In September the financial advisors at Ruedi Wealth Management wrote five more columns for The News Gazette’s Business Extra section. Make sure to look for the columns every Sunday, but in case you missed the columns from this past month, all five are below.
Treat Yourself Responsibly
Paul R. Ruedi, CFP®
When it comes to treating themselves, people don’t seem to naturally fall into a balance. Frugal people tend to have a hard time enjoying spending to treat themselves and tend to under-spend. At the other end of the spectrum, some people find it very easy to treat themselves and are likely to over-spend as a result. Neither is a great route, and it is up to every person to find balance and treat themselves responsibly. But how much is the right amount?
For something that seems like such a large part of our culture these days, a quick Google search will show we are somewhat starved for spending rules for people treating themselves. The most common one I saw was the 50/30/20 rule, that suggests people should spend 50% of their income on essentials, 30% on guilt-free spending, and the remaining 20% on saving and investing.
I personally believe the 30% figure to be a little high, but would perhaps think of it as an upper limit to rein in people who have an easy time spending to treat themselves. But I think a lot of people would feel guilty about spending more than they are saving. Though I am not extremely frugal when it comes to enjoying spending money, I personally wouldn’t feel right spending more to treat myself than I was saving.
For that reason, I personally follow a little different model. When it comes to treating myself, I have generally limited myself to spending less than 1% of my net worth. Though rules of thumb are never perfect, I like one that scales to net worth because it limits spending at lower net worth amounts when people should be saving more, while allowing for some truly guilt-free spending for frugal people who have built up a large net worth as a result.
But there are some caveats. I would never spend more treating myself than I would save in any given year. Any of this spending will be done using cash, likely from my income that year, which will also serve as a limiting factor. If I experience a low-income year, I will likely have less cash on hand to spend treating myself, forcing frugality when it is likely needed.
Whether you follow the 50/30/20 rule or some other responsible hybrid model, the important thing is that you have some sort of reasonable plan for treating yourself. If you are unsure how much to spend treating yourself, you may want to talk to a financial planner.
Leaving Your Job? Don’t Forget About Your 401(k)
Daniel Ruedi, CFP®, RICP®
A survey released by Bankrate in August suggested that a staggering 55% of people plan to look for a new job within the next year. There are so many people leaving and planning to leave work these days the phenomenon is being called The Great Resignation. If you are one of the people planning to switch jobs, you won’t want to forget about your 401(k) if you have one. There are several things you should keep in mind.
I will start with loans against your current 401(k) plan because they have the potential to be the biggest hazard when switching jobs. If you leave your job and still have a loan balance, your old employer will likely require you to pay it back quickly. If you don’t, your account will be reduced by the loan amount and it could be considered a taxable distribution, and if you are under 55 that means an additional 10% penalty as well. However, you have until tax day the following year to replace that loan amount and avoid the taxable distribution.
You will want to be conscious of the vesting schedule of your employer’s contributions. Some companies follow vesting schedules where employees don’t own the employer contributions to their 401(k) right away. In some cases a certain percentage of employer contributions vest each year, but others may have a cliff, where contributions become 100% vested all at once after a certain number of years. If you are about to leave a job you may want to be conscious of these vesting periods and make sure you don’t leave right before a vesting breakpoint or cliff.
You will eventually need to decide whether to leave your money in your old employer’s plan (if possible), roll it over to you new employer’s plan, or roll it over to an IRA. If the old employer’s plan is low-cost and you like the investment options, you may consider leaving it there provided they allow it, and you won’t forget about it later. If you want to simplify to the greatest extent, you may want to roll it into the new plan. If you want to take a more self-directed approach to your investments and plan to retire after age 59½, you may want to consider rolling into an IRA.
If you aren’t sure about the impact switching jobs will have on your ability to save for retirement, or aren’t sure where or how to roll over your retirement funds, you may want to talk to a financial advisor.
Rolling Over a 401(k)
Daniel Ruedi, CFP®, RICP®
In my last column I discussed how a record number of people plan to switch jobs within a year, and a few things they need to be aware of regarding their 401(k). Today I want to go into more details about rolling over your 401(k) plan into a new 401(k) or self-directed IRA, and how to avoid a couple common issues.
If you like the investment options of your old 401(k) and the plan is very low-cost, you may consider simply leaving it there. Employers must let you hold money in their 401(k) indefinitely if you have more than $5,000 in the account. But many people will want to move their money to their new employer plan to simplify their investments. If you like the investment options and are comfortable with the costs of the new employer’s plan, this is a good option.
