Quite often, financially intelligent young professionals get out of school, start in the professional world, and actually stick quite strongly to the “spend less than you earn” mantra. They fund their Roth IRAs and their 401(k)s, but they still find themselves spending much less than they’re bringing in. And they wonder what’s next.

“Fred” writes in with a question along these lines:

I’m in my mid 20’s and just got my first job, currently make ~$50k. In 3 years I will graduate from medical residency and be making 3-4x that. I’ve had a very fortunate upbringing- no student loans, no credit card debt, and about $100k invested in securities. My question is regarding IRA and 401k contributions. Once I’ve contributed up to my 401k’s match, and max out my Roth IRA what should I do next? The current wisdom is to max out my 401k contribution. I feel quite certain that my taxes (once I make ~$200k annually) will eventually be much higher because of our spiraling debt/ Obama tax plan. Would it still be wise to max out my 401k?

There are several pieces of the puzzle worth discussing here.

First, never, ever count your chickens before they hatch. The most common mistake that I see people making is their assumption that they will be earning more in the future. That may be the plan, but plans can change - they are often derailed by life, health, changing interests, opportunities both missed and otherwise, and so on. Do not make spending decisions now based on what you hope will happen in the future.

When I found myself in a very long-term stable job in 2004, I made the mistake of essentially betting that I would have that income in perpetuity - nothing would keep me from earning that money until retirement. Flash forward to 2009 and what do I see? An opportunity came along and I jumped on board. I’m earning less than I might have otherwise, but every morning I feel absolutely that I made the right choice.

So many things can happen over the next few years. You might become disenchanted with your current work. You might fall in love and have a child. You might fall into ill health. In each of these events, you likely will not be earning three times your current salary in a few years.

Instead, a much more prudent path is to build a firm foundation for whatever may come. As I noted above, many people are at least peripherally aware of this, investing money into retirement. But retirement investing is just the start.

Build a very healthy emergency fund. It’s always useful to have at least six months’ worth of living expenses available in a very liquid place, like a high-interest savings account. Don’t be afraid of the size of the goal - just start an automatic plan to scoop some portion of your paycheck right into that savings account. Hold onto it - use it for big emergencies, then replenish it afterwards.

Invest in yourself. Never be afraid to invest money in making yourself better. Lose weight - if you have difficulty doing it on your own and can afford it, hire a trainer to motivate you. Get your teeth straightened and cleaned. Work on your self-confidence and take opportunities to speak in public. Invest in clothes that are well-made and durable - ones that will last through whatever may come.

Invest in a taxable account. If you’ve got an emergency fund, no debts, and a well-padded emergency fund, start investing in a taxable account. How exactly you do this depends on your risk - my recommendation is to invest in index funds using a buy-and-hold strategy. Hold onto that money for now and wait for opportunities to come to you. That money may eventually become a home. It may become the basis for a business. It may become the backbone of a very early retirement. Whatever it is, having it in a taxable account means you can utilize it for whatever you need, whenever you need it.

What about investing more for retirement? If you’re already maxing out an IRA and picking up all of your employer’s matching in your 401(k), your bases are pretty well covered for retirement. Investing beyond that can be helpful over the long run, but if you’re doing it at the expense of an emergency fund, your own personal health, or other personal goals, you should spend some time asking yourself what your true goals are.

My argument is simply this: money invested in a taxable account is likely a good option in this situation. While you do have to pay capital gains tax on the dividends (as well as on the gains if you sell the investments), that money can be used for any purpose without penalty: retirement, a home, startup money for a business, a wedding, education for a new career, or anything else that might come your way. Your future is not set in stone - don’t set all of your savings and investments in stone, either.

Good luck!

This past weekend, my wife and I were watching Clark Howard’s show on Headline News. During the program, Clark stated a canard that I’ve heard several times from personal finance “gurus” over the past couple years: instead of saving for a child’s college education, parents are better off saving for their own retirement.

Clark’s main reason was pretty simple: people can’t receive scholarships or student loans for retirement. Obviously, that’s true: my children will be able to get all kinds of assistance for their college education, while I won’t be able to get any sort of aid for retirement. Not only that, if your child does have to get into debt for college, they’ll have many, many years to earn their way out of it, whereas when the children go off to college, you won’t have too many years to keep saving for retirement.

