estimating the Expected Family Contribution (EFC). Every year, families submit the Free Application for Federal Student Aid (FAFSA) form. FAFSA updates the school on the income and assets of students and their parents used to determine eligibility for need- and non-need based financial aid. Need-based aid is the difference between the Cost of Attendance (COA) for a particular school and a family’s EFC. Non-need based aid is the difference between COA and financial aid already awarded to the student. Students that do not expect to qualify for grants and scholarships should still consider filing FAFSA. First, they may be in for a pleasant surprise and qualify for aid. Second, schools use FAFSA to determine eligibility for some student loans.

Investing time to understand FAFSA can yield returns by helping a family reduce its EFC. Smart decisions can increase financial aid by reducing income or assets reported on FAFSA and a family’s EFC. FAFSA places more weight on income than assets. It may count up to 47% of parental adjusted annual income toward EFC. For assets, FAFSA counts 20% of student assets and 5.64% of parental assets. See from the U.S. Department of Education for more details.

Timing matters

Families should consider how the timing of when they take income could affect financial aid. Parental income counts 8x more than assets in the EFC formula. Parents can reduce the income reported on FAFSA, for example, by choosing to delay or advance the time they realize capital gains or take a bonus.

FAFSA has a new look back policy for income. Starting with the 2017-2018 school year, FAFSA will implement a new two-year look back rule. Before, it used a one-year look back to determine the current year’s financial aid eligibility. The change means that 2015 income used for the calculations for the 2016-2017 school year will also apply for 2017-2018. Figures for 2016 income will apply for the 2018-2019 school year. In other words, this year’s income will not affect financial aid until the school year starting in fall 2018. Families, especially those with students starting or finishing school in the 2018-2019 school year, should plan accordingly.

Ownership matters

When it comes to assets, who owns the account can affect EFC and eligibility for aid. The treatment for parental assets is more favorable than student assets. FAFSA counts 5.64% of parental assets toward EFC for a dependent student. It counts 20% for a student’s assets. Assets owned outside of the immediate family can have a more favorable 0% weight. At present, FAFSA does not ask about assets not owned by the dependent student or the parents. In contrast, a student’s UTMA or UGMA custodial accounts have the higher 20% weight. For the purpose of financial aid, FAFSA considers the student to be the owner of the UTMA/UGMA.

In a previous article, I wrote about the benefits of 529 accounts as a way to save for college. If used for higher education as intended, earnings in 529 accounts are not subject to tax. This would leave more to pay for school. Disbursements will not count hurt a student’s financial aid eligibility the next school year if the FAFSA form included the 529 account balance.  They can hurt eligibility if funds came from a 529 account that was not included on the FAFSA. Such funds would count as a student’s untaxed income.

Prioritizing which accounts to tap first can greatly affect financial aid. A bad choice can increase income on next year’s FAFSA. Imagine if grandpa paid for freshman year with a $50,000 disbursement from the 529 he owned instead of mom paying using money from her 529. The money from grandpa would count as income for the next year because grandpa’s 529 was not reported on the FAFSA for freshman year.  FAFSA counts 50% of the income towards EFC, effectively increasing EFC and reducing aid eligibility by $25,000 for sophomore year. Had mom paid for freshman year using her 529 account, which should have been reported on FAFSA, there would not have been a reduction in eligibility for aid.

Location matters

FAFSA does not treat all assets equally. Asset location can affect EFC. Two families with the same amount of assets and income can have very different EFCs. Imagine if one kept its assets in cash, checking, brokerage and 529 accounts while the other kept its assets in its home and retirement accounts. The first family would have much higher EFC and less eligibility for financial aid.  The EFC calculation includes more of its assets. The second family would have much less assets because FAFSA excludes the value of a primary residence and retirement accounts. FAFSA also excludes the value of life insurance policies and tax-deferred annuities. Other exclusions include the value of a small family-owned business and some rental property. Check with the Department of Education and the school for the fine points for what counts and what does not. A family can be strategic about how to position its assets to increase eligibility for aid.

Not all schools use the FAFSA to determine eligibility for financial aid. About 300 schools, including many of the top private and some public institutions, use the CSS/Financial Aid PROFILE form. The CSS/Financial Aid PROFILE form uses a different methodology to calculate EFC. They differ in their treatment of the value of a primary residence, accounts not held by parents or students, the weight on student assets and many others. Schools may also use their own formulae to calculate EFC.

