Smart Couples Finish Rich, Revised and Updated

by David Bach

  CDs are great investments if all you’re interested in is preserving capital—say, if you’re already retired and can’t afford to take any risk at all with your money. But if your goal is to build a retirement nest egg, investing in something that generates an annual return of only 5 percent or so is crazy. Actually, there’s a technical term for that kind of retirement strategy: I call it Going Broke Safely!

  RULE NO. 2

  Make sure your retirement money is invested for growth.

  When you’re building your retirement account you can’t finish rich with fixed-return investments. It’s that simple. Fixed-return investments such as certificates of deposit are earning less than 3 percent right now, and if that’s all you’re making on your money, you may never be able to build substantial wealth.

  The fact is, most people undercut their ability to finish rich by investing too conservatively. Because their retirement money is so important, they don’t want to take any chances with it. What they don’t realize is that the biggest risk you run with a retirement nest egg is that it might not be substantial enough to live off of when you retire.

  If your money is not growing at a rate at least 4 to 6 percentage points higher than inflation, you face the possibility of outliving your income. The bottom line here is that you need to invest for growth. In practical terms, this means that a portion of your retirement portfolio must be invested in equities. You can do this by purchasing individual stocks or shares in one or more equity-based mutual funds. But whatever form it takes, you’ve got to keep at least some of your money in equities.

  RULE NO. 3

  Allocate your assets so that you maximize return while minimizing risk.

  The rule of thumb when it comes to investments is simple: the higher the return, the higher the risk. What this means is that a smart investor is always engaged in something of a balancing act. As I noted, being overly conservative when it comes to your retirement nest egg can undermine your chances of finishing rich. On the other hand, you don’t want to be too much of a gambler. The key to finding and maintaining the right balance between risk and reward is what is known as asset allocation.

  Asset allocation is one of those terms that can sound more complicated than it really is. In fact, all we’re talking about here is how much of your retirement money should go into relatively safe, relatively low-yielding investments (like fixed-return CDs) and how much should go into riskier, higher-yielding investments like growth stocks.

  Figuring out how to allocate your assets doesn’t need to be difficult. Obviously, as my grandmother liked to remind me, you don’t want to keep all your eggs in one basket. But how do you know what proportion of your nest egg should be invested in equities vs. fixed-income securities? There are all sorts of ways to calculate this. For my part, I prefer the following simple rule of thumb.

  Take your age and subtract it from 110. The number you get is the percentage of your assets that should go into equities; the remainder should go into bonds or other fixed-income investments.

  Here’s how this rule works. Say you’re 40 years old. You subtract 40 from 110, and you get 70—which means you should put 70 percent of your retirement assets into stocks or stock-based mutual funds. The remaining 30 percent of your assets should go into safer investments such as certificates of deposit, money-market funds, or fixed-income securities such as bonds or bond funds.

  If you’d prefer to keep things even simpler, forget about subtracting your age from anything—just put 60 percent of your retirement in stocks and the remaining 40 percent into bonds. Known as a “balanced account,” this allocation typically delivers about 90 percent of the stock market’s return with about 30 percent less risk. It’s what I call a “sleep well at night” asset allocation, and it’s especially good for people who are nearing retirement age.

  While this may sound oversimplified—and it is—it’s also a great way of maximizing your return while minimizing your risk.

  Once you’ve figured out how you want to allocate your assets, you’ll need to choose the actual investments. Because this decision is more specific, I recommend you discuss it with a knowledgeable financial advisor. Reviewing your risk tolerance in detail with a qualified financial advisor can really make all the difference in how you do. If you work with a financial advisor who knows what he or she is doing, the advisor will run you through a detailed financial-planning process to help you evaluate your goals and risk tolerance that will drive your customized asset allocation model. It is critical that you don’t take more risk than you are truly comfortable with—and that you understand how much risk you are taking. In any case, whether you plan to go it alone or just want to do your own research, there are plenty of useful Internet sites that can help you with retirement planning. (Check out some of the sites listed on this page.)

  RULE NO. 4

  Invest in your company’s stock, but do your homework!

  I mentioned earlier that if you work for a publicly traded company, one of your 401(k) options may be to invest all or part of your retirement nest egg in your employer’s stock. As a loyal employee, you may feel this is definitely the way to go. But be careful. While it’s certainly true that investing in your company’s stock can make you very rich if the company does well (we’ve all heard about the employees of Google, Facebook, and Amazon who became millionaires and in some cases billionaires), it can also make you poor if the company stumbles. And even great companies occasionally stumble. In 1987, for example, IBM’s stock fell by more than 70 percent. There were people close to retirement age at IBM, heavily invested in company stock, who saw literally half their nest egg disappear in a matter of months. Most recently, this month as I write this update, Amazon bought Whole Foods, and as a result rivalry grocery stores saw tens of billions in equity value decline in a day! An entire industry was hit by one simple announcement. Here’s what is scary—and I’m making this boldface and all caps so you really catch the point: MANY OF YOU HAVE WAY TOO MUCH OF YOUR NEST EGG IN YOUR COMPANY STOCK AND YOU DON’T REALIZE IT! This works great, until it doesn’t work.