On paper, the argument does make a lot of sense. On paper.

This equation leaves out an enormous human element. For many people - myself included - retirement isn’t the big ultimate goal. I might like to think about retiring a bit early, but my big motivation in life isn’t related to retirement at all.

My big plans right now involve guiding my children into adulthood with enough life skills and opportunities that they can basically choose to do anything they want - and run with it. In most ways, my financial choices revolve around that motivation. I started 529 accounts for my children before they were even born (starting them with myself as beneficiary, then changing it). I’m already investing in educational opportunities for them.

Yes, I’m saving for retirement. However, I could be saving substantially more for retirement if I were not directing significant money to my children’s future - and I don’t just mean college savings, either. Other opportunities, such as camps that revolve around their interests, international trips, equipment and instruments they might need, and so on are also important - and by planning for them and saving for them now, I reduce the chance that changes in my career will affect the opportunities that my children have.

Clark’s advice is correct on paper, but it leaves out one of the biggest aspects of personal finance: setting your own goals. Most of my goals revolve around my children - thus, my savings and investment choices revolve around what paints the best future for them.

The lesson here is not every “rule” of personal finance applies to every situation. Instead, you should figure out what your own goals are and then seek out advice on how to make those goals actually happen.

Good luck!

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

Even before I began my financial turnaround, I dreamed of being able to settle into some form of “semi-retirement” around age fifty or so (when the children are out on their own). I dreamed of spending mornings working on my writing, spending my afternoons volunteering, and spending a lot of long, wonderful days with my wife as we grow into our golden years together, chasing grandchildren and enjoying each other.

Obviously, before I began my turnaround, this really was a pipe dream. If I had continued down my road of rampant spending, I would have been working until I fell over. Now, with a few years of good financial management under my belt, the dream is starting to become a little more realistic - but I know I’ve still got a lot of years of work ahead of me to make it happen.

Work Less, Live More by Bob Clyatt is basically a “how-to” guide for building such a state of semi-retirement later in life. I tend to think that this book speaks to a lot of people. I think many people dream of an active retirement of some sort where their time is filled with regular activity, and for many, that will include a part time career of some sort.

But how do you get from here to there? That’s what Work Less, Live More is all about. Let’s dig in.

Figure Out Why You Want To Do This
Clyatt opens the book by arguing that there needs to actually be a compelling reason to choose a path to retirement or semi-retirement. If you’re actually content with your job, why quit? It fills your time with something that fulfills you and earns you money, after all. If you’re going to consider a path to semi-retirement, it should be pushed not only by a discontent with where you’re at right now, but also a desire to accomplish something different with your time. Clyatt offers a lot of exercises here to help you walk through this, because in truth, there’s a lot of introspection and self-discovery here.

Live Below Your Means
Once you’ve figured out what you want, the first big step on the journey is to, well, spend less than you earn. That means both striving to earn more as well as focusing on frugality in your life, with the goal of maximizing the difference between your income and your spending. Clyatt focuses mostly on the “spend less” part of the equation, discussing things like creating a spending plan and seeking out chunks of regular spending that you can cut out.

Put Your Investing on Autopilot
Most people put far too much stress into investing. Clyatt proposes that it’s actually quite easy for most people if you just follow a few basic principles: invest in a lot of different things, avoid fees, and don’t micromanage it. His suggestion is to stick with index funds in your retirement accounts, either by using a “target retirement” fund or by buying small amounts of a very diverse selection of index funds. Then, once you’ve set up this investing plan, just let it sit and don’t worry about it - it’ll go mostly up and sometimes down no matter how much you stress or don’t stress about it.

Take 4% Forever
How much do you need to save for retirement? Clyatt says that you need to have enough so that you can just withdraw 4% of the starting balance each year and be just fine. So, let’s say you’ve decided you need $40,000 a year from your account - you’ll need one million dollars to be ready. Obviously, you should only withdraw as much as you need - the 4% is just a maximum. If you’re calculating into the future, you should keep inflation in mind - you might be able to get by on $40,000 a year now, but $40,000 today will be worth quite a bit more than $40,000 will be in ten years.

