Calculating Required Retirement Savings Rates: Part 3

In Part 1 of this series I outlined a method for estimating how much you need to save to have a good shot at a financially secure retirement. I put this in terms of a retirement savings rate, calculated as your required annual savings divided by your gross (before tax) annual income. For example, if your gross annual income is $50,000 and you estimate that you must save $7,500 annually, your required savings rate is 15% (7,500 / 50,000).

In Part 2 I discussed how to estimate living expenses in retirement, and gave a few examples of how this affects the retirement savings calculations. In this post I'll discuss how to estimate your Social Security retirement benefit, since this can have a significant impact on how much you need to save for retirement.

Calculating Required Retirement Savings Rates: Part 2

In Part 1 of this series I outlined how to estimate the savings rate required to ensure a financially secure retirement. The required savings rate estimate depends a lot on various projections and assumptions that I outlined in Part 1. In this post I'll discuss how to estimate your expenses in retirement. In subsequent posts in the series I'll discuss how to estimate your Social Security retirement benefits, how to estimate the expected rate of return on your investments, and how much you should expect to be able to safely withdraw from your retirement savings each year.

Calculating Required Retirement Savings Rates: Part 1

In one of my early blog posts, written in December 2009 for recent college graduates , I wrote, "You must manage your spending so that you can save a significant portion of your income -- at least 10%, and more if possible." How do we determine if 10% is enough, or could it even be more than you really need to save? Although there are too many unknowns to answer this precisely, we can make various assumptions to calculate a range of savings rates that are likely to enable you to enjoy a financially secure retirement.

In this post I'll show how we can calculate that a savings rate of about 14% of gross (before-tax) income is required, given the following facts and assumptions:

• Current savings: $0.
• Current age: 25.
• Retirement age: 65.
• A steady income with annual raises equal to the annual inflation rate.
• A 4% annualized real rate of return on your investments.
• Annual living expenses in retirement will be 80% of your current salary (adjusted for inflation).
• Social Security benefits will cover 35% of your living expenses.
• The remainder of your retirement living expenses will be covered by annual, inflation-adjusted withdrawals of 4% of your retirement savings.

So the 10% savings rate I mentioned in my 2009 post was too low given these facts and assumptions. I'll discuss the assumptions listed above in subsequent posts in this series, and make some different assumptions to see what other required savings rates we come up with.

CD Rates Falling, But Yield Premiums Still Attractive

Rates on several 5-year CDs I've been monitoring have fallen in recent weeks, but good CD (Certificate of Deposit) deals still are available, and the yield premiums of good CDs over Treasuries of the same maturities still are attractive. Ally Bank recently dropped its 5-year CD rate from 2.00% to 1.75% APY (1.70% if less than $25,000), and more recently Barclays Bank dropped its 5-year CD rate from 2.05% to 1.75%. The rate on the Synchrony Bank 5-year CD still is relatively attractive at 2.05% (2.00% if less than $25,000), but Synchrony recently increased the early withdrawal penalty (EWP) on its 5-year CDs from 180 days of interest to 365 days of interest, so even this CD is somewhat less attractive than it was before this change.

Brexit and Stock Market Volatility

You probably heard the news about the Brexit vote results on Friday, June 24, in which a majority of United Kingdom voters voted to leave the European Union (EU). If you caught any financial news, you heard that global stock markets dropped a lot in response. I'll discuss the stock market reaction in more detail below, but the most important message for long-term investors is to not worry about daily stock market volatility. As I've discussed before, worrying about daily financial and economic news can be detrimental to your emotional health, and if you act on scary-sounding news or daily stock market volatility based on emotions, it also can be detrimental to your wealth.

New Online CD Management Functionality at Ally Bank

Only a few days after I published a blog post on how to give advance instructions to Ally Bank to not renew a CD (Advance Request to Not Renew Ally Bank CDs at Maturity), Ally has added functionality to its online banking interface to allow modifying what happens to the CD proceeds of taxable CDs at maturity. So although the instructions in the previous blog post still will work, it now is much easier to make changes to taxable CDs using the new online functionality. 

The new functionality also allows changing the interest disbursement option (reinvest, mail a check, or distribute to another Ally or non-Ally account), and changing the term of the CD if you choose to renew. 

For IRA CDs, you still must call or use online chat to make changes.

