“Shane” writes in:

I’m twenty three years old. I just got a really great job with a 401k that’s matched 100% by my employer up to 10%, which I’ve heard from others is a really great deal that I need to take advantage of. So I started investing 10% of my paycheck so I can get the matching funds.

The only problem I have with this is that I have no idea about retirement. It’s more than forty years away. I just put my money into the investment the person told me to put it into so I have no idea if it’s a good one for my retirement. I don’t even know where to start.

I get emails like this quite often from young professionals who are completely clueless about retirement – and for good reason. When you’re forty years away from retirement age, the thought of retirement seems incredibly distant. It feels more than a lifetime away – that’s because it is more than a lifetime away.

The one piece of knowledge that many young professionals do have, though, is a solid sense of self. They have a good basic understanding of who they are, even if they haven’t pieced through the details yet. And, quite often, this basic understanding is more than enough to make some sound retirement decisions.

Here are three questions I’d encourage any twentysomething to ask themselves.

If money were no object, what would you do with your time?
Some people would choose to be idle with their time, enjoying all of the freedom that comes with it. They’d party. They’d go on trips. They’d goof off. They’d play on their Xbox all day long.

Other people would want to work for something or build something. They’d spend their time with a volunteer project – or maybe even start their own. They need to have a big productive project in their lives in order to feel fulfilled and happy.

Most retirement advice is written for people in the first group. They’re the ones who, when they reach retirement age, will want to travel and spend their later years enjoying themselves with leisure as much as possible.

The other group gets personal enjoyment out of working and being productive. With the many opportunities already available for people to work as late as they’d like in life, such people will probably work at something – whether it’s gainful employment or a big volunteer project or some mix of the two – until they drop dead with a tool in their hand.

If you’re in the first group, you need to be saving as much for retirement as possible. While it’s fine to put money into riskier investments when you’re young, you should start moving into more conservative investments – like bonds or treasuries or cash – pretty early on, even as much as twenty years before retiring.

If you’re in the second group, saving for “retirement” basically means saving for the last year or two of life when you’re unable to work and also saving for some supplemental income for the last few decades of your life. You likely don’t need to kick the savings into high gear and can afford risk a little later than the other group, sliding the money into conservative investments five or ten years before you begin to withdraw it.

Are you frugal?
Do you carefully watch your pennies? Do you spend time seeking out the best deal on an item? Are you find with eating beans and rice a few evenings a week because it’s a dirt-cheap meal that’s still pretty healthy? Do you buy – or at least try – generic versions of products?

If such choices come naturally to you, to put it simply, financial life as an adult is going to be easier for you. After all, if you’re careful with your pennies, the dollars will follow. Because of this, you’re likely to have built up significant assets before you reach retirement age – in which case, pushing your retirement savings to the hilt might stand in the way of your other goals in life.

If such choices seem completely alien to you, you’ll have a more challenging road ahead of you. Almost always, you’re better off financially if you minimize the number of financial mistakes you’ll make along the way. In that case, you’re probably better off pushing your savings up a bit.

Are you interested in having children?
When you picture yourself twenty years in the future, does that vision involve children? For some people, it does – I know it certainly always did for me. For others, it does not – some of my closest friends are wonderful around my kids, but they can’t imagine having children of their own.

Parenting is not for everyone. It can be infinitely rewarding to the right person, but infinitely frustrating to others. On top of that, it’s incredibly costly – little people are unquestionably expensive. They rely on you for everything – their food, their clothes, their space, their education. If you don’t relish in this thought, parenting might not be right for you – and that’s fine.

If you do envision children in your future, kick start that retirement. The more you save now means that later on you’ll be substantially ahead of the savings curve and you can pull back on your contributions in order to devote more resources to raising your children. Even if you end up not having children, you can still pull back later on in order to enjoy travel and other adult endeavors. Also important is the fact that a well-funded retirement means that you’ll never wind up being a financial burden to your kids.

On the other hand, if you are doing everything you can to avoid the remote possibility of children, it makes sense to save for retirement at a slower rate now, allowing you extra money to enjoy the more adult-oriented things you want out of life.

Just worry about the saving for now – don’t sweat the details.
Many people get overly wrought about making sure that their money is in the “perfect” investment. To put it simply, your investment choice is secondary – by a long shot – to simply saving your money as soon as possible and as much as possible.

Start saving now. If you don’t know what to invest in, just ask for suggestions from the representative there. Since it’s a tax-deferred retirement account, you can make investment changes later on without any tax issues.

One good default choice is a “Target Retirement” plan, which basically means that the fund manager will put you in aggressive investments when you’re young, then gradually make the investments more conservative as you grow older. This is a great choice if you’re unsure.

Later on, when you’ve gained some experience in the world and perhaps learned more about investing, you can take a more direct hand in your choices.

For now, though, the best decision you can make is to simply start saving.

Good luck.

Every other Sunday, The Simple Dollar reviews a personal finance book.

Ever since I first gave it a sincere read-through in late 2006, The Bogleheads’ Guide to Investing has been my go-to guide for investment advice, the first place I turn when I have a question about investing. My paperback copy is now well-worn and thoroughly enjoyed.