If you don’t like the investment options in either 401(k) or if they have high fees, you may want to consider rolling over into a self-directed IRA. The benefit of a self-directed IRA is that you have more investment options. The downside is you must wait until age 59 ½ to withdraw from an IRA without penalty; with 401(k)s you can withdraw money penalty-free if you are 55 or older in the year you separate from that company.
When performing a rollover, you should be very careful about who the check is made out to. If your old 401(k) sends a check made out to you in your name, it is initially considered a distribution, and the plan is required to withhold 20% to pay taxes. If you intended to roll over the entire amount to a new plan, you will have to come up with the 20% that was withheld, and put it into the new 401(k) or IRA. If you do not, the 20% that was withheld will be considered a distribution, and thus subject to taxes (and possibly a penalty if you are under age 59.5).
If the check from the old 401(k) financial institution is made out to the new 401(k)/IRA financial institution on your behalf, there is no tax withholding, avoiding this issue altogether. So it is generally recommended to do a "direct rollover."
There are several things to consider when making the rollover decision, and a few things you need to get right to avoid some headaches, or worse, losing money to taxes and penalties. If you aren’t sure how to roll over a 401(k) yourself, you may want to seek the help of a financial advisor.
Our Favorite Investing Books
Paul R. Ruedi, CFP®
Though it is an important life skill, our education system simply doesn’t emphasize lessons on investment philosophy and how to invest in the best way possible. Though I majored in finance in college, most of my practical financial education was the result of guided self-education by reading the books Paul Sr. recommended. Four books in particular stick out as being the most helpful, and all four or which I would highly recommend to readers of this column.
The first book is The Investment Answer by Daniel C. Goldie and Gordon S. Murray. Of all the investing books I’ve ever read, this book provides the most information with the least pages by far. At only 96 pages, it manages to cover whether or not to manage your own investments, asset allocation, diversification, active vs. passive management, and rebalancing. It is 100% practical and easy-to-read, as it purposely avoids financial jargon.
Simple Wealth Inevitable Wealth by Nick Murray is a book Paul Sr. thinks so highly of he has been giving copies to clients for over 20 years. The book emphasizes how wealth is the result of patient, disciplined investing in the stock market. This requires a long-term perspective on the growth of wealth stocks have provided investors throughout history, but also avoiding big investing mistakes like selling in a panic when the market is down. As the title implies, if investors simply invest in the great companies of America and the world and stick with their investments, building wealth over time is inevitable.
Winning the Loser’s Game by Charles D. Ellis emphasizes how investing, for most people, is a “loser’s game” – whoever makes the fewest mistakes wins. It provides a deep dive on active vs. passive investing, and shows how trying to beat the market through stock picking or market timing is more likely to cost you than it is to provide excess riches. The author explains that even 4 out of 5 professional money managers fail to “beat the market,” so the best option for most people is to buy a simple, passive index fund.
The Behavior Gap by Carl Richards focuses on the ways emotions and behaviors often make people terrible investors. It focuses on the human side of investing, and is sympathetic to the struggles investors face merely because they are humans who aren’t necessarily hard-wired to be good investors. The book does a great job of providing perspective on common behavioral investing mistakes and how to avoid them.
Income “Too Low” To Save?
Last month the Transamerica Center for Retirement Studies published the results of its 21st annual retirement survey, where they asked thousands of people questions about preparing for retirement. The study included the data from over 3,000 currently employed individuals, and as in years past, highlights many of the challenges people face when planning for retirement, and several misconceptions that people have about preparing for retirement. One of the things I found the most interesting was that almost half (48%) of people in the survey reported that their income was simply too low to save for retirement.
I am sympathetic to the fact that many people, especially those starting their careers, have a relatively small amount of money to go around. If deciding between saving for retirement or paying an electric bill, of course you have to deal with your more immediate needs and worry about retirement later.
But I often hear this from people who should be well above those tough decisions from an income standpoint and simply aren’t making saving a priority. I find that many people who are afflicted by this issue when they have a low income continue to be afflicted by it even when their income rises. For whatever reason, even though they are making a higher income their expenses always seem to rise to eat up more of that income. Somehow there is just never enough left over to save for retirement.
I have seen many people save amounts they honestly can’t even spend while having never made a particularly high salary. They all tended to be frugal, and naturally had room in their budgets to save as a result. They “paid themselves first” by saving before they spent. Over time, it piled up in a way that created wealth they would have never thought possible. If you think of wealth as the ability for your assets to provide for your lifestyle, these are often the “wealthiest” people.
If you are struggling to save for retirement don’t beat yourself up, but you may consider freezing your spending now and saving any increases in income to get that process started. If you aren’t sure how to do that yourself, or are unsure the amount you are saving will enable you to retire comfortably, you may want to talk to a retirement planner.