Recently, a family that I know received different EFC estimates from two Ivy League schools. The difference was significant. One school offered much more grant aid, increasing its affordability. It turns out that the schools used different forms and methodologies to calculate EFC. The family informed the less generous school of the discrepancy. At the end, the less generous school adjusted its EFC estimate and increased its grant offer to make the actual cost to the family competitive.

How to Get a Free Lunch with Diversification

The closest thing to a free lunch when it comes to managing your money is diversification.  When done properly, diversification can help you achieve what every investor wants – returns with less risk. Unfortunately, the benefits often get lost in translation when put into practice.

What is Diversification?

Simply said, diversification is the process of spreading your (nest) egg across different baskets. It means holding uncorrelated or less correlated investments that zig while others zag as they grow over time. In my opinion, diversification is more about reducing risk than increasing returns. What it can do is smooth out the growth of your portfolio. A properly diversified portfolio can reduce the risk of being too heavily invested in one area when it performs particularly bad. Diversification does not guarantee against losses. Diversification does increase the likelihood that a portfolio will participate in gains, whenever and wherever they occur. This is because a well diversified portfolio casts a wide net to capture returns. Over time, a well diversified portfolio is a more resilient to market downturns.

You can think about baskets for your investments in many ways. Different asset baskets may be stocks and bonds. Location baskets may be US vs. International, California vs. New York, etc. Style baskets may be growth and value or active vs. passive money management. Account baskets may be taxable vs. tax-preferred accounts such as IRA and 401(k) accounts. How they differ defines why they zig and zag. They also affect the costs and taxes related to your portfolio.

In terms of assets, you should expect different return profiles between stocks and bonds. Shareholders of a company’s stock own a part of a company. They expect to participate in the company’s future growth. Bondholders lend money to borrowers such as companies and governments. Instead of future growth, bondholders expect to earn interest and get their money back when the bond matures. Either stock or bond Investments may lose money. In practice, the two are not always so clear cut. Some stocks have return profiles like bonds, and some bonds have return profiles like stocks. It is always good to review and have some understanding of what you own.

How Diversified is Your Portfolio?

There are simple ways to gauge the diversification of your portfolio. Start by looking to see if a small handful of your holdings represent a large portion of your portfolio. Depending on your personal situation, flags should go up when you see a single holding account for more than 10% (lower to be more conservative). Also see if your portfolio has any concentration in any sectors, industry, high/low risk, fast/slow growth segments, etc. For the more ambitious, review the correlation of the holdings. Correlation, which ranges from -1 to +1, describes the relationship between the returns of two investments. Ideally, a diversified portfolio holds un- or less-correlated, which is why stocks and bonds are often mentioned together.

Surprise, Surprise

When I review a portfolio for someone, a lot of people get surprised when I tell them that their portfolio is very risky. They may hold many different stocks, for example, but a portfolio with mostly high growth companies is generally not very diversified. Some hold many mutual funds. That may sound like diversification, but not if there is much overlap in the different funds. Another surprise is when people learn that the correlation of their holdings changed over time. What was once uncorrelated may have become much more highly correlated over time.

There are many tools on the internet or your employer’s retirement plan that can help you get started with diversification. You can reduce the risk of your portfolio for very little cost with simple decisions about diversification, making it the closest thing to a free lunch you can get in investing.

Fed Hits Pause on Rate Hike

The Fed, as expected, hit the pause button on its plan to hike interest rates following its FOMC meeting today. The sell-off in the stock market and oil prices are adding to the of cross currents about the health of the economy. The Fed hiked short-term rates last December, the first time in almost 10 years. Its target range is currently 0.25% to 0.5%, very low by historical standards. The Fed indicated that it may increase its target to about 1.25% in 2016, which it believes would be consistent with inflation around 2%.

The challenge for the Fed is balancing U.S. job growth and price stability. Recent news suggest that the US and global economies may be slowing. Even though the US job market is healthy, we expect the Fed to be sensitive data that points to deterioration in the outlook for jobs. It has kept interest rates low to support economic growth and jobs. Standard lessons from economics say that inflation increases if interest rates are too low for too long. The problem is that rates have been extremely low for almost a decade, but inflation is still running below its 2% target.

