The Collision of Retirement Planning and Asset Diversification
Phases of Retirement Planning
Retirement planning is something that all of us hopefully have the opportunity to experience sometime in our lives. Our lives can be broken up into distinct seasons or phases of life. Our foundational and educational years end when we move into the workforce. For many, there is also another phase that includes starting a family. In between the beginning of a career and retirement, there are many smaller events like job and employer changes, as well as career changes. However, through all of this, nearly everyone is trading their time and labor for compensation. During this time, it is extremely important to continually be in the process of building assets, leveraging your earning ability to increase your value as an employee, and making smart investments in areas that will yield value in the future. Investments in yourself during the earning years will pay large dividends in higher levels of compensation in the future. Sometimes this is going back to school for an advanced degree, or pivoting out of one career and into another that has better growth prospects. A reinvestment in yourself could even be taking the skills that have been built during the early years in your career and taking the risk of starting your own business. It is extremely important to think of your time and labor as resources that are slowly consumed over your career. As reserves begin to be depleted, it is impossible to refill those reserves, so it is most important to grow earnings early and often.
Retirement Planning for the Masses
Saving for retirement is communicated to the mass market as utilizing your 401k plan and a Roth IRA, striving to max these accounts out every year. Now, don’t get me wrong, these are great savings vehicles and are very good for individuals that want a “turnkey” system to retirement savings. It is quite a simple formula to determine how much you should save every month or year in order to reach your retirement goals. However, utilizing and saving to 401ks and IRAs are not the only way to efficiently reach your retirement goals. Arguably, saving to these retirement vehicles can actually constrain your ability to reinvest back into yourself during your career.
Career Changes and Personal Reinvestment
Take as an example, there is an opportunity to leave your occupation as a travel agent considering the industry is slowly dying with online travel bookings much more common now than it was 15 years ago. Your new industry is software development, however, it is going to require paying for a coding bootcamp, and carrying your personal expenses for 6 months until you can make the transition. In addition, the starting salary of your new job will likely still be 20% lower than your salary as a travel agent. However, as a travel agent, there was very little opportunity for your compensation to rise, but as a software engineer your salary will likely rise 5-15% annually. If, as an employee, the only savings decisions you made during your time as a travel agent were to save to a 401k and IRA, there are going to be hefty penalties and taxes for withdrawals to pay for the bootcamp as well as your personal expenses for 6 months. If instead of putting all of your savings towards retirement accounts you purchased a few rental properties, there would likely be equity in the properties that could be utilized with a Home Equity Line of Credit (HELOC) as well as cash flow from the properties without tax impacts. In fact, you might end up paying less in taxes during this time!
Millennials are Changing the Workforce
This example is not an unusual one, especially with a new generation of workers that are less inclined to stay at one employer for their entire careers. According to Gallup, 50% of millennials plan to be working at their company one year from now, and 21% of millennials have changed jobs within the last year, which is three times more than non-millennial workers. It is for this reason that diversification doesn’t just need to happen on an account level, but also on an account type level. This means that it isn’t sufficient to just have qualified retirement accounts, but you should also have cash, after-tax holdings of stocks and bonds, as well as physical assets like real estate.
Retirement Planning through a Different Lens
Let’s take a look at the prior example of the travel agent, named Joe. Let’s say the bootcamp is going to cost him $30,000 and the 6 months of zero income will cost $24,000 in personal spending needs. If the only investments available to Joe are retirement plans, that means the $54,000 of expenses will require a withdrawal of $68,300, which will cover the $54,000 + 15% tax withholding + 10% tax penalty. That is 25% extra that does not add value, and is largely going to the federal government. However, let’s consider that Joe had two investment properties with $100k of equity and cash flow of $1,500 per month. Since the cash flow will be coming in already, it can be used to offset the approximately $4,000 per month in personal spending, bringing it down to $2,500 per month. This means Joe will need $30,000 for the boot camp and $15,000 for the gap in his living expenses. There are lenders who will allow investors to borrow up to 80% of the value in their investment properties. Because of the 80% loan to value limit, Joe will not be able to borrow all of his available equity, however, after doing the calculations he is able to borrow $50,000. This ends up working perfectly for him since he is able to borrow $45,000 from his HELOC to cover the additional spending needs and the boot camp.
Holistic Retirement Planning
The popular definition of retirement planning is geared towards putting workers capital into specific accounts and leaving the capital for 30+ years. However, it is so important to remember and understand that retirement planning is not just about putting enough assets away for age 65. It is also about reinvesting in the to-be retiree so they are able to increase their earning potential and reach their retirement goals with a higher level of confidence and certainty. Tax optimization has always been the top priority, however, with tax rates at the lowest rates since 1916, this should cause some reconsiderations for saving as much as possible to tax-deferred accounts. All of these planning ideas have specific facts and circumstances that make it very difficult to have a one-size fits all approach. For some, only saving to tax-deferred retirement plans might make very good sense, however, for others this could be one of the worst pieces of planning advice possible. Just like many other things in life, moderation is a very good thing. It usually isn’t a very good idea to only eat one type of food for a prolonged period of time. There are good reasons we have lots of variety in food selection. Carbohydrates and vegetables are very different foods, and each serve the body in different ways. The same is true for tax-deferred retirement plans and after-tax investments in real assets.
One Size Does Not Fit All
If you have been approaching retirement planning using the “traditional” method, it might be wise to consider the additional risks that are associated. Additionally, opportunity cost is a major factor that most don’t consider when determining how to allocate their time, labor and capital. When all three of these factors can line up together in the right place, it can be an accelerant for the person that is in the right place with the right resources available to them. The old method of retirement planning isn’t broken, but it certainly isn’t right for everyone. Consider your situation closely on whether you should take a different approach, if necessary, let’s have a discussion about your optimal path forward!
About Daniel:
Daniel is a trusted financial planner, real estate investor, small business owner, and AirBnB Superhost. I started RE|Focus Financial Planning, a boutique planning firm focused on working with real estate and cryptocurrency investors. As a CERTIFIED FINANCIAL PLANNER™ professional, I help successful individuals and families gain clarity on their current situation and future goals. If that sounds like you, let’s have an introductory conversation to learn more.