Stop Worrying About Taxes
Many people who move into semi-retirement situations often get very worried about the tax bill at the end of the year. Clyatt’s solution? Don’t worry about it - just save plenty and you’ll be fine. He offers a few basic tips for minimizing your tax impact in semi-retirement. For instance, if you’re strongly thinking about semi-retirement, you should definitely be utilizing a Roth IRA for at least some of your retirement savings so that you’re not required to pay taxes on that money in your later years, when you’ll still be earning some income.

Do Anything You Want, But Do Something
Many people, once they’ve ushered their children out into adulthood and find their careers winding down, discover that suddenly they have many more hours than they know what to do with. Clyatt argues that the key to a successful semi-retirement is to fill those hours with some sort of activity to keep your mind and body engaged. Retirement does not mean idleness.

Don’t Blow It
Guilt. Boredom. Panic. Financial worries. Bruised ego. These are all psychological traps that people can fall into upon retiring - and they’re all real and worth consideration. Clyatt offers great, specific advice for these concerns and many others, but most of them revolve around the fact that you’ve worked your entire life to earn the freedom to choose what you want to do, so get out there and do whatever it is you want to do.

Make Your Life Matter
Keep a healthy body and a healthy mind. Build healthy relationships. Be involved in activities that are meaningful to you. Don’t worry about the past - instead, look forward to the things that are happening now and will be happening soon. In other words, you have all the time in the world to build the best quality life you can, so take advantage of it.

Is Work Less, Live More Worth Reading?
In many ways, I expected Work Less, Live More to be a book heavy on the personal finance specifics, dealing with questions about how to invest for semi-retirement, how to transition to a part time career, how exactly to manage your money during those years, and so on.

While that material is covered, Work Less, Live More takes a much broader view of what it would mean to be semi-retired - and Clyatt actually seems to focus on other issues, such as thinking ahead about what you want out of your life, maintaining psychological health during the transition, and living a full life in retirement.

For some, this won’t be the book they need. It’s not going to provide the tools you need to exactly calculate the optimal financial plan for moving into a state of semi-retirement. Instead, Work Less, Live More does a fantastic job at something else: getting your mind in the right place to create a great, successful semi-retirement. From where I stand, Work Less, Live More can be incredibly helpful for people who are thinking about the possibilities and challenges of being semi-retired in the future, but if you need strong help with the exact financial planning, you may want to seek additional help beyond this book. Nevertheless, I found it an excellent and thought-provoking read.

This started off as an email to a reader, but I thought that many other readers might find this of some value.

Recently, I received a long email from a very distraught woman (that I’ll call Mary) who has finally come to the realization that she will not be able to retire in seven years as has been her plan all along.

For the past twenty five years, she’s been contributing a regular small amount to her company’s optional retirement plan - about 7% of her salary. Her company has also chipped in about 3% on that savings, bringing her to about 10% of her salary each year in total savings.

She invested that money pretty conservatively - but it’s an investment plan that seems reasonable to me. Half of the money went into bonds - mostly treasury notes. The other one went into the S&P 500 as an index fund.

On average, over the past twenty five years, her plan has returned 7.5% - and that’s a number she’s become quite comfortable with. As her retirement age approached, she began to use that number to calculate forward from her current state - and this enabled her to plan for retirement in 2015.

Then 2008 came along, and at the end of the year, she received her statement. Her stocks had dropped 39% on the year, wiping out about 16% of her overall retirement savings. This one single year had dropped her annual returns from a 7.5% average to almost a 7% average.

The end result of that swing? Unless the stock market has a gigantic rebound over the next few years, Mary won’t be retiring on time.

For most of you, Mary’s story is pretty ho-hum. Almost every baby boomer is going through some version of what Mary is dealing with right now - I can certainly say that the boomers I know are working through what to do.

