Expert Interview with Jon Petersen About investing for Retirement

Investing for retirementSometimes simpler is better.

While we may appreciate complexity in our sports cars, our flavor palates, even our stock portfolios, understanding those portfolios should not be complicated.

This is the main premise that inspired Jon Petersen to start the blog Novel Investor, where he investigate the nuanced, intricate world of finances and reports on his findings.

Can you introduce us to Novel Investor?

I started Novel Investor back in 2010. I’m based out of Chicago, with a background in finance, though I spent the decade prior working in small business. The financial crisis renewed my interest in finance, particularly investing. It also left me with no job. So, I took the opportunity to reevaluate my options. I built the site not knowing which direction I wanted to take it beyond sharing what I already knew, what I’ve since relearned, and what I continue to learn about saving, investing and more.

Who is your main clientele, and how does Novel Investor meet their particular needs?

Clientele is a bit too formal. I don’t consider myself an expert, and I’m not looking for clients because I don’t offer individual advice. I’m just looking for like-minded readers who want to learn more about the topic. I believe bad behavior and lack of knowledge are the biggest obstacles keeping most people from reaching their financial goals. In other words, we are our own worst enemies when it comes to money. A lot of the basic mistakes people make can be prevented just by knowing a little bit more about financial topics. I can’t stop people from making financial mistakes, but I can share what I learn. Maybe that is helpful for the next person.

Novel Investor is based around the concept of simplifying the complex subjects of saving, investing and growing your client’s money. How do you go about achieving this? Why is it important?

Well, there are two reasons.

Most of the stuff we do in life, we try to simplify. Yet for some mysterious reason, the common view is that because saving and investing seem complex, they should be complicated. That’s just not the case. You can make them complicated if you want. But saving and investing can be simple, and simple works very well. So I try to cover topics as simply as possible and show how well simple works. After knowing that, if someone still wants to choose complicated or complex, that’s their choice. I believe most people are better off with simple. Now, I’m still interested in the complex topics, so I cover those too (as simply as possible).

The other reason – over the past few years I’ve learned that writing helps my learning process by trying to simplify what I’ve read into a few key points. If I can do that, then I generally have a good understanding of the topic. Sometimes it works. Sometimes I fail miserably. In which case, I read more and rewrite. Most of what I write never sees the light of day.

You’ve written that the past few decades have changed the way we save for retirement. Can you detail what a few of these changes have been? What kind of impact are these changes having?

Retirement savings in the US basically moved from forced saving (through pensions) to optional saving (with 401(k)s). In the past, pension contributions were mandatory. In return, you were paid a lifetime income in retirement. Even if you never saved any extra money, a pension offered a decent retirement income.

Unfortunately, pensions had a few drawbacks – people lived longer and the cost to companies rose – so most employers switched to 401(k)s. My first introduction to a 401(k) plan was a 15-minute meeting with a couple salesmen from the plan provider. The other employees and I were handed a packet full of information and investment choices, told to fill things out, and return it if we wanted to contribute – no mention of the tax benefits, how much to save, or which funds to choose. I had to figure it out myself.

Today, with 401(k)s and similar plans, there’s a disconnect. Either people don’t save, don’t know how much to save, or don’t know how to invest the savings. A pension took care of all of it. The 401(k) works well, but it requires some extra learning. If you don’t have a pension (which most people don’t) and plan to retire (which most people want), you must know at least the basics about how your retirement plan works.

You’ve also written that retirement planning has its own set of rules, limitations, and tax advantages. What are a few of these specifics of which people might not be aware?

Well, the biggest is the tax advantages. Money in a retirement account grows, tax-free. So it doesn’t get taxed as long as it stays in the account. And depending on the type of plan, it may or may not get taxed when you take it out.

Then there is the possible tax deduction, like with a 401(k). Any money you put in offsets your income as far as the IRS is concerned. Lowering your taxes because you saved for retirement sounds like a great deal to me. Lastly, some companies match a certain percentage of what you put into your 401(k) every year. That’s free money everyone should take advantage of.

The limitations are fairly straightforward. Every retirement account – 401(k), IRA, etc. – has limits on how much money you can put in every year and when you can take it out. And IRAs have rules around income limits, age limits, and more. The rules are fairly extensive. You don’t need to know all of them, but you should have an idea of how each plan works as far as putting money in and taking money out.

What are some reasons someone should begin preparing for retirement early, no matter what phase of their career they’re in?

I’m not sure how much preparation needs to happen early beyond just saving. When I got out of college, retirement was the last thing on my mind. I had no idea what my retirement plans were. I still don’t. But I still saved money. Just doing that gets you in the habit of saving early. The early savings gets some help from compounding, which makes things easier when you finally do have a plan later on.

What are a few things someone just starting out needs to know, as far as investing for retirement is concerned?

It doesn’t get any more tax efficient than investing through a retirement plan, so take advantage of it. Keep in mind, you can go insane trying to optimize everything to the last penny. Instead, focus on what you can control. How much you save is more important than how you invest the savings, especially early on.

At the very least, if your company offers a 401(k) match, you should contribute enough to get the full amount. A better idea would be to contribute a percentage of your income every year, say 15%. This way, whenever you get a raise, your retirement savings gets a raise too.

As far as investing for retirement – keep it simple at first. A total stock market fund and total bond market fund are more than adequate to get you started. As you learn more, and save more, you can make adjustments to your investments. Lastly, don’t be afraid to ask for help. There are a lot of great certified financial planners out there – look for the CFP acronym – to help with retirement planning and more.

In the post “A Saver’s Guide to Retirement Accounts,” you break things down into three main categories: 401(k), traditional IRA, and Roth IRA. Could you briefly recap the difference between these?

The biggest difference is 401(k)s are offered through work while IRAs you set up yourself. If your company offers a 401(k), it’s the best savings tool you have. If you need to save more money, an IRA is a great supplement to your 401(k). Between traditional and Roth IRAs, the big difference is when the money is taxed. Money in a traditional IRA is taxed when you take it out. Money in a Roth IRA is taxed before you put it in.

Those are the basics. I suggest people read through each guide for more information.

What advice do you have for people who are concerned about the rising cost of living, and outliving their retirement plans?

This goes back to focusing on what you can control. Right now, the cost of living isn’t rising that fast. Inflation has been well below average the past six years. And nobody knows what inflation will be like in the future.

We can’t control inflation but we can control what we buy and how much we spend. We can control how much we save. Outliving retirement savings is a problem partially due to not saving enough but also spending too much in retirement. So, a budget is important. And sticking to the budget is important. That said, you still need to save enough so your budget is easy to live with. That means saving enough money every month to meet your retirement goal. The alternative is a drastic downgrade in your lifestyle once you retire.

What’s a rough estimate of what someone might need to retire, as far as what they should shoot for? How would someone go about calculating this figure for themselves?

Most people do this wrong. They look for a nice, round number based on how much income they think they want. Instead, they should look at how much income they need to cover their expenses in retirement and work backward.

The best place to start is with your current monthly budget. Take out what you won’t be paying for in retirement (like college costs, mortgage, and retirement contributions), add in extra expenses you think you might have (like travel or hobbies), add a cushion to be safe, and multiple by 12 for your yearly costs. Now, divide your annual cost by 4% (this allows for inflation and a conservative estimate of investment returns) to find out how much you need to save.

For example, if $40,000 covers your yearly expenses, you’ll need $40,000/0.04 or $1,000,000 saved. Keep in mind this is only an estimate. Like every other retirement calculator, it can’t predict the future, but it does give you a goal to strive for. You still need to build a retirement plan to reach the goal.

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