Reading Blog Posts in Email

If you are an email subscriber and tried to read the last blog post in email, you may have noticed that it was garbled. If so, this is because the screen shots don't appear in email, and instead you see either nothing or a bunch of garbled text. The fix is simple: click on the blog post title at the beginning of the email, and because the title is a link to the blog, a new window or tab should open showing the blog post directly on the blog, and the screen shots will appear properly. If for some reason the link doesn't work, simply type KevinOnInvesting.com into your browser address bar to take you to the blog, and you can then read any of the blog posts.

Advance Request to Not Renew Ally Bank CDs at Maturity

As a follow up to my post about what to do with maturing CDs, I wanted to share that you can request in advance that your CDs at Ally Bank not be renewed at maturity. I think you can do this by phone, but I have only done it using online chat. In this post I describe how I've done it, and how you can too.

CD 5-Year Report Card: Part 3

In the first two posts in this series, I compared the 5-year return of a 5-year direct CD to a 5-year Treasury security, and provided a fairly detailed explanation of how to evaluate risk and return of fixed-income investments, such as CDs, bonds (including Treasuries), and bond funds. In this post, I conclude the series by presenting the 5-year returns of various Vanguard bond funds, and by comparing these results to the CD and Treasury in terms of risk as well as return.

CD 5-Year Report Card: Part 2 (Risk and Return)

In my previous blog post, CD 5-Year Report Card: Part 1, I compared the 5-year annualized return of a CD I bought about five years ago to the 5-year annualized return of a 5-year Treasury security (Treasury bond, or more formally, Treasury note) I could have bought on the same date. Although that's the most relevant comparison, it's not particularly interesting, since the annual percentage yield (APY) of the CD and the yield to maturity (YTM) of the Treasury basically predetermine the returns at time of purchase (assuming the CD or Treasury is held to maturity). 

(From now on, the term yield refers to yield to maturity (YTM) for a Treasury, other bond, or brokered CD (purchased through a broker), and it refers to the annual percentage yield (APY) for a direct CD (purchased directly from a bank or credit union). Also, the term return refers to annualized return).

In my next post, I'll review the 5-year returns for various bond funds, and compare them to the 5-year return of the CD. However, to evaluate these returns rationally, it's necessary to understand the relationship between risk and return for fixed-income securities, which is what I'll examine in this post.

CD 5-Year Report Card: Part 1

Now that the 5-year CDs I bought about five years ago are maturing, I thought it would be interesting to compare the 5-year CD returns to the 5-year returns of some other fixed-income alternatives I could have invested in five years ago. All we should really have to do is compare the APY (Annual Percentage Yield) of the 5-year CD to the YTM (yield to maturity) of the 5-year Treasury at the time of purchase, since that's the most appropriate comparison in terms of risk and expected return for the forward-looking 5-year period. 

Looking at past returns raises the issue of hindsight bias, or as Larry Swedroe refers to it, confusing strategy with outcome. Nevertheless, people seem to have a hard time not using past returns to evaluate their investments, so I'll compare some of the more relevant returns in this and the next one or two blog posts.

What To Do With Maturing CDs?

I started buying 5-year CDs directly from banks and credit unions ("direct CDs") about five years ago, because I learned about the advantages in terms of risk and expected return compared to bonds or bond funds. Perhaps you did too, either based on my musings or those of bloggers from whom I learned about direct CDs, like Allan Roth and The Finance Buff. Now that our CDs are starting to mature, what should we do?

Northwest FCU 3-year 3.04% Add-On CD

Today someone asked a question on the Bogleheads forum about saving for a house down payment in 3-5 years from now, so as part of answering the question, I checked the 3-year CD rates at DepositAccounts.com. I was flabbergasted to see a rate of 3.04% APY at the top of the list (with the closest competition at 1.85%). This is a promotional CD special ("Dream Fund Certificate") offered by Northwest Federal Credit Union (NWFCU), with a minimum deposit of $10,000 and maximum of $100,000. After finishing up my answer to the forum question, I quickly investigated the CD deal, then proceeded to complete the online application to join the credit union, open an account, and buy this CD. It took about 15 minutes.

The Value of an Investment Policy

If you've paid any attention to financial markets lately, days like today and weeks like this week provide examples of the value of establishing and following an Investment Policy (IP). Among other things, an IP establishes your target asset allocation and rebalancing policy. So when stocks drop much, all you do is check your current asset allocation to determine if your rebalancing policy requires shifting some money from fixed income (CDs, bonds, cash) to stocks.