What intrigued me was that Mary didn’t want help for herself. She wanted to know what exactly she should have done in the past to not put herself in this situation. In her words:

My daughter just started a great job. We’ve talked a lot about this and she doesn’t have any idea what to do with her own money now. She’s worried about being stuck in my situation later on. What should she do differently than what I did?

Here are seven tactics I recommend for Mary’s daughter (aside from get started now).

Contribute a little more. If you’ve decided to contribute 7% to your retirement account, make it 8%. If you’re at 8%, consider bumping it up to 10%. You’ll likely not notice the difference in terms of your day to day spending, but bumping your retirement savings up from 8% to 10% gives you 25% more money to work with in your retirement account - money that might help you retire early, but might also simply help you survive another down year.

Don’t repeat the same formula when you’re 60. If you’re just starting out, going aggressive with your retirement savings is fine - you have plenty of years to recover from any early down years. However, don’t just keep riding with that same strategy because it’s comfortable and it’s worked in the past. Over time, you should gradually move your money into something more conservative - that usually means out of stocks and into something more stable, like bonds.

An easy way to do that is with a target retirement fund. Most retirement plans offer an option called a “target retirement fund.” The way it works is pretty simple - they do the gradual shift to more conservative investments for you over time, so you’re not caught holding the bag when it comes to another 2008.

Assume some bad years - and don’t be despondent when they happen. Over the course of a career, there will be some bad economic years. Know this up front - you can’t expect every single year to reward you with a big return. When the bad years happen, remember the good years - and if you’re getting close to retirement and realize you can’t afford a really bad year, make your retirement allocations more conservative.

Don’t be afraid to ask for help. Many people feel as though retirement planning is a burden they must carry themselves - and they often put it off or make bad choices simply because they’re unsure what they’re doing. Don’t fall into this trap - ask for help. Ask the person in your workplace who manages such plans. If you’re really unsure, ask a fee-only investment advisor for help. Don’t put it off simply because of ignorance - get educated and get going.

Don’t invest in something you don’t understand or seems risky to you. This is a great rule to follow. If you’re looking at your investment options and you don’t understand some of the options, learn more about them on your own. If you’re still confused - or if it seems overly risky - don’t invest. Everyone has a different level of risk tolerance, and you’ll only regret it if you exceed your risk tolerance, particularly in your retirement account.

Don’t plan for a “full” retirement. Assume that your retirement will contain some degree of activity that can earn an income. Many people after retiring seek out some sort of activity to fill their time and a part-time job or a seasonal job can be just the ticket. Instead of trying to figure out how you can possibly replace your whole income in retirement, focus on just replacing most of your income under the assumption that you’ll want to remain active in retirement.

Over the next few days, we’re going to take a look at five common New Year’s resolutions that people often adopt for their finances, evaluate some of the traps that people fall into with regards to that resolution, and come up with some real actions that can turn a challenging New Year’s resolution into a success.

Retirement planning is one of those painful things that we all know we should be doing, but for those of us who started our careers with a routine of not saving for retirement, it can be a painful subject to consider. Yet another drain on my current paycheck? It doesn’t sound like something that many of us would look forward to.

Because of this tug-of-war between a recognition that we need to save for retirement as opposed to a desire to maintain as much take-home pay as possible, people often resolve to make the coming year one where they finally take charge of their retirement planning, but often it’s a resolution that falls short. They find little things standing in their way and use that as a reason to not take control of the situation.

No more. If 2009 is going to be the year when you take control of your retirement, you need a plan. Here are some simple steps you can take to get a retirement plan in place for yourself, no matter what your situation is.

First, find out if your place of employment offers a retirement plan. Likely, you already know this - if you don’t, contact your supervisor and find out who you can contact to find out more. Many workplaces offer some form of a 401(k) or 403(b) retirement plan which is very easy to participate in.

If you do find that your place of employment offers such a plan, get signed up as soon as possible, even if you’re unsure how much you will be contributing to the plan. You’re better off getting the plan in place now, since you can change your contributions later on. Actually signing up for the plan should also be straightforward - if you need help, ask for help from the person who gave you the forms.

How much should you contribute? This is the stumbling block that catches many people and keeps them from actually pulling the trigger. They consider contributing 5% to a 401(k) plan, but when they envision their paycheck dropping by that much, they don’t even want to think about having to deal with that kind of pay cut.