  Not only do great companies sometimes stumble, but great economies sometimes slow, causing great stocks to crumble. So you want to be careful to limit how much of your retirement money you invest in one company’s stock—even if that company happens to be the one you work for. Many experts recommend that you never invest more than 10 to 20 percent of your nest egg in your employer’s stock. While investing in your company stock can make you rich when things go right, it can also make your poor overnight if things go horribly wrong. My recommendation today is never invest more than 10 percent of your 401(k) plan money in your company stock, and if you’re already investing or getting company stock or options, I would pass on investing in the company stock in your 401(k) plan.

  I also strongly recommend that you do some research into your own company’s stock, before you invest. The simplest way to do this is to call your company’s investor-relations department and ask for what they call an “investor kit.” Virtually all publicly traded companies offer these kits. They include articles about the company, a copy of its latest annual report, and what is known as its Form 10-K. The 10-K is a report that all public companies are required to file annually with the Securities and Exchange Commission. It provides detailed information on the company and its finances. Whether or not you’re planning to buy stock in your company, I suggest that you read its 10-K.

  Although the 10-K can look complicated, it’s not really all that difficult to understand—and it can be incredibly informative. Indeed, reading through a 10-K will tell you everything from what your company does to how much its top executives are paid. It also details every possible thing the company thinks could go wrong that might adversely affect the price of its stock. This is really important information to know not just as a potential investor but also as a current employee. You can also listen to the company’s quarterly earnings conference call with Wall Street analysts or review the transcripts
that are often available on SeekingAlpha.com.

  Once you’ve absorbed all this, you can supplement your knowledge by going online and checking out one of the many websites that specialize in providing information about individual stocks.

  There are too many to list here, but a useful roster would include the following:

  www.google.com/​finance

  www.finance.yahoo.com

  www.sec.gov

  www.marketwatch.com

  www.morningstar.com

  www.valueline.com

  www.thestreet.com

  www.fool.com

  www.barrons.com

  www.nyse.com

  www.nasdaq.com

  www.seekingalpha.com

  RULE NO. 5

  Make sure you read all of Step Eight.

  In Step Eight, I list some of the biggest mistakes investors make. Make sure you read this step all the way through, because committing just one of these errors could cost you a fortune in retirement income.

  Well, that’s it. The two of you should now have all the information you’ll need to create your retirement basket and finish rich. Both of you should know now why you need to max out your retirement contributions and how to invest the money you’ve committed to put into your retirement plans.

  Of course, none of this will matter if you’re not totally motivated to pay yourselves first. I hope you both are. Remember, the one thing that can prevent you from finishing rich is you. If you don’t do this stuff, it won’t work. If you don’t sign up for your 401(k) plan and max it out, or open and fund a SEP if you’re self-employed, it’s not going to happen. If you don’t teach your children about Roth IRAs, they might not learn about them until it’s too late.

  The key is to act on this chapter now. If you set this book down and never come back to it but do what I discuss in just this one chapter, you’ve got a great chance of ending up in the top 10 percent of wealth in this country. But don’t settle for just that. I want to get you to the top 5 percent. And with that in mind, let’s look at how you are going to protect your wealth against the uncertainties of life by building a security basket.

  * * *

  *I know it’s hard to believe that once upon a time you could get a CD at 7 percent, but you could.

  STEP 6

  BUILD YOUR

  SECURITY BASKET

  So the two of you are putting aside a set percentage of your income, building a retirement basket that will enable you to finish rich. I’ll bet you both feel a lot more secure about the future than you did when you first started this journey. You should, because you are. But that doesn’t mean you can sit back and relax. Just the opposite—now is the time to start planning seriously for life’s unexpected problems.

  THE REALITY IS THAT SOMETIMES LIFE IS MESSY

  I’m a positive person and I’d like to be able to tell you that everything is always going to be just fine for all of us. Unfortunately, the reality is that sometimes things don’t go that way. The reality is that sometimes things can go wrong—really wrong. People lose their jobs, marriages fall apart, businesses go bankrupt, breadwinners get sick and occasionally even die. Stuff happens.

  There’s no getting around it. Stuff has always happened, and it’s not going to stop happening now just because you’ve decided to be smart about your finances.

  But that’s no reason for the two of you to get discouraged.