Recently, a follow-up (of sorts) has appeared on the scene. This time around, however, the book is more of a collaborative effort, containing chapters written by different authors who focus in on specific topics. What they all have in common, however, is that they are all “Bogleheads,” referring to people who believe strongly in the investment philosophy of John Bogle, the chairman of the Vanguard Investment Group.

To put it simply, The Bogleheads’ Guide to Retirement Planning focuses on a fairly conservative investment philosophy, one that doesn’t involve extremely risky investments or exposure to cataclysmic failure in the face of a market downturn. The Bogleheads’ philosophy instead mostly focuses on careful balancing of one’s portfolio (so that a sudden stock market swan dive won’t ruin your future) and investments designed to match the market at a low cost instead of gambling on a chance to beat the market that has a high cost attached to it.

Intrigued? Let’s dig in and see what the book has to say. I’ve broken this down into individual chapters and have labeled each chapter with the chapter’s author.

The Retirement Planning Process
Thomas L. Romens
THe book opens with a chapter that discusses the difference between saving for retirement – something every adult should be doing as soon as they enter the workforce – and planning for retirement. Saving merely means socking away money into something designed for long-term growth. Planning for retirement, on the other hand, involves knowing in great detail what one’s retirement will look like – standard of living, personal goals in retirement, and what assets are needed to get a person to that point. During the saving phase, a person should sock away as much as he or she can, so that the planning phase is much simpler and less prone to risk (since, without adequate savings all the way along, retirement planning will have to involve significant risk or a significant extension of one’s working life).

Understanding Taxes
Norman S. Janoff
Taxes are confusing (and I believe they’re unnecessarily so). Mostly, this chapter just highlights most of the areas of tax law that are really relevant to individual retirement planning. Since the amount one pays in taxes has a direct impact on how much money one needs to have in retirement (the more taxes you’ll have to pay, the more money you’ll need), understanding taxes is vital. This is mostly just a great little reference to the different taxes that most of us are subject to.

Individual Taxable Savings Accounts
Dan Kohn
The first retirement savings option that’s discussed in the book is the individual taxable savings account. These can vary in type from savings accounts at your local bank to investment accounts at a brokerage house. These all work in more or less the same way – you put in money you’ve earned from your career after taxes, pay taxes on any gains that you make with that money, but you have the freedom to withdraw it and do what you want with it without any additional penalty. Such taxable accounts have one very big advantage – flexibility.

Individual Retirement Arrangements
Jim Dahle
Another option for a person wanting to take ahold of their own financial destiny are individual retirement arrangements, like Roth IRAs. These are accounts you can set up with brokerage houses that take advantage of specific tax laws to either defer your tax payments on your earnings to retirement or, in the case of Roth IRAs, eliminate them entirely. Typically, such accounts are set up directly by you with a brokerage house. Usually, you set up an automatic investment schedule and you’re completely responsible for the account, from investment choices to withdrawals. Thus, such options tend to provide much more flexibility than employer-based accounts (like 401(k)s), but tend to require a bit more effort on your part.

Defined Benefit Employer Retirement Account
The Finance Buff
The title of this chapter refers to pension plans – and if you have one, you’re lucky. Your primary concern should be how these plans are insured against the health of your business. What happens to your pension plan if your business fails? Most modern plans have some sort of insurance against this – often, the plan is run by a third party that specializes in such plans. If you have this plan, it’s usually very easy to understand as it clearly outlines the exact benefits you’ll receive in retirement.

Defined Contribution Plans
Dan Kohn
For most of us, this means 401(k) or 403(b) plans. Such plans allow us to put in pre-tax money (meaning money is taken out of our paycheck before taxes and we only pay taxes on the remainder) and then pay taxes on it only when we withdraw it in retirement. Such plans usually also include some matching funds from our employer, which is essentially free money for retirement. If you can get that free money, get it now – start saving immediately if you have access to matching funds from your employer. If not, you may want to consider your 401(k) or 403(b) plan to be a backup and look at individual retirement arrangements, as they will minimize your tax burden in retirement.

Single-Premium Immediate Annuities
Dan Smith
Annuities are actually a form of insurance, in which you pay a premium regularly over a long period of time in order to ensure some specific amount of income in retirement. Annuities can be valuable tools, but they offer some risk in the form of insurer default (the insurance company going out of business). They also leave no legacy to your children. However, they do offer a solid return on investment provided the insurer is a stable company with a long history.

Basic Investing Principles
Bob Davis
You can’t control the stock market, nor can you consistently beat it over a long period of time (as a small-scale investor, anyway). However, there are many strategies you can use to ensure a stable and steady return on the money you save for retirement. One important part of investing is understanding how much risk you can tolerate, which involves how many years you are away from your goal as well as your personal psychology. Rebalancing (and knowing how to rebalance) your portfolio is also vital, especially as you approach retirement age. Costs are also important – if you can keep costs low, you keep more money for retirement in your own pocket.

Investing for Retirement
David Grabiner and Alex Frakt
In order to invest successfully for retirement, you need to have a plan. That involves calculating exactly how much money you’ll need in retirement, determining how much (realistically) you can safely earn each year in your investments, and then using that to figure out how much you need to be saving each year. Just having a plan isn’t enough, though – you need to implement it and then continue to follow through with it. Take the time to actually write out your investment plan in detail – putting it down in writing makes it concrete.