I do not agree with market pundits that believe that the Fed will keep rates low to support the stock market. Lessons learned from my time at the Fed and acting as a Fed Watcher during my time as a Wall Street economist is that the Fed’s decisions are more about jobs and inflation. I would look for the Fed to act if it believes that a sell-off in stocks will derail the trend in job growth. Barring concerns about job growth, I would look for the Fed to stay its course.

Based on current trends, I continue to expect the Fed to raise rates roughly once every other or third FOMC meeting. Although Fed officials indicated earlier that its target range may be near 1.25% by the end of 2016, I think it will be closer to 0.75%. The economy needs to show better job conditions and price gains making good progress toward 2% inflation for the Fed to make good on 1.25% target.

We expect the Fed to announce changes in its interest policy after its FOMC meetings. It will meet seven more times in 2016 in March 15-16, April 26-27, June 14-15, July 26-27, September 20-21, November 1-2 and December 13-14. It is unlikely, but the Fed can change policy in between meetings if necessary.

What all this means is that interest rates overall should remain low by historical standards. However, short term interest rates should end 2016 higher than they are now. Long term interest rates, which are influenced more by inflation expectations and demand for a safe haven investment, will likely remain near current levels. Borrowers using floating-rate loans, which are usually tied to short term rates, will likely see rates edge higher. Borrowers of fixed-rate loans such as 30-year mortgages, which are linked to trends in long-term rates, will likely see rates near current levels.

Five Things to Do Before Retirement

Ready or not, retirement may be around the corner. Maybe it is coming early or long coming. Either way, it will be a time for adjustment for many people. By some estimates, 10,000 baby boomers will retire every day. Here are five things to do before retirement.

  1. Review investment portfolio and implement adjustments to reflect retirement needs.

The purpose of an investment portfolio often changes as someone enters retirement. An investment strategy that appropriate for building assets may not be appropriate for spending down assets. During the building phase, people invest savings for goals that are years and decades in the future. In the spending phase, pull money out of the portfolio to fund goals today and the immediate future.

Too much risk and bad timing can wreak havoc for someone making the transition to retirement. Before retirement, time and new savings can help a portfolio recover after a market sell-off. In retirement, portfolio recovery is greatly challenged. Time for recovery is limited. Many people are spending not adding money to their portfolios.

Imagine being someone in 2008 planning to retire in 12 months. You believed you were ready for a happy and long retirement with your stock portfolio and home equity. Both stocks and homes were priced near their all time highs. As retirement day approaches in 2009, the happy and long retirement was in serious doubt. With the drop in the market shown in Chart 1, the stock portfolio is now worth half and the home lost one-fifth of its value. The retirement does not look so promising anymore. You may need to delay retirement, work in retirement or scale back retirement spending.

Chart 1: Bad Timing Hurt New Retirees in 2009Big market downturns hurt retirees relying on stocks and home values.

  1. Diversify sources of retirement income for greater retirement security

It is hard to predict when unexpected things happen. When they do, retirement plans can be derailed. Had retirement income, as discussed above, been diversified beyond a stock portfolio and home equity, retirement security would have been much higher. Having diversified income sources means having unrelated income streams. A disruption to one should not have much effect on others. Different types of income included guaranteed income, income from investment and liquidity accounts,  income from work and money from rental property, business and other sources.

I would start with guaranteed sources of income as the first group. The payor has an obligation to provide a fixed income stream over a predetermined period of time. Examples include Social Security benefits, pensions and annuities.  Guaranteed sources are an important start place because retirement security increases if guaranteed sources cover a greater portion of the estimated retirement income need.

Unfortunately, most workers do not expect guaranteed sources to be a major sources of retirement income. By itself, Social Security will not enough for most people. Less and less people have access to pension benefits. Individuals can buy annuities for guaranteed income, but annuities may not be suitable for everyone.

Next, I would consider investment accounts, which will likely be the major source of retirement income. Investment accounts include retirement accounts such as traditional and Roth IRAs, and employer sponsored 401(k), 403(b) and 457(b) accounts. I would also add traditional brokerage accounts.

