The Bogleheads' Guide to Retirement Planning Read Online Free PDF Page B

more than any other expense. You can grow your retirement account faster by using a tax-deferred savings account such as a 401(k), 403(b), 457, SIMPLE or SEP account, traditional IRA, or tax-tree Roth IRA. Assume you save $500 per month for 30 years at 5 percent interest in a tax-deferred or tax-free account. The account grows to a total of $417,863. If you save the same amount for 30 years in a taxable account, the result is $364,201 at a 15 percent tax rate or $324,290 at a 28 percent rate. You will learn more about tax-advantaged strategies in other chapters throughout this book.
Risk Tolerance
    All investors should assess their risk tolerance when getting started in investing. Your risk tolerance is an assessment of how you will react psychologically when the stock market and your investments go up and down.
    Investors who buy riskier mutual funds could use one or more of the Internet-based risk tolerance assessment tools to help them determine what percentage of their investments they wish to have in stocks and what percentage they wish to have in less volatile investments like bonds and certificates of deposit (CDs). A high risk tolerance indicates an investor who is less likely to sell shares when the market is down, a key attribute needed if you hope to match or beat overall market performance. Do be aware that you probably can’t really appreciate your risk tolerance until you pass the sleep test during a major market downturn such as those experienced in the early 1970s, 1987, early 2000s, and in 2008. Down markets of 20 percent or more happen more frequently than people think.
Diversification (Asset Allocation)
    Overall portfolio risk is controlled through diversification. In financial planning, diversification of a portfolio is usually referred to as asset allocation. In its simplest form, asset allocation is a recommended percentage of assets that should be in equities (stocks or stock mutual funds) or in fixed income (bonds, money markets, or certificates of deposit).
    Rebalancing is the process whereby you periodically adjust the current allocation of your portfolio to stay close to your desired asset allocation, thus controlling your portfolio risk. For example, when the equity percentage is too high because your stocks went up in value, sell some equities and buy more bonds. This sell high and buy low transaction can be an effective strategy to keep you on track to meet your goals. No matter what your risk tolerance is, your asset allocation should become more conservative as you approach retirement age or as you realize your planning goal—regardless of age. Later chapters cover rebalancing in more detail.

CALCULATING YOUR NUMBER
    Most couples planning for retirement want a savings number that will tell them when they can retire. In his book The Number , Lee Eisenberg refers to it as “how much [you] need to walk away on [your] own terms, never to look back.” Coming up with an accurate savings or net worth number is difficult because you have to weigh numerous factors that affect your decision about when to voluntarily retire: health, age, savings, and lifestyle.
    The rule of thumb many financial planners use to determine how much income you will need to maintain your current lifestyle in retirement is 70 to 80 percent of your income while working. Unfortunately, the 70 to 80 percent guide can be an erroneous amount because it is based on earnings, not spending. Many people live on much less than they earn, and others with the same income struggle from paycheck to paycheck. The 70 to 80 percent guide also oversimplifies the issue since it fails to take into account your age at retirement, pension from an employer, eligibility for Social Security benefits and Medicare, postretirement health insurance costs covered by your employer, your health, and even your lifestyle. A better approach is to do a financial plan that includes a detailed retirement budget, as Eisenberg suggests.

LIFESTYLE IMPACT ON