Investment Allocation and Investment Location: Both are Important!

As my amount of money invested slowly grows I am paying more attention to where my money is invested and how I invest it. I believe the most important part of investing is diversifying your investments using mutual funds that track the market indices. For me I use a 90% Stock / 10% Fixed Income portfolio that I rebalance yearly. Doing this keeps my risk exposure where I like it and forces me to sell high and buy low.

I further split my stocks portion into 50% US Stock Market Index and 50% International non-US stocks (this goes between International Index and Emerging Markets Index). For now I have all of my fixed income money in US domestic bonds as I have not found an international fixed income fund that I like.

Now that I have a sizable sum invested in the market I am starting to evaluate the investment location. I have to also look at the tax implications of which types of investment I hold in which type of accounts. Currently I have a Roth IRA, SIMPLE IRA (like a 401(k)), and a taxable brokerage account (currently empty).

These are the 3 main choices for all of us in investing. My first choice is to get my employer's match on the SIMPLE IRA. It is also the easiest as it comes out of my pay directly. Second I put whatever I can in my Roth IRA as it is all tax free on the back end. That is as good as it gets! If I max out my limit on the Roth I will add to the taxable account.

With the tools in place I have to decide which investments fit in which account based on tax advantage. It is best to put high income producing assets in the Roth IRA as interest is taxed at your normal income tax rate. Inside the Roth you never pay any taxes ever. Make the most of it!

Next best is to have any low or no income producing asset in a taxable account (once you max out the Roth IRA). If the stock or fund pays a low or no dividend it is best held here because you don't pay tax until you sell the asset. You only pay tax on whatever dividends are paid out. The end gain at time of sale is taxed at a lower long term capital gains rate. If you have a loss you can also use that loss against other gains to avoid tax. An added benefit is that if someone inherits your assets the cost basis resets to the value at the time of your death.

The traditional IRA/401(k) is the worst option in my opinion. You do save a little income tax up front but every cent that comes out of the account later is taxed as ordinary income. You also lose the ability to recover losses from the assets if you have them. The one advantage is that you can possibly wait for a low income year to withdraw from this account to reduce the amount of taxes you pay. You can also convert assets to Roth if you meet the requirements but still have to pay the tax on the converted amount now.

Now that we fully understand the options available we can make decisions accordingly. In my case I put 5% of my income in the SIMPLE and add sporadically to my Roth IRA. As my situation improves I will start a monthly contribution to my Roth to start the habit. I hope as time goes by and I earn more I can max out my Roth IRA and start with my taxable account. I welcome to problem of tax on investment gains!

My Goals for Retirement

Retirement is a subject I think about a LOT but I still don't feel like I have a clear path and goal for it. At this point I see myself in retirement doing a fair bit of travel abroad and spending at least half the year outside of the USA. If I do spend time within the USA I will most likely be visiting with family and friends for shorter periods of time.

What I want in retirement:

• Passive Income: I want enough money coming in to cover my basic costs
• No outstanding loans or liabilities
• No need to work 40 hours a week to cover my costs
• Projects to give me focus and self enjoyment (ex: volunteering abroad)

Figuring out what I wanted was the easy part. I do have a vision of where I want to be in life. The unclear part is 1) How much money do I need to have saved? and 2) How will I earn and invest the money I do save in order to meet that target?

Assumptions:

• Annual Rate of Return: 8%
• Monthly Income needed: $2,100 (in today's dollars)
• Desired rate of withdrawal 4%

Based on my assumptions that means that if I were to retire today I would need $630,000 invested at 8% return in order to be able to draw 4% ($25,200) annually. This is assuming taxes are already paid and my take home is $2,100 month.

If I factor in an assumed total tax rate of 20% then I need to withdraw $31,500 per year to be able to have $25,200 in spendable cash. That raises my total assets target to $787,500 if I were to live completely off investments with no other income source.

This raises yet another issue for me. I am considering having some rental properties that will generate income and therefore reduce my need for investment. I like the idea of paying a mortgage each month and gaining rent where I keep the difference. The homes are still investments and I have the added advantage of not needing to pay FICA taxes on the income. I also will find side work from time to time but have decided that will be bonus "play money" for splurges that I will want at the time.

Looking at the big picture I am a long way off from this goal. My main goal for this year is to increase my income as much as I can this year and beyond. Each dollar I save is another dollar closer to the above dream. I will have to keep the focus and not fall victim to too much lifestyle inflation a long the way.

The math behind converting from a Traditional IRA to a Roth IRA

A lot of people ask if it makes sense to contribute and/or convert to a Roth IRA. If you have money in a traditional IRA and want to convert it to a Roth (either all or part) you have to pay income taxes (but not any penalty) on the amount you convert. The big question is: Does this make sense financially for me?

Here is an example: You have $10,000 in a traditional IRA. You are considering converting it all to a Roth.

The Numbers: Your total income taxes (Federal, State, Local) come out to be 25% of your income. This means you would have to pay $2,500 total in taxes to do this conversion. This will obviously change if your actual tax rate is higher or lower but I am using this for simpler math.

You also have to look at the back end. For this I will assume an 8% annual rate of return and the same 25% tax rate. Let's say you withdraw the money from the IRA account after 20 years.