Funding Your Retirement Accounts
David Grabiner and Ian Forsythe
If the first step is to begin saving, where do I begin? Where do I start putting my money if all of these options are available? The first step is to start living within your means – spending less than you earn consistently – and putting your money towards repaying high interest debt. The only retirement savings you should be doing while doing this is in accounts where you receive an employer match. Once that’s done, move some of the money you were using for debt repayment into other plans. Use a Roth IRA if you’re in a low tax bracket – otherwise, use a tax deferred plan like a 401(k). The chapter goes into great detail about additional options as well.

Understanding Social Security
Dick Schreitmueller
Here, Schreitmueller gives a great overview of how Social Security works today in very readable terms – this can be really useful information for people near retirement age now. However, I find this advice is less and less useful the further you are from retirement, simply because I do not believe that Social Security will be a viable option for retirees in thirty years or so. I’m planning for a retirement without Social Security – if it happens to be there, I’ll look at it as icing on the cake.

Withdrawal Strategies
Carol Tomkovich
The amount you withdraw each year from your retirement accounts doesn’t have to be set in stone at all. It can vary greatly depending on your actual needs – they might be more or less than you expect – and whether or not you’ve found a new job or income stream. Many retirees find that, with so much idle time on their hands, they need to find something to do with their time and, for many of them, that means a second career or a new job. Also, some older folks will realize that if they conserve their retirement savings well, they may be able to pass on a legacy to their children and grandchildren – that legacy becomes very important to them.

Early Retirement
Jeff McComas
Everyone follows a different route to retirement. Few people simply walk out the door and into the waiting arms of Social Security on their 65th birthday. Quite a few people retire earlier than that (or at least jump into a second career). There are several tools people can use to handle an earlier-than-usual retirement: penalty-free withdrawals from a Roth IRA (since you can withdraw the balance at any time), self-employed pension programs, sapping your home equity, and so on. Each option has advantages and disadvantages and are worth exploring on their own.

Income Replacement
Lee E. Marshall
What about the unexpected? What if you are injured, acquire a long-term illness, or unexpectedly die? If your current financial state would cause such events to be completely disastrous, you need to look seriously at insurance solutions to protect you and your family against such outcomes. Long-term disability insurance and life insurance are all important to at least consider and evaluate.

Health Insurance
Lee E. Marshall
On the flip side of that coin is care for illnesses from which you may recover (at least partially) after a period, such as cancer. Again, if you can’t afford the costs for such incidences out of pocket (and most of us cannot), you need to evaluate insurance for such situations. Health insurance and long-term care insurance are both worth investigation to keep your family safe and secure.

Essentials of Estate Planning
Robert A. Stermer
Estate planning can be really complicated. Make sure that you, at the very least, know what durable powers of attorney, living wills, wills, and trusts are and which of those you need to have for your financial situation. It is never too early to do this kind of planning – even a simple will can aid the people who survive you in the event of something untimely occurring to you.

Estate and Gift Taxes
Robert A. Stermer
If you leave behind even a moderately-sized amount of money, there’s a good chance that a significant portion of that legacy will be eaten up by transfer taxes and estate taxes. Such taxes are confusing and often unclear to the layperson. If you are planning on leaving behind a significant amount of money to others, it’s well worth your while to study such taxes thoroughly – this chapter really only gives a brief overview of things and helps you identify whether or not you should dig into the topic.

Seeking Help from Professionals
Dale C. Maley and Lauren Vignec
There are many, many finance professionals out there who would love to have your business as you piece through these issues. Of course, muddying the water are individuals who are simply out to line their own pockets by collecting commissions on sub-par investments, as well as others who are quite happy to run up a big pile of fees. The first step is for you to learn as much as you possibly can without a professional so that you know exactly what you do need from a professional. Once you’ve reached that point, you should be able to formulate the exact questions you need answers for, which you can then take to a financial professional of your choosing. The chapter provides an excellent guide for finding one.

Divorce and Other Financial Disasters
David Rankine
Divorce sometimes happens and it can be a real financial burden. One option is to sign a prenuptial agreement to protect both parties and make the divorce process easier (if it happens). Without it, the best route of attack is to simply incorporate the realities of your divorce into your retirement savings – likely, it means that you’ll have to begin saving a larger portion of your income. Another important note from this chapter: most retirement savings are exempt from the claims of creditors, so if creditors are knocking at your door, don’t strip your retirement savings to appease them.

Is The Bogleheads’ Guide to Retirement Planning Worth Reading?
If you’re of any age and a little worried about your retirement (especially in the light of the 2008 financial mess) and are willing to actually invest the time to learn about what retirement investment means and how it works, The Bogleheads’ Guide to Retirement Planning is the book for you. It’s thoroughly well-written, has a consistent set of ideas behind it, does a great job of breaking down concepts into understandable pieces, and leads right into sensible action.

Admittedly, I’m partial to the book due to the philosophy. My own investing ideas are very similar to those of the Bogleheads – I believe in buying low cost index funds for pretty much any long term investment purpose. The Bogleheads’ Guide to Retirement Planning goes far beyond that, though, explaining why one would do that and how it works in terms of planning for a successful retirement.