Consumption Smoothing and Adjusting Your Frugality Setting

Consumption smoothing is the economic concept used to express the desire of people to have a stable path of consumption throughout their lifetimes. The ideal consumption smoothing case, assuming no bequest motives, is to save just enough during your working years to be able to spend your retirement savings to fund about same lifestyle in your retirement years, and to die broke. Of course since we don't know how long we'll live, or exactly what our expenses will be in retirement, this is a difficult ideal to achieve.

To give yourself a reasonable margin of safety for retirement, you may need to be more frugal in your accumulation years than you want to be. Conversely, if your investment returns were better than expected, or perhaps you were just more frugal than you had to be while working and saving, it might be reasonable to be less frugal in your retirement years than you disciplined yourself to be in your accumulation years. Your consumption smoothing may not end up being ideal, but perhaps it then makes sense to work on overcoming your previously virtuous frugality, and spending more to enjoy your remaining years more.

USAlliance Financial 2-year CD, 2.27% APY

Today I became a member of USAlliance Financial credit union, and opened a new 2-year CD with an APY of 2.27%. This is an incredible rate on a 2-year CD, with most of the 2-year CD competition in the 1.5% ballpark, and the 2-year Treasury yield at about 0.7%. This 2-year rate is even a bit better than the 5-year CD rate at Synchrony Bank (2.25% APY). This premium rate is available only to new members, and is a limited-time offer, with a maximum deposit of $100,000. I haven't paid much attention to laddering CDs, because generally I can earn a better return doing early withdrawals from longer-term CDs, than by holding shorter-term CDs in a ladder. But this CD is an exception to the rule, and provides a nice 2-year rung in a CD ladder.

First bank-to-bank IRA transfer from a maturing IRA CD

I recently completed my first transfer from a maturing IRA CD into a new IRA CD at another bank, and everything went very smoothly. There are two reasons I would consider doing such a transfer: 1) better rates at another bank or credit union; 2) stay within FDIC/NCUA insurance limits. Both were applicable in this case. If neither was a factor, I would have just rolled the maturing CD into a new CD at the current bank. Unless you own any IRA CDs, and you may eventually want to transfer the balance to another bank or credit union when they mature, there is no need to continue reading; there are no other investment lessons here.

Human Capital, Financial Capital

The value of a young person's future earned income typically is much larger than the value of her savings and investments. In economics jargon, her human capital is much larger than her financial capital. Conversely, an older person has much less human capital and hopefully much more financial capital. Human capital is converted to financial capital by working and saving over the years. A higher savings rate converts more human capital to financial capital. The ratio of human capital to financial capital is an important consideration in determining ability to take risk in one's investment portfolio.

Synchrony Bank 5-Year CD

Note: Since originally publishing this, GE Capital Retail Bank has been renamed to Synchrony Bank, and the 5-year CD rate now is 2.25% instead of 2.30%. I have re-titled the post accordingly and done a few minor edits since I refer to this blog post so often in my Bogleheads posts.

I am in the process of transferring out of some bond funds and a money market fund in my IRA at Fidelity to a new IRA CD at GE Capital Retail Bank (GECRB, now Synchrony Bank). The CD interest rate is 2.30% APY (now 2.25%), and the early withdrawal penalty is six months of interest. This is an excellent fixed-income choice in today's ongoing-low-rate environment. PenFed credit union offered a much better deal back in December 2013 and January 2014, with a 5-year CD earning 3.03%, but nothing has come close to that since. Top CD rates have been hovering around 2.25% lately. Following are some details about what I've done so far to open the account and transfer the funds, and a recap of why I like CDs purchased directly from banks and credit unions.

Market Update

Financial markets have been relatively calm so far in 2014: US stocks have gained about 1-2%, total international stocks are up almost 3%, and total return on US bonds has been about 3.5% (I'm using returns from Vanguard's Total Stock Market Index, Total International Stock Index, and Total Bond Market Index funds). There was a mild correction in late January with US stocks down about 5% and international stocks down about 7%, but other than that, stocks have been mostly bouncing around the +/-2% range.

By contrast, 2013 was a big up year for stocks and a down year for bonds. US stocks returned more than 30%, international stocks returned about 15%, and the Total Bond Market index fund lost about 2%. US stocks got an extra boost from small-cap stocks which returned about 38% in 2013. International stocks were dragged down by emerging markets which lost about 5% in 2013, while developed international markets gained about 22%. Bond fund losses, caused by generally rising interest rates, were proportional to interest-rate risk (average maturity/duration of fund), with Vanguard's Inflation-Protected Securities fund losing almost 9% and its Long-Term Government Bond Index fund down about 12.5%.