First of all, your paycheck won’t actually drop that much. For example, if you contribute 5% of your paycheck to a 401(k) or a 403(b) plan, your take-home pay will only go down 3 to 4%. Why? The 5% is taken out before taxes. Let’s say you earn $10 an hour, earning $400 a week, and 25% of that is eaten up by taxes of various kinds. That leaves you with a $300 paycheck at the end of the week, right? Well, let’s say you elect to contribute 5% of your pay to a 401(k) plan. You earn $400, then 5% of that is taken for the plan, leaving you with $380 in pay and $20 contributed to the plan. Then, 25% of that is taken in taxes, leaving you with a take-home of $285. You were able to contribute $20 to your retirement, but your take-home only went down $15. (In fact, it might even be better than that, because likely you’re going to have slightly less of your check taken out in taxes, but that’s a much more complicated story.)

Second, the reduction in your paycheck will be easier to handle than you think. Whenever a person’s earnings fluctuate a bit, their spending almost always automatically fluctuates to keep pace with it, and it’s often not noticed at all. In the example above, the $15 difference in paychecks would likely quickly evaporate in the form of different food purchases, for example.

So, how much should you contribute? For most people, 10% is a good number to target when you’re first starting out. Some employers actually match your contributions, so you can include their matching in that 10% - if you contribute 5% and they match 5%, there’s your 10%. If you’re over 30 and you haven’t started yet, you should look at a bit higher number - 12% or 15% might be better for you.

Even if the percentage seems painfully high, give it a try and see how it works. You might find that it’s easier to deal with than you think - and if it’s not, you can always request to lower your contribution percentage.

What if I don’t have a 401(k) or 403(b) option? Your best option is to start a Roth IRA, which is an independent retirement plan you can easily set up yourself. I recommend using Vanguard to manage it - that’s the group I use. You’ll have to make contributions to this plan directly from your checking account - I have a small amount withdrawn each week for my Roth IRA. They do all of this automatically for you - you only have to set it up once, then you can forget about it.

How should you invest the money? For most people, the easiest solution is to simply put all of one’s contributions into a “target retirement” fund. Most retirement plans offer several of these target retirement plans, which are intended to automatically manage your money over time, helping you get big growth early on, but slow down and become more stable as you near retirement. Pick the one with the year that’s closest to when you turn 65 - for example, if you’re 25 in 2008, you’ll be 65 in 2048, so you should choose a Target Retirement 2045 or 2050 plan. If you don’t have a “target retirement” plan, go conservative. Put 50% of your contributions into one of the stock options (preferably whichever one is the broadest one) and 50% into one of the bond options (again, whichever one is the broadest). This is a pretty conservative choice, but it will keep your money fairly safe no matter what the future holds.

The bottom line is to just take that first step. Even if you’re not contributing much at first, at least you’re setting up the plan and making a start at things.

After writing my piece yesterday on fear and the economic situation, a very eloquent reader named “Maggie” wrote to me:

I completely agree with your assessment on the economy, particularly if you’re young. There is no crisis that is well served by panic and I don’t think that the current economic situation is anywhere near as bad as the Great Depression.

That doesn’t change the fact that many people (myself included) are looking at their 401(k) statements for the year and are seeing 20-30% drops for the year. I looked at my 401(k) and I saw that it’s down about 19% for the year.

I’m about six years from retirement, or at least that was my plan until this year. Now that I’ve lost so much money, I don’t know if I can retire then. I will probably have to work several more years beyond that, because even if the stock market goes up 20% the next two years, I’ll still only be back to about where I started.

Got any suggestions?

Maggie tells a story that’s been repeated in the media quite often over the last week or so. My mother-in-law and father-in-law are also likely in the same group as Maggie - they’re in their mid 50s and are building a solid nest egg in their 401(k)s, but have watched some sizable chunk of that savings vanish this year.

If you’ve already lost that money, it’s gone. There’s no magic way to get back what you’ve lost. For some people who are getting close to retirement age, that means you will have to work a few years more. Your retirement date probably went from 2014 to 2020 or so. That’s unfortunate.