Be aware, though – this book is fairly heavy. It’s quite readable, but it’s not breezy beach reading. It’ll take you some time to read through it. But if you give this book your time and attention for several evenings and think about what’s being said in terms of your own life – and then turn some of the ideas into action – you’ll find yourself in a much better place for retirement.

This may just be the newest addition to my bookshelf.

A couple days ago at the doctor’s office, I picked up the newest issue of Time, which featured a cover story entitled “Why It’s Time to Retire the 401(k)” (and you can read the article online).

The article was filled with lots of stories about individuals close to retirement age who lost a large portion of their retirement savings in the stock market market downturn of 2008, including some who were forced to return to work. The article concluded that the 401(k) system is thus broken, since it’s letting down the people who rely on it.

Here’s the problem, though: 401(k)’s aren’t at fault. Personal responsibility (or a lack thereof) is.

A 401(k) plan is basically just an investment opportunity where employees can put in their money before taxes, then pay income taxes when the money is withdrawn much later in life. While the money is inside the account, account holders have a wide array of investment options. Some of them are very stock heavy and, yes, include a lot of risk; others are more diverse and offer lower risk. The choice of options is left up to the individual investor.

In the end, the investors who suffered a disastrous, life-altering 2008 in their 401(k) accounts were either contributing too little and essentially gambling with it or they didn’t bother to learn or understand how investing works.

A stock fund with a 10% annual return is not a guarantee of a 10% return each year. Minimal reading and investigation into investing reveals this to be true. Thus, if you need that balance to be there for you, you shouldn’t have it in stocks.

Some of the people who are suffering right now were not aware of this fact. They either didn’t bother to investigate their investments further or they simply chose not to think about it at all.

In either case, they chose to invest their future into something that they didn’t fully understand. That’s an incredibly dangerous individual choice.

And, honestly, my sympathy for them is somewhat limited. To build up the large balances that they had in their 401(k)s requires years and years of regular, steady investment – a substantial portion of the financial output of their life’s work. Yet, in many cases, the investors never bothered to truly learn about their investments or make any effort to diversify, using other funds or balancing things out with a conservatively-invested Roth IRA.

There’s a lesson to be learned here. Know where your money is going. Know where your investments are placed. If you can’t afford to take a loss on that money, move the money to something safe, like bonds or treasury notes. If you’re young and have many years until retirement, carefully investigate your options and know that investments in stocks will go up rapidly and down rapidly over and over again with, over the long term, a general upwards trend that will usually beat more conservative choices.

Should special help be given to people who have to re-enter the workforce because their 401(k) didn’t hold up? No. They made the personal choice to expose their investment to a lot of risk when they most needed it. If you argue that they didn’t know, I say that they didn’t bother to educate themselves about the very investment that’s supporting their entire lifestyle – another personal choice.

401(k)s are not the magic answer to retirement problems. They’re a tool, one that requires careful reading of the instruction booklet to use properly. And this time, you need to read the instructions, because if you use this tool wrong, you can cut years of healthy, happy retirement living out of your life.

Marcia writes in:

I’m having a hard time figuring out exactly how much to put away for retirement each week. I’m twenty five years old and most of the advice says to put away 10% of your salary into your 401(k) but I think I should be putting away more. I have three great grandparents that are still alive and over 100 and all of my grandparents are over 70 and still alive. Unless there’s something bad and unexpected I will probably live quite a bit longer than the average person. So should I be putting away more for retirement? How much more?

The best way to answer this question is to roll the clock ahead to age sixty five and ask yourself what you would like to be doing then.

Think about it. When you’re sixty five, do you intend to walk away from your job and settle into a non-employed retirement? Do you want to perhaps seek a different kind of employment, perhaps following a dream of being a writer or a painter or something like that? Do you want to keep doing the job you’re doing until you drop to the floor?

I’ve known the answer to this question all my life. I do not want to be idle in my later years – I’ve always intended to fill them with my writing and that dream is no different now than when I was younger.

Until the final year or two of my life (or when I’m unable), I intend to work and earn some sort of income. What does that mean for my retirement savings? For the later years of my life, my retirement savings will only be a part of my income. I won’t need to withdraw all the money I need to live on from it each year.

Thus, it makes sense for me to not save quite as much purely for retirement and instead invest in long term care and long term disability insurance – these cover the situations in which I’m unable to work.

What does your story look like? Assuming good health, do you intend to keep working productively for as long as you can? If so, then you don’t need to put as much away annually as you might otherwise. On the other hand, you might want to enjoy a long retirement period that doesn’t involve working for an income. If that’s the case, then you should scale up.

Here’s the truth: most retirement planning advice out there assumes that you’ll retire at sixty five and then live without an income for at most another twenty years. In many cases, neither one of those assumptions are true. I certainly don’t want to be completely idle for the last twenty years of my life and I’d love to be able to see my great-grandchildren born – I got to know one of my own great-grandparents very well, in fact.

Instead, I think retirement planning should involve assuming you’ll live as long as possible. I’d take the age of your ancestor that lived the longest and tack on five years. Then, I’d ask myself how many of those years I wanted to spend without earning money – or with earning only some of the money I needed for retirement. Do you want a long “retirement” period or not? Some do, some don’t.