  If you know that things can go wrong, then you can prepare yourselves, and being prepared puts you in a position of power. Having a “Plan B” in case things don’t work out the way you want them to doesn’t only make you feel secure, it actually makes you secure. That Plan B, of course, is your security basket, and building it is like building the foundation for your family’s financial home. You could build a really great house (by doing a great job on your retirement basket), but if you don’t put it on a solid foundation (a well-stocked security basket), that gorgeous home of yours (your financial well-being) could come crashing down on you and those you love.

  HOPE FOR THE BEST, BUT PREPARE FOR THE WORST

  The point of a security basket is simple. It’s meant to protect you and your partner and your children (if you have any) in the event you’re hit by some unexpected financial hardship. This hardship could be something major, like the loss of a job or a death in the family. Or it could be something minor, like the car needing new brakes or the dishwasher going on the fritz. The point is that unanticipated problems are bound to arise, and while you may never be able to guess in advance where exactly they might come from, you can still be in a position to handle them.

  In my seminars, I liken the security basket to what the automobile companies like to call their “passive restraint systems”—that is, the seat belt and air bag that are required in all new cars these days. When you get a new car, you pay for an air bag and you wear your seat belt as a matter of course. This doesn’t mean you want or plan to get in an accident. You’re simply being smart; you’re making sure you’ll be protected in the event of a crash. Well, that’s exactly what we’re going to do now. We’re going to install a financial “air bag.”

  SIX THINGS TO DO RIGHT AWAY TO PROTECT YOURSELVES

  In order to be properly protected, you must fill your security basket with the following six safeguards.

  SAFEGUARD NO. 1

  Set aside a cushion of cash.

  When I was a little boy, my Grandma Bach used to tell me, “David, always have some ‘rainy day’ money, because when the rain comes, cash is king!”

  It was good advice then, and it’s good advice now. I know I feel better having a nice cushion of cash available in case of trouble. You will too. So follow my grandma’s advice and set up an emergency account for yourselves. I want the two of you to think of this as your “air bag” of cash, a cushion that will soften the blow in case you lose part or all of your income for any reason (whether it’s job loss, disability, a bad economy, or whatever).

  The question, of course, is how much of a cushion is enough. How much money do you need to set aside to feel protected—and, in fact, be protected—against the “stuff” that “happens”?

  The answer is simple. It depends on what you and your partner spend each month. The key word here is “spend.” It doesn’t matter what you earn. If you’re making $5,000 a month, you don’t really have $5,000 passing through your hands each month, do you? After all, you’re putting at least 10 percent of it into your retirement basket (you are, aren’t you?) and you’re paying a chunk of the rest to the government in taxes.

  The two of you should have figured out how much you spend each month in Step Four (“The Couples’ Latte Factor”). If you didn’t do it then, definitely do it now. (You can use the form called “Where Does the Money Really Go?”)

  Once you know the figure, you can calculate how thick your cash cushion should be. In my opinion, the bare minimum you should set aside is an amount equal to three months of expenses. In other words, if the two of you spend $2,000 a month, you need to keep at least $6,000 in cash in your security basket.

  But that’s just a minimum. In some cases, you might want to keep as much as 24 months of spending in reserve. I realize that’s a huge spread. The reason it’s so big is that the amount you should set aside depends on a lot of issues. For instance, if you suddenly lost your job, how long would it take you to replace your income? It used to be that the more money you made, the harder it was to find a new job. As a result, experts used to recommend that you should set aside a month’s worth of expenses for every $10,000 a year in income you earned. (In other words, if the two of you had a combined annual income of $50,000 a year, the experts would suggest you set aside five months of spendable income.)

  Is this sort of caution still necessary? In some sectors of the economy, things are so hot that you can lose your job—and have five offers for a new one in less than a week. But there are no guarantees, and hot economies can turn cold with breathtaking speed. As a result, it’s hard to generalize.
You and your partner should have a heart-to-heart talk about your spending, your ability to maintain your income stream if one or both of you were to lose your job, and what I call your “sleep at night” factor. The last recession also taught us that things can go bad quickly and stay bad for years. Don’t assume your perfect tech job today is safe forever. Whatever you do, nothing will help you through the next recession as well as having a nice big cushion of emergency money set aside.

  HOW MUCH MONEY WILL IT TAKE FOR BOTH OF YOU TO BE ABLE TO SLEEP WELL AT NIGHT?

  This “sleep at night” number is different for everyone—including partners. Almost invariably, one of you will require more of a financial -security blanket than the other to be able to sleep well at night. While three months of expenses is the minimum I recommend to save, many couples choose to have as much as 24 months’ worth of expenses saved. You need to decide together what makes sense for the two of you as a couple.

  I will, however, offer one general rule: in my opinion, there is no reason to save more than 24 months of expenses in your security basket. Anything more than that is overkill. And one more thing: if you’re in doubt about how much cash to keep in your security basket, err on the side of caution and save more, not less.