But the blame doesn’t go to the flailing of the stock market. The blame actually goes towards poor asset allocation in your retirement account.

Stocks are inherently a risky investment. If you look at the long term history of the stock market, there are a lot of years where the stock market goes up 15 to 20% in a year. There are also a lot of years where the stock market drops 20% in a year. Over the very long haul, these average out - that’s why holding a broad range of stocks (like in an index fund) is a good idea if you’re investing for the far future.

The problem comes in when that future isn’t quite so far any more. If you’re getting close to retirement, your investment in stocks becomes less of an investment and more of a gamble.

Think of the stock market as being kind of like a coin flip. Think of each year as being like a single coin flip, where a heads flip will get you a 15% gain and a tails flip will get you a 10% loss. The more times you flip a coin, the more likely you are to get a roughly equal mix of heads and tails results.

Since I’m thirty years away from retirement, I have a lot of coin flips ahead of me. I’ll likely see some runs of heads and some runs of tails, but over that long period, it’ll approach an even split in flips. That even split will mean a pretty good return on my investment.

But let’s say you’re now five years from retirement. That means you have only five coin flips. There’s now a measurable chance (a little over 3%) that all of your remaining flips will be bad, losing you a significant amount of money. Instead of being a volatile investment, it moves more towards being a gamble.

So what’s the solution? Most money managers recommend that as you get closer to retirement, you should slowly start taking your money out of stocks and putting it into something safer, like bonds or money markets. These investments won’t return as well over the long haul as stocks, but they’re as steady as can be - a 2% to 6% return that comes in like clockwork.

You’ll hear a lot of different methods for how to do this. My suggestion for most people is to do it automatically - simply put all of your retirement money into a Target Retirement fund that’s close to your retirement date. For example, I use a Target Retirement 2045 fund for my Roth IRA (which matches when I turn 67).

A Target Retirement fund automatically does this transition for you. Right now, my Target 2045 fund (since I’m so far from retirement) is almost entirely in stocks (and it’s been painful to watch it drop). But I have many, many years for it to rebound. When I start to get closer to retirement - in 2020 or so - the fund will automatically begin to adjust, reducing the amount of my retirement money that’s invested in stocks and increasing the amount that’s invested in other things. When I get very close to retirement, most of the money is not in stocks.

Unless you know the ins and outs of risk management and asset allocation, there’s no reason to not use a Target Retirement fund in your 401(k). Call up your plan manager and see if there’s anything like it available to you. If you want to push the risk a little bit (but, of course, remember what 2008 has been like), then use a fund that’s a little bit past when you want to retire. If you’re conservative, use an earlier fund. Then just dump all your contributions into that fund, sit back, and relax.

The next time the stock market flops, you might worry about it a bit, but it won’t be cataclysmic. You’ll be appropriately diversified without having to even skip a beat.

Yesterday, I had a long conversation with a friend of mine, mostly about what we plan to do for the rest of our lives. I told him about my plans and dreams - writing, volunteer work, local politics, and so on - and I also mentioned how I was saving carefully for retirement.

Right then, he asked a key question, one that has left me thinking carefully and deeply over the last few days.

If you’re planning on working until you literally can’t work any more, why are you saving so much for retirement?

This is a question that a lot of self-motivated individuals should be asking themselves as they put together their retirement portfolios. I know I certainly don’t plan on sitting around all day twiddling my thumbs when I reach some mythical retirement age, and I don’t plan on spending all my time traveling around, either. I want to be out there, contributing what I can to society.

So what does that mean for retirement savings? Here are my thoughts regarding my own situation.

First, right now is the time to save for the future, no matter what the situation. At this point in my life, with two young children at home, I need to be at least somewhat careful with my work. That means I have to be very careful with my career choices, selecting paths that pay well and give me some degree of security. Also, my life naturally trends towards frugality - most evenings are spent at home with the family, making a homemade supper and enjoying simple fun together. Relatively low spending coupled with a focus on steady, strong wages equals a surplus (or at least it should), and that personal surplus should be invested.