From there, you’ll start getting an idea of how many years you want to cover. Start playing with retirement calculators using these assumptions and see what you come up with. After all, if you think you’ll live to 95 and intend to work until you’re 80, you have fifty five years to save for retirement, thus you don’t need to scale up at all. On the other hand, if you think you’ll live to 95 and intend to retire at 65, you’re almost assuredly going to have to put more away for retirement.

Remember, focus on what makes you happy. If there’s an endeavor that earns a good income that you would be happy spending the rest of your life doing, then spend the rest of your life doing it!

One final caveat: long term care and long term disability insurance are both worth considering. Mostly, they’re hedges against something devastating happening in your life. They ensure that if something does happen that prevents you from working in a productive way, you won’t be a financial burden to those around you. They should at least be considered as part of any long term financial planning.

I am absolutely honored to feature a guest post today by Vicki Robin, someone who I’ve had the privilege to get to know a little over the last year or so. Vicki is co-author of Your Money or Your Life, one of the books that changed my life. Currently, Vicki is teaching tele-classes about money and life as well as speaking, writing and consulting.

Financial independence – ahhh, what a dream! Doing as you please, not as you must. Having all the money you need without needing a job. Travel. Adventure. Relaxation. Time to write that book you’ve been thinking about for years.

Well, I’ve been there and done that since I was 25 years old. I’ve had an adventuresome life. I’ve worked for love, not money. I’ve slept late when my body needed it and worked late into the night when the juices were flowing. And I’ve written a book (actually two, one published) which lays out how anyone can have what I have – without risky business ventures or shady deals or being born into the right family. The book, of course, is Your Money or Your Life, which presents a step by step approach to the process of earning, spending, saving, giving and investing with a focus on having enough for life, not “it all” or “more and more.”

We just updated it and, thanks to The Simple Dollar among other frugality sites, we were able to focus on the core strategy and let go of being the go-to people for how to save money on specific purchases.

I’d like to unpack this notion of “financial independence,” though, so we can see it not simply as being filthy rich with a mega portfolio but rather as having a diversity of ways to assure your needs will be met with minimal if any paid employment. It’s a combination of passive income, occasional income, frugality (increasing your unnecessary income) and reciprocity (freely sharing stuff, services and skills with others).

First, you need to understand Financial Independence as having what YOU need to support a life you love. Not what the Wall Street Journal or People Magazine say is rich, not what your financial adviser says you must have, but what you determine is enough by observing and refining your spending patterns until you neither squander nor hoard money. You come up with “your number” – the monthly income needed to have all you want and need but nothing in excess. This is your “enough point”. If FI means having everything the rich people do, you’ll never get there. But if it means having enough income from sources other than work to cover your expenses, we can all achieve through investing time, intention and focus.

Second, you need to take seriously the old saw of penny saved is a penny earned. Let’s say that through comparative shopping you can get your car or refrigerator for 25-40% off retail price (I have done just that. My car was $16000 rather than $22,000, my fridge $750 rather than $1200). Should such savings generalize to all your spending, then your “enough point” might be $40,000 a year instead of $50,000. That’s phantom income – you still have a $50,000 a year lifestyle, but $10,000 of it comes from sheer frugality.

Third, you need to only buy things that only money can buy. For example, there are several ways to get food on your table. You can buy it. You can grow it. You can forage (like picking blackberries by the roadside). There are also several ways to satisfy a gnawing hunger. One is eating. One is having a glass of water since most of us drink far too little each day. Another is to ask before eating: What am I really hungry for? It may be peanuts or it may be the oil in peanuts or the crunch of peanuts or writing in your journal about how mad you are at so and so. Sometimes we consume something material when the need is emotional or spiritual. There are several ways to read the books we like: buying them new, buying them used, borrowing from friends, borrowing from the library. Likewise, there are several ways to look terrific at a wedding. One is to buy a new dress. One is borrow a dress from a friend. One is to shop your closet and wear last year’s new dress because you still look great in it. Being resourceful is a great income stream because some things you need come into your life without spending dollars. Substituting creativity and awareness for knee jerk spending might save you another $5000 a year!

Fourth, you need to only pay others to do what you really can’t or won’t do for yourself. Every competency is an income stream because you don’t have to pay others to handle it – and plumbers and electricians and mechanics are mighty expensive. You don’t have to do everything yourself, but you can pick one task of daily life to do yourself and this further reduces the amount of income you need to be FI.

Fifth, you need to find ways to share resources with other people. There truly could be one lawnmower or extension ladder per city block if people could work out a trading system. You can rely on pure neighborliness, or you could set up a neighborhood listserve where offers and asks are posted or, if you’re lucky, your community might have a more elaborate alternative currency system. Even without such a system, though, we’re awash in other currencies. Discount coupons can be substituted for dollars so they are a means of exchange. Air-miles are also a currency. IOUs are also currency – that slip of paper could change many hands before it comes back to you for final payment.

Sixth is to turn things you do for love into things you do for money – without stress. Sell birdhouses if you love making birdhouses. Sell flowers if you love growing flowers. Do fundraising part-time if you’ve become a great fundraiser through serving on many boards. Baby-sit if you love kids and one more running around your house is no problem.