Developing a strategy for retirement income from investments can be complex. It requires careful consideration of your goals, tax situation and your holdings. Two important components are asset allocation and asset location. Asset allocation will determine the long-term growth and riskiness of an investment portfolio. It will also influence how long a portfolio will last and the security of the income stream. Asset location is about choosing the type of account to hold different investments for greater tax efficiency. A popular strategy is to hold investments that provide interest income in tax-preferred retirement accounts because the income may not taxed until it is taken out of the account. If held in a taxable account, the income would be taxed regardless if the money leaves the account. Done properly, taxes can be lowered, leaving more money for retirement.

Liquidity accounts are primarily bank accounts. They include CDs, savings and checking accounts. Bank deposit accounts are the most liquid and among the safest. The price for liquidity and safety is that money in these accounts are not expected to grow much. The risk is that inflation erodes the purchasing power of money in liquidity accounts.

Wages from part- or full-time work during retirement is becoming increasingly popular. About 73% of current workers expect employment to be a source of retirement income according to the 2015 Retirement Confidence Survey by the Employee Benefit Research Institute. The Survey highlights that many people work during retirement for reasons that are not financial. Nonetheless, one must consider that earning too much in retirement while receiving benefit can reduce the payout from Social Security.

  1. Catch up on your retirement savings.

Someone over age 50 can make catch-up contributions to boost their retirement accounts. Catch-up contributions are up to $6,000 in 2015 for 401(k), 403(b) or 457(b) on top of the maximum contributions of $18,000.  Catch-ups are up to $1,000 in addition to the annual contribution limit of $5,500 for traditional and Roth IRAs.

  1. File for Social Security about four months before you want benefits to begin.

Having spent time waiting in a Social Security office, I am glad that online filing is available at Benefits can start as early as age 62 and as late as age 70. Full retirement age is 67 for someone born after 1960. Early retirement reduces benefits. Late retirement increases benefits. For example, someone retiring at age 62, 60 months before their full retirement age, would receive monthly benefits 30% less. By waiting, benefits would increase by 8% per year or 24% if benefits did not start until age 70.

There is no single best answer for when to start receiving Social Security. The decision depends on a variety of considerations. They include expectations of longevity, health and work. Working while receiving Social Security can result in a reduction in benefits. Someone can also receive Social Security based on a spouse’s (including ex-spouse) work history. Smart planning can help maximize Social Security benefits in retirement.

  1. Know Medicare options before the initial enrollment period.

The initial period lasts for seven months, beginning in the three months before becoming eligible at age 65. Medicare is an alphabet soup of many ingredients. Traditional Medicare includes Part A for hospital and Part B for medical.  Traditional Medicare is fee-for-service based on a 80/20 model. For coverage of the remaining 20%, many private insurance companies sell Medicare supplemental policies, a.k.a. Medigap. Medigap policies have names that go from Plans A through N. Each plan covers 20% differently. Part D covers prescription medicine. Part C, a.k.a. Medicare Advantage, is the managed care version of Medicare. It covers Medicare Parts A, B and often D. The popularity of Medicare Advantage has been increasing. At present, it represents about 30% of people on Medicare.

Based on the experience of elderly family members, I believe it is important to consider before initial enrollment the pros and cons traditional Medicare and Medicare Advantage. Although there were opportunities to switch, they found making the change very challenging. The Medicare website at provides a wealth of information. It may be worth consulting Medicare health insurance specialists to appreciate the Medicare alphabet soup.

Am I Ready for Retirement?

A friend recently asked me if I thought he was ready for retirement. Fred’s nest egg had grown nicely over his 20-year career. Retirement meant leaving behind a steady paycheck and the benefits of a big company with a generous stock option plan. But as someone in his mid-40s, Fred could return to work if necessary, and he felt now was the time to enjoy life in the Bay Area. He might pursue something entrepreneurial over the next few years, but the family goal was for both him and his wife to be altogether retired within the next 10 years. Near term, they would live off one income and not tap into their nest egg until his wife joined him in early retirement. They knew their options but were not confident enough about their retirement readiness to take the next step.

Know Your Timing

Fred had already answered one of the three key questions to explore how well he was prepared for retirement. He knew about the timing. Leaving work now would mean a retirement lasting roughly 45 years based on average life expectancy. According to the actuaries at the US Social Security Department, men and women aged 65 have a life expectancy of 84 and 87, respectively. One in four 65-year-olds can expect to live beyond age 90 and one in ten beyond 95. Not knowing if he would be in one of these select groups, Fred wanted assurance that he would be covered in case he was among the one in ten.