Second, once the kids are old enough to no longer rely on us, I’ll be more willing to take risks and bold steps. When my children reach the point of independence and we have our home paid off, I’ll be far less worried about the day-to-day bills and will be much more willing to take risks. That includes taking on community jobs I’d never otherwise consider (like running for the county board of supervisors, etc.) or even looking at volunteer leadership positions within the community.

Third, by the time they move out, I’ll be reaching the eligibility age to start withdrawing some of the money in retirement accounts without penalty. Given our plan for having more children, I will be 57 by the time the last one likely moves out. I can begin withdrawing from my Roth IRA without any taxation or penalty at age 59 1/2. It’s pretty nice how those two ages line up, isn’t it?

Another factor to consider is that health care is steadily improving. I’m thirty. What medical advances will be made available by the time I’m sixty? A cure for cancer? Genetic revitalization? Nanobots to repair damaged tissues and clear arteries? Whatever it is, I plan to take full advantage of it and live as long and active of a life as I can. That may mean I’m productive into my nineties - or even older - and saving now gives me plenty of resources to do interesting things with that stage of my life.

In short, for me, Roth IRAs and 401(k)s are not retirement vehicles - they’re merely tax-advantaged investments to help pay for my activities in the second half of my life. Right now, when things are financially stable, I can save up for periods later on in my life where, by my own choice, things aren’t quite as stable.

What about financial security during the end of your days? Many people mistake retirement savings for a long-term care and long-term disability policies, ones that will pay for their health care costs when they reach those final years.

My approach to this is to get such policies early and lock them into low premiums. This way, whenever I reach a point where I’m unable to keep going, whether at age fifty or age ninety, my care is paid for. This is my end of life planning, and I’m currently shopping around for such policies.

This doesn’t really change the amount I’m putting away for retirement. The more I put away now - while I can - the more options I have further down the road. It’s also a big carrot for me to focus on my personal health so that I can enjoy those golden years when they come around.

I don’t want to spend my golden years on a golf course. I want to spend it doing something that matters.

If you’re an active and self-motivated person, don’t just think of a Roth IRA or a 401(k) as a retirement account. Think of it as a long-term investment that will pay off when you’re sixty, perfectly timed to help you do spectacular things with that period in your life.

Lola had an interesting question about retirement:

I asked if, by calculating our monthly expenses, we could multiply that by 200, and if that would be enough to retire. So, if one’s expenses were about $24,000 a year, if having $480,000 would be enough. And you said - rightly so - that this figure doesn’t include inflation, and that a safer amount would be close to 2 million! That’s a lot of money, and I must agree with one of the readers who said very, very few people can afford to save that amount during a lifetime.

I strongly disagree with the statement that very, very few people can afford to save that amount during a lifetime. The combined powers of compound interest and inflation will easily push a person’s investment level higher and higher. Many young people today, if they get started, will have millions in the bank when they retire, even if they don’t have a top-paying job.

I’ll use Jeff as my example. Let’s say Jeff is 25 years old and currently makes $35,000 a year. He wants to retire at age 65. He decides to put 10% of his income away into a 401(k), earning a 5% match from his employer. If you assume he gets a 9% annual return on his investment over the long haul, that inflation is at 4.5% annually over that period, and that the only raises he gets are cost of living raises to match inflation, he’ll have $2.018 million in his account on his 65th birthday. There’s nothing unrealistic about any of the assumptions here.

The problem is that from today’s perspective, $2 million seems like an enormous amount of money. And it is, in today’s dollars.

Comparing 1968 to 2008
But let’s roll back the clock forty years and see how things have changed. I’ll use the CPI-A for my historical inflation numbers.

The CPI-A is a number you can use to compare prices from one year to another. It takes into account the changing prices of goods and services and comes up with a number that expresses that difference. For example, on January 1, 2006, the CPI-A was at 199.4, while on January 1, 2008, the CPI-A was at 212.516. This means that the goods you could buy for $199.40 on January 1, 2006 would cost you $212.52 on January 1, 2008.