Finally, you do need to invest in financial instruments that give you a return on investment – the classic form of financial independence. You might own bonds or stocks or mutual funds or real estate.

My financial independence is based on all these “income streams”. I do have a small but steady fixed income from several sources: bonds, a rental house I own and soon Social Security. I do have a little side income from selling a few hours a month of my expertise (conducting tele-classes, facilitation, coaching, meeting planning, running workshops). I am frugal to a fault and if I were to tally up how much under retail I pay for all my purchases I’d likely find I live on half what others do for the same set of things. Having lived with other people for most of my adult life I know how to share, which means I know how to negotiate, to ask for what I need and take no for an answer, to be direct and not underhanded, to return things in better shape than I found them, to understand where I can be generous and when I just can’t give an inch.

In these tough financial times, which may last far into the future and become the new norm, the smart money is on people who know how to manage these multiple streams of income so that their core well being does not depend on any one of them. This is truly diversifying your “portfolio” for financial security.

This is the eighth of twelve parts of a “book club” reading and discussion of Dave Ramsey’s The Total Money Makeover, where this book on debt reduction is teased apart and looked at in detail. This entry covers the ninth chapter, finishing on page 167. The next entry, covering the tenth chapter, will appear on Wednesday.

A few weeks ago, I took my three year old son to the theater to see Up. It was his first time in the theater and he loved the movie, particularly the friendly dog character, Dug.

I was much more entranced by the central character, Carl Fredricksen. Much like me, he married an adventurous girl he’d know since he was a child – I couldn’t help but see myself in Carl right off the bat.

Watching him progress forward to retirement – and finally realizing that this is his opportunity to do something he had dreamed about with his wife for their whole lives – really hit me with the idea that retirement isn’t just about stopping your work. It’s about continuing your life’s work, except without the constraints of having to beat the pavement each day.

The Total Money Makeover touches on this theme right off the bat.

Retirement Isn’t the End; It’s Security
On page 152, Ramsey makes the point that retirement means security, not just freedom from work:

When I speak of retirement, I think of security. Security means choices. (That’s why I think retirement means that work is an option.)

I agree wholeheartedly with this perspective, to the point that I no longer think of 401(k) savings or Roth IRA savings as retirement savings. In fact, I often have to change things I write about both accounts for simplification.

If I don’t think of them as retirement accounts, what are they? I think of them as “crossover point accounts” with some very nice tax benefits.

Here’s why I think of them this way. I have two young children. Realistically, I know that, unless a major windfall comes my way, I won’t be reaching my own “crossover point” (the point at which I can survive on my own investments) until after they’re out on their own for at least a few years. This puts me at an age that begins to approach the minimum ages for non-penalized withdrawals from my Roth IRA and my 401(k).

Do I intend to “retire” at 59 1/2? Not at all. I have a lot of plans for my life after the point where I am financially self-sufficient that don’t involve golf and fishing. They involve large volunteer projects and activities that simply wouldn’t be feasible without a large financial cushion. The last thing I want to do is waste away.

The Job You Hate
I really like this bit, from page 152:

If you hate your career path, change it. You should do something with your life that lights your fire and lets you use your gifts. Retirement in America has come to mean “save enough money so I can quite the job I hate.” That is a bad life plan.

This idea really hit home for me at a time when I was becoming unhappy with my career in many ways. Over the course of several years, I went from being very passionate and involved and pushing forward a fascinating project to being a system administrator charged with also maintaining a very large code base, something I absolutely didn’t want to do.

To me, the idea of simply switching careers was anathema. I had invested so much effort into my career at this point that I didn’t want to lose it. I was also trapped financially – I needed that income to keep coming in.

I knew what I wanted to do – creative-oriented work that really got people to think about their lives – but that seemed light years from what I was doing. But the investment I had already made and the financial state I was in kept me mentally locked into the idea of keeping on with it.

Don’t let your life be controlled by the need for a few more dollars. It’s not worth it.

15 Percent?
On page 155, Dave encourages people to invest big in their retirement plans:

The rule is simple: Invest 15 percent of before-tax gross income annually toward retirement.

In other words, your 401(k) contributions plus your Roth IRA contributions should add up to 15% of what you earn before taxes in a year, not what you bring home.

I think that 15% number is a bit loaded in a way that Dave doesn’t discuss. I think he makes an enormous assumption in this book, that people reading it are at the very least over the age of 30. The thought process behind this is simple: if you’ve dug yourself into an enormous debt hole, figured out that this is a problem, and dug yourself out, you’ve likely got quite a few years under your belt already.

The catch is that it’s those under the age of thirty that can really make a killing with retirement savings. If you save 15% a year from age 22 to age 30 for retirement in an account that returns 8%, you’ll make more just from those early years than you would if you started at age 30 and saved until age 65. Thus is the power of compound interest.

I think Dave’s absolutely right – if you’re over 30 and have peanuts saved for retirement, 15% is a requirement. If you’re just getting out of college, 15% would be sweet, but you can have a healthy retirement for less if you’re committed to contributions throughout your entire adult life.

What About Employer Matching?
Dave offers up his thoughts on how to consider employer matching on your 401(k) on page 155:

When calculating your 15 percent, don’t include company matches in your plan. Invest 15 percent of your gross income. If your company matches some or part of your contribution, you can consider it gravy. [...] By the same token, do not use your potential Social Security benefits in your calculations.