Define Your Retirement

Fred needed to assess his situation based on his unique definition of retirement. He did not envision retirement to mean golfing every day or sitting on a beach. It was not a simple dollar figure either. Many retirement calculators assume that retirement income will be equal to 70% to 85% of the retiree’s pre-retirement income. This did not apply because Fred and his wife enjoyed a lifestyle that required that they spend well below the standard assumptions. The solution for them was to take a closer look at their daily spending. Fred and his wife identified their essentials—housing and related expenses, food, medical, etc. They kept a separate account of the discretionary spending that defined their lifestyle—fine dining, visits to wine country, travel overseas, the number of cable TV channels, and spending for regular technology upgrades and new musical instruments. Lastly, they created a wish-list for things that weren’t critical to their happiness but would be nice to have. Knowing their requirements, they would be worry-free if their nest egg could cover the essentials. They would be happy if they had the resources for the essentials and to sustain their lifestyle.

How Much Savings is Enough?

Now that they had a handle on how much they needed for retirement, their attention shifted to whether their accumulated savings were sufficient to provide the money they would need. Many factors must be considered to make this determination, and the answer is not always a simple yes or no. Retirement readiness can change, influenced by factors such as investment conditions, taxes, job situation, lifestyle, health and unexpected events in life.

Fred considered the habits that had led up to this situation. His savings habits were good, as he and his wife saved more than 10% of every paycheck. Unfortunately, good habits don’t automatically mean retirement readiness. The rule is based on the idea that someone starts saving early and saves regularly. It assumes that they save from their 20s into their 60s, when they retire. It also assumes that the savings are held in investments with annual returns several percentage points over inflation during this 40+ year period. In today’s low-interest-rate environment, too much safety can be dangerous. Flags came up for Fred and his wife in this test. Their savings habit would end once he took early retirement. They saved, but they did not invest to let their money grow. Fred and his wife liked to save by putting money in their checking account. Checking gave them ready access and no risk of loss. Unfortunately, checking also meant that they did not earn any interest and they didn’t let their money work for them.

Not All Retirement Calculators are the Same

Fred and his wife also tried to assess their situation using several retirement calculators available from the web. They found calculators offered by his company’s 401(k) plan, brokerage firms, and websites such as and After entry of current age, expected retirement age, current income, and assets, the calculators quickly provided simple yes/no assessments. One calculator said they were on track based on assumptions of how much it expected the investments and spending to grow.

The retirement calculators helped Fred and his wife start to understand their situation but also raised more questions. Some calculators allow users to factor in other sources of income such as Social Security and pension benefits, different spending levels, and inflation rates. Fred found that his results varied depending on the calculator. In general, he could cover his essential spending. The calculators differed when Fred included his discretionary spending and wishes. His retirement readiness was very sensitive to assumptions about investment returns, inflation, taxes, spending, and saving. For example, he noticed that using investment return assumptions based on long-term history produced results that were very different than using returns based on recent history. He saw how sensitive retirement readiness was to inflation and what would happen if his wife lost her income.

Fred and his wife felt that early retirement is a very big decision that warranted a more detailed review of their nest egg. They also saw the need to monitor and regularly review their portfolio of investments. In the end, after considering all the factors described above, they concluded that their nest egg was sufficient for Fred to proceed confidently with early retirement.

Financial Lessons from Emergency Response Training

Along with 70 other San Franciscans, my wife and I recently completed NERT training. As Neighborhood Emergency Response Team volunteers, we would assist the San Francisco Fire Department and our community in case of disaster. Much of what we learned about responding to earthquakes and fires can also apply to financial lessons for the management of personal finance disasters.

Personalize It

A key to disaster survival is to have plan. The plan should be personalized to your circumstances. As NERT volunteers in San Francisco, we focused more on earthquakes. If we were in New Orleans, we would have emphasized flooding. A recent college graduate loaded with student loans should plan differently than a classmate with no debt. A person working at a startup in need of funding should plan differently than an engineer at an established company with steady income. Similarly, retirement saving for someone living in an area with high housing costs may need to be very different from someone in an area with low housing costs.