Now, let’s say Jeff started saving in June 1968, when the CPI-A was 34.9. Then, he retired in June 2008, when the CPI-A was 219.181. This means that every $34.90 Jeff earned in 1968 was worth $219.18 in 2008.

Now, let’s translate those numbers a bit. Let’s say Jeff had $2 million in 2008 dollars. In 1968 dollars, it’s only $318,459.

On the flip side, let’s look at investments. On January 2, 1968, the Dow Jones Industrial Average was at 906.84. On December 31, 2007, forty years later, it stood at 13,264.82.

That means, in order to have $2 million in 2008, you would have had to only put $136,728.58 into the Dow Jones blue chips in 1968.

Comparing 2008 to 2048
Now, let’s say you’ve decided that you need $24,000 in today’s money as living expenses when you retire in 40 years. Let’s also assume the stock market and the CPI-A change remain the same over the next forty years as they were over the last forty (they won’t be, but we can use them as a yardstick).

First of all, your annual $24,000 today would have to be $150,276.19 in 2048. That would actually be $12,560.52 a month in that timeframe. Using Lois’s “monthly amount times 200″ equation, she’d actually have to have $2.5 million in the bank then.

If Lois set her retirement goal at $480,000, she would be starving in 2048.

But she’s forgetting that compound interest works more strongly in her favor overall. A person today, filing singly, who has $24,000 in income that they can spend actually has a salary of about $30,000 before income taxes.

So, let’s say Lois is actually just trying to keep her current standard of living. She’s 25, earns about $30,000 a year, and never has any interest in climbing the corporate ladder and earning more - she’ll just earn cost-of-living raises for the rest of her career (ideally, this isn’t true, but we’ll make a “worst case” scenario for Lois). Her employer matches 1% for every 2% Lois contributes to her retirement account.

All Lois has to contribute to her 401(k) to reach her goal (using the assumptions above) is 15% of her salary. That’s assuming no performance-based raises ever, no promotions ever, and no job changes ever. If Lois commits herself to building a career and gets a few promotions along the way, her contributions can easily be lower than that.

$2.5 million is a completely realistic retirement goal for a young person only earning $30,000 a year. They’re helped along by the power of compound interest.

Is Lois’s “200 Times Monthly” A Good Thumbnail?
It’s only a good thumbnail if you’re starting off with your estimated monthly costs in retirement. Even then, it’s a bit on the risky side, as it will require solid returns on the investments to keep up with the spending.

There are two big problems with using such easy thumbnails, though.

The first one is math based. If you figure everything in today’s dollars, you won’t make ends meet later on. You’ll have to estimate what you expect to spend then. Doing that in Excel is easy, actually. If you believe that inflation will be at 4.5% from here until retirement, enter something like =2400*1.045^25 where 25 is the number of years you think you’re away from retirement and $2,400 is the amount you expect you’ll need in today’s dollars each month (for those curious, it’s $7,213.04).

If you then take that number and multiply it by 200, then you’re starting to get a reasonable retirement figure. I think, actually, that 200 is a bit low, as it assumes a 6% annual return in retirement just to break even. Try using 240 (which assumes a 5% annual return) or 300 (which assumes a 4% annual return) for more safe and realistic thumbnail estimates.

The second one is psychological. The numbers you’ll come up with doing this math seem frighteningly large. Most people then react by ignoring the numbers, arguing that they’re false, or using some other form of psychological crutch to make the number seem more reasonable. But it already is reasonable. It’s important to remember that a 1968 dollar is worth $6.28 in today’s dollars. If your old man was earning $10 an hour at the factory in 1968, that’s like earning $62.80 today. In reverse, a dollar today can only buy what $0.16 bought in 1968. These trends will be (roughly) the same into the future. A dollar today will likely be worth somewhere between $5 and $10 in 2048.

It’s for those two reasons that I don’t find a “target” for retirement to be too useful, especially early on. It can play psychological tricks on you and it can trip you up if you’re not strong on the math.

Instead, just stick to a strong savings plan from your first day at work. Don’t even think about it - just start putting away 10% of your salary either into a 401(k) or a Roth IRA (or some combination thereof). If you do that and work hard at your career, your retirement will be in fine shape.