Why not include these things in your calculations? We all know about the lack of stability in Social Security – I, for one, have little interest betting my long term stability on it. But why not the matching?

Dave really doesn’t give an argument for why he believes you shouldn’t include it beyond “consider it gravy.” I tend to think the reason that ignoring matching is a good rule of thumb is that quite often employee matching money has special investing rules tied to it.

Another good reason – perhaps even more important – is that it’s better to save more than you need than less than you need. If you wind up at age 60 and have more money than you expect, that’s a good thing (provided, of course, that you’re not negatively affecting your life along the way).

Another interesting question: is investing in your own business worth considering for retirement savings? I don’t think it is. For one, a small business is notoriously unstable. For another, I think a small business functions more as a giant emergency fund than as a retirement account, since it can be tapped regardless of where you are in life. I wouldn’t include any sort of business as part of one’s retirement plan.

At Age Sixty Five…
An interesting fact worth thinking about, from page 164:

The investing you do systematically and consistently over time will make you wealthy. If you play with this by jumping in and out, always finding something more important than investing, you are doomed to be one of those fifty four out of one hundred sixty-five-year-olds still working because you have to work.

When I read that quote, I immediately began thinking of all of the people I know that are close to sixty five years of age and whether they still need to work. According to my math, seven still have to work and six do not. From my little bubble, it looks like that 54% figure is pretty spot-on.

One interesting difference between the two groups is that the working group tends to spend money more easily than the non-working group. The people I know in the working group tend to go on a lot of vacations and have shiny new cars, but their days are still filled with their jobs. The people I know that are not working for an income at age sixty-five are not doing as many expensive things, but instead are involved in things like volunteer work and actually working at their own small business that doesn’t turn a big profit but is a lot of fun for them. They don’t have shiny new cars and they don’t fly to Europe regularly, but they’re doing things they value.

I’d like to be able to go on some trips when I’m that age, but overall, I’d rather be in the group that doesn’t work for a living income then.

The Rose
On page 165, there’s a short parable about a rose growing from a plain seed into a beautiful bloom. The comment on this parable is interesting:

The story of the rose is about human potential and about not being defined by what you do, but rather by who you are. [...] Push with gazelle intensity [on your savings] to bloom, but know that as long as you take the progressive steps, you are winning.

For me, this all comes back to the idea of spending less than you earn – it’s the engine that drives everything that I truly value in life. Spending more than I earn means lots of little trifling goodies right now, but it means pain in the future – something I learned the hard way.

Spending less than I earn, though, is much like planting a seed and watching it grow. At first, it seems painfully slow, as a seedling barely peeks through the soil and seems to grow at a snail’s pace. But if I keep fertilizing it and working with it, it grows.

Before I know it, it’s a large blooming bush and the fragrance of freedom is in the air.

Do you have any other thoughts on this chapter of The Total Money Makeover? Please share them in the comments – and feel free to respond to any of my impressions as well. After all, a good book club is all about discussion!

On Wednesday, we’ll tackle the tenth chapter – College Funding.

Haruki writes in:

I am putting 15% of my salary into my 401(k) which gets a 5% match from my employer. I also contribute the max to my Roth IRA.

I followed up with Haruki and found that his salary is $46,000 per year and he’s twenty seven years old, just for calculation’s sake.

So let’s put all of the math together. Haruki contributes $5,000 a year to his Roth IRA. He also contributes $6,900 to his 401(k) and his employer contributes $2,300 to his 401(k), too. Added together, Haruki’s retirement savings each year is $14,200 – 30.9% of his salary.

I think that’s excessive, and I told Haruki why.

First, saving 31% of your income for retirement will give you an abundance in retirement savings. When you finally retire, even if you step away at the minimum possible age that you can access your retirement savings without penalty, you’ll have more than enough for retirement. For some, this seems like a problem they wish they would have, but having excessive income in retirement means excessive taxes in retirement. In short, if you have a mountain of cash in your 401(k), you’ll be paying more taxes upon withdrawal than you ever would if you were more careful about your life’s financial plan.

Second, when you hit your “number,” you’ll likely be many years short of retirement. If you’re saving this much for the dream of retiring early, you might not wind up happy. When you do hit your “number” – the amount you need to have to live sustainably in retirement – and you’re much younger than your retirement age, you’re stuck. You’ll have all the resources you need, but they’re locked up. Of course, you can use your Roth IRA contributions for a few years, since you can withdraw your contributions without penalty, but it won’t cover you for more than two or three years.

The big reason, though, is that excessive retirement savings takes away from your other life goals. Dropping that 401(k) contribution back to 10% gives you another 5% of your salary – $2,300 pre-tax – to save for other life goals without diminishing the quality of your retirement. Instead, start socking that money away for other goals: a big fat emergency fund, a home down payment, a small business you dream of starting, a vacation, or whatever it is that really makes your life worth living.

Haruki is doing tremendously well – this is not a criticism of his saving habits, which are stellar. If you have the capacity to save more than you actually need for retirement, that’s awesome. It’s not a bad thing.

Instead, take some time to step back from your retirement savings Think through your life goals and make some serious, well-informed decisions. Here’s how.