Build an Emergency Plan

Planning ahead for emergencies has its benefits. It can prevent a lot stress and bad decisions when bad things happen. Thinking through your responses to a few simple questions will assess how well prepared you are. For example, what would you do financially if you were out of work for an extended period? When would your action plan make sense and when wouldn’t it? Do you have a reliable source of resources to carry out your plan?

In NERT training, we practiced what should be done for protection during an earthquake and escape routes for fire. We reviewed what to include in our emergency kit to survive for 3-days, the expected time to get assistance. In case of a financial emergency such as a sudden loss of income from a layoff or illness, how would you protect yourself? What financial resources can you count on to give you time to find a new job or heal? In my opinion, good answers include a balance between savings and investments, insurance, other jobs or alternative sources of income such as dividends, interest, rental property and others. Less preferred solutions are borrowing money at high rates or being forced to sell assets to raise cash. With our Dashboard tool, or clients can organize their finances so they can keep track of their resources. We help them understand their resources and how they can be used in difficult times.

Establish Emergency Reserves

Emergency reserves allow you to recover from a bad situation. NERT instructors prescribed an emergency kit with essential items such as water, food that you normally eat, suitable clothing, personal items such as medication and others. The goal for emergency savings is similar. The savings should be sufficient to cover payments for essentials such as food, utilities and mortgage payments. The funds can be used to cover unexpected home repair or medical expenses. Personalization is important. A kit with bad food, ill fitting clothes or insufficient funds will only make a bad situation worse.

Emergency savings should be held in a form that is safe and readily accessible on short notice. Cash and FDIC insured bank accounts are common ways to save.

How Much is Enough

How much is reserved for emergencies depends on the types of emergencies that you are trying to cover. For loss of income, three to six months may make sense if that is how long you believe it will take you to find a new job. It is important to review savings to reflect the times. The median time for unemployment is currently 11.7 weeks but was as high as 25.2 weeks in 2010 according to the Labor Department. Three to six months is also a common wait period for long-term disability insurance. If you’re pursuing something entrepreneurial, you may need a very different plan altogether. The three to six month target is a good starting point. For greater context and precision, I would prioritize and quantify spending needs.

Develop Good habits

The process of building emergency savings can instill good habits. A popular saying is to “pay yourself first.” Another is “out of sight, out of mind.” Strategies such as automatic paycheck deductions into separate accounts can go a long way to save in general and to build emergency reserves. Automatic deductions for 401(k) is an example for how many are making progress with their retirement nest eggs. In an earlier post, I discussed how good savings habits that make use of both savings can help someone accumulate $1 million in their 401(k) account.

Ways Avoid Bad Decisions in Times of Stress

Knowledge and comfort with a personal plan can prevent injury and support recovery. Panic and running outside during an earthquake often results in injury from falling debris. Reacting out of fear during a financial crisis often has similar results.

In either situation, try to stay calm and to find safe cover during the crisis. It is hard to predict when and how quakes will strike. To mitigate damage during an earthquake, a home can be reinforced by bolting a house to its foundation and adding cripple wall shear support. For a financial quake, personal finances can be reinforced with insurance, multiple sources of income, a diversified investment portfolio that is rebalanced regularly.

In recovery, it is hard to predict ahead of time, which holdings will recover faster or fully. Diversification helps increase the chances of participating in a rebound and limiting the damage of segments that don’t.

Have a process to assess the damage. In NERT, we practiced a logical process of sizing up a situation and following a pre-agreed upon protocol in conducting the search. The instructors stressed the need to keep focus and avoid distractions. This process helps maintain organization and safety in uncertain situations.

Following a logical process would have helped many people during the Great Recession of 2007-2010. During this period, 9 million jobs were lost. Home prices fell. Investment portfolios collapsed. Household net worth fell by $16 trillion. Many people panicked. With much thought to their investment time horizon, they responded by selling their holdings indiscriminately. They were effectively “throwing the baby out with the bath water.” Instead, they held cash and did not look back, only to miss out on the recovery that ensued. Our philosophy is to apply the logical process in an Investment Policy Statement that we tailor for each of our investment advisory clients.

NERT emphasizes safety in helping victims survive and recover from disasters. Many of the lessons taught in NERT training also apply for survival and recovery from financial disasters.