First, calculate your “number.” In other words, figure up how much you’ll need to live on sustainably in retirement. There are tons of different calculators and calculations out there – your best bet is to use several and trust the one that estimates the largest total amount – then add 10%. CNN’s retirement calculator and MSN’s retirement calculator are both useful places to start, but try running your numbers through every one you come across.

Next, calculate how much you need to put away each year to reach that goal at your target age. Assume a 7% annual return on your investments, which is what Warren Buffett suggests is the long-term trend for stocks. One way to get a bead on this is to tinker with the numbers on retirement calculators – set the annual rate of return to 7% and play around with the annual contributions you would need to make to get to your target number. This will give you a good savings number to shoot for each year.

Once you’re sure that you’re saving enough for retirement at the age you want to retire, target the rest of your savings towards other goals. Save for a home, for a car, or for a small business. Give money to a charity. Our goal is a home in the country with a barn in the back which we want to make as green as possible – we want to shoot for near self-sustainability. We also want to do some serious volunteer work in retirement.

What if extra retirement savings makes you feel more secure? If that’s the case – and you don’t have any other goals you’re strongly pushing towards – then feel free to contribute more towards your retirement savings.

In the end, it’s worth your while to make sure that, if you’re focused on saving, that your savings are helping you truly fulfill your dreams. Good luck!

One big point that I often bring up in favor of Roth IRAs is the fact that you’ve already paid your income taxes on it. When you take money out of your Roth IRA at retirement age, you don’t have to pay income taxes on any of your withdrawals. On the other hand, with a 401(k), you’ll owe income tax on all of your withdrawals.

Obviously, the big difference comes when you pay into these accounts. With a Roth IRA, you put your money in after taxes – from your take-home pay. With a 401(k), you invest with money before taxes. Thus, a 401(k) investment reduces your taxes today, while a Roth IRA investment reduces your taxes tomorrow.

Many people want a simple answer to the question of which retirement account type is better – but it’s not that simple at all. To truly know which option is the best one would require a crystal ball.

The best we can do is make the case for a future where a Roth IRA is better – and a future where a 401(k) is better. Let’s look at each one.

A Roth IRA Is Better If…
… income tax rates go up from where they’re at now. Let’s face it – the United States is deep into debt. The revenue to pay for that debt will have to come from somewhere. At the same time, income tax rates are currently about as low as they’ve been in decades. What’s a reasonable conclusion from this? The government will raise individual income tax rates gradually over time to make up for all of the rampant spending since the start of the Reagan years.

… your earnings go way up from your current level. If you have higher earnings later in life, it’s likely that most of your retirement savings will also come later in life so that you can have a standard of living in retirement that’s notably higher than what you have now. If you need a lot of money in retirement, it’ll be very useful to have some of that money arrive on your plate tax-free, especially if the income tax rates are higher. In other words, if you have a big entrepreneurial bone in your body, a Roth IRA is probably a better option.

… you have other avenues of income in retirement besides the Roth IRA. Most likely, if your income goes way up, you’re going to have investments of all kinds that earn income for you in retirement. Almost all of that will be taxable income. Again, having some of your income in a non-taxable form means substantially less taxes for you, particularly, again, if tax rates are higher.

… your employer isn’t offering matching contributions into a 401(k). If you’re self-employed or with an employer that doesn’t offer a 401(k) – or doesn’t offer any sort of 401(k) contribution matching – a Roth IRA definitely looks good in comparison, since the 401(k) doesn’t have this huge advantage.

A 401(k) Is Better If…
… income tax rates stay at the same level – or go down. Many argue that the best way to increase revenue is to actually lower tax rates, spurring on business growth. If future governments apply this philosophy, it’s likely that tax levels will either stay steady or decline.

… your earnings decline, stay the same, or only go up at a slow rate until retirement. If you’re not entrepreneurial in any way, shape, or form and you’re not interested in battling your way up the corporate ladder, your income will likely remain pretty steady throughout your life. This means you won’t bump yourself up to higher tax brackets later on and you’ll likely be in this tax bracket (or a lower one) in retirement. Thus, deferring the taxes until then is advantageous.

… your main income (besides Social Security) will be your 401(k). If your income in retirement will mostly come from your 401(k) and not from outside investments, your total tax bill will be limited significantly. You won’t have additional income pushing up your tax burden (which your 401(k) will contribute to).

… your employer offers matching 401(k) contributions. This is free money that blows away any tax benefits that might come from a Roth IRA. If your employer matches your contributions, the decision becomes pretty easy – take those matches all the way to the bank.

What About a Roth 401(k)?
Some people also have the option of a Roth 401(k), which essentially works like a 401(k) except with after-tax money. A Roth 401(k) often ends up being like a Roth IRA that gets employer matching, which means that most of the arguments in favor of a Roth IRA apply to it.

In the end, though, you need to decide for yourself where you’re headed and where you believe the government is headed. Of course, all of this is moot if you don’t start saving right now. Regardless of what you choose, you’ll lose any advantage of either choice by putting off saving while you decide. If you’re unsure, sign up for one plan or another and start contributing. If you change your mind later, switch your savings plan. But, no matter what, start saving now – don’t put it off.