If you leave it in the traditional IRA: $46,609.57 - $11,652.39 = $34,957.18.

If you convert the assets to a Roth IRA: $46,609.57 tax free! (you save $9,152.39 in tax by paying the taxes now).

This is a very simplified example but if you were to withdraw $46,000 for 1 year of retired life expenses you come out way ahead in the case of the Roth. If your tax rate is lower you still come out ahead but not as much. The general rule is to go with Roth if at all possible. Especially if you have a long time to invest the money before taking it out.

The only scenario where this doesn't make sense is when you have a high tax rate now. If you expect your taxes to be significantly lower during retirement it may make sense to leave it in a traditional IRA. Secondly if your income is too high you may not be eligible to convert it to a Roth IRA. A tax specialist can shed more light on this specific case.

The bottom line is that unless you are a very high wage earner you should go with the Roth IRA. This is one of the few truly tax free accounts that we can take advantage of. Time is on your side if you use it wisely! Run your own numbers and see how much you can come out ahead!

Paying off Low Interest Debt versus Retirement Savings

The question I have been analyzing lately:

Should I accelerate payments on my student loans and/or mortgage or add more to my retirement accounts. A lot of blogs out there trumpet to become debt free then save. Based on the math I have to disagree. The return on paying of lower interest debt is significantly reduced and in a sense you can lose money by not investing for retirement!

My Scenario:

I have 2 existing debts: my mortgage (4.5% fixed) and my student loan (2.625% fixed). Interest on both loans is tax deductible. With my risk tolerance and investment fix I am assuming that my returns from investing will be significantly higher than 4.5% (my highest rate debt). If this is true then I lose the return from the investments by paying down my mortgage faster. If I assume I will average 8% return over the long haul that means I stand to lose 3.5% per year and that is before I factor in the tax deduction. That adds up over the 30 year life of my mortgage and the compounding of my retirement savings!

As a result I have decided to make the minimum payments on the two loans and any additional money will go to my retirement and other savings goals. I am in the middle of building my full blown emergency fund now so it will get all of the extra money first. One I have it at a comfortable level I will focus mainly on retirement (I admit I am behind here) and then look at car replacement fund, laptop replacement fund, and other smaller goals that need to be addressed after my emergency fund is completely built.

In most cases if you return on the retirement savings investments beats your low interest debt be 1% or more you are probably better off saving the money instead of accelerating debt pay down. It feels great to pay off debts early but feels even better to know that you can retire comfortably without worrying about  making ends meet in your elder years.

Moving to Schwab: Saving money!

Today I have decided that I am moving all of my investments from Firstrade to Charles Schwab. A few years ago I would not have even considered this because of Schwab's high fees. The landscape has changed and now I am making my move just in time for tax season!

Here are my reasons for moving, in order of importance:

• The big one: $0 commission on Schwab Funds and Schwab ETF's versus $6.95 currently.
• Consolidation: Accounts in less places (combining with new Schwab Checking Account)
• Schwab has branches: If I have an issues I can visit a human!
• Mint.com access: I can see my Schwab accounts in Mint. I cannot for Firstrade

All of above make this move make sense for me. I especially like that I can invest in ETF's with no commission. It makes re-balancing possible and MUCH cheaper over the long haul. Every dollar counts in a Roth IRA! I will combine this move with a re-balance as I will sell every position and move cash to start clean and save on transfer fees.

One final step I am taking is to take what used to be in my taxable brokerage account and move it to my Roth IRA. This requires me to sell all positions (which I have done for a gain!) and deposit cash as a contribution. It makes sense to do this now since it will count as a 2010 contribution and leave me more room for 2011. This will also cut my tax bill over time significantly!

Long term I plan to start using my Schwab Checking account more too. It refunds all ATM fees AND does not charge me a percentage for foreign ATM withdrawals. As a lover of international vacations this can save me thousands over the long haul. As long as this policy continues I may considering using them for other things as their account pays a small amount of interest too!

Getting started with retirement investing

I find that the biggest barrier for saving for retirement is that most people do not know where to start. People tend to get confused by paperwork, minimum investment, tax laws, what to invest in, etc. The main thing to do is to take the first step and get started. What to invest in can come later but simply putting the money aside each month or each pay period is the crucial first step.

The best option is to start with an employer sponsored plan. This can be a 401(k), SIMPLE IRA, or some other similar plan. Most of the time you fill out paperwork and the savings is deducted directly from your pay. This makes it easy for you as the money never hits your checking account. You can start by putting the money in a money market fund while you learn more about the other investment choices and can make an educated decision on what to invest in.

If your employer does not have or you are not eligible for the plan you need to venture out on your own. A Roth IRA is the best choice as all the money grows tax free. A lot of brokerages and mutual fund companies have a set minimum, usually $500 or $1000 to get started. A lot offer $0 minimum if you commit to a set monthly amount to automatically transfer in. I always suggest Vanguard as they offer low fees on accounts and have a good selection of funds to fit most peoples' needs.

If you are venturing on your own and need to meet a certain minimum start by transferring a set amount each month or each paycheck to a savings account. When you hit the minimum target open the account and make the transfers go there instead. Automating your savings will make sure you get it done and that it happens without temptation to spend the money elsewhere. While you are saving up for the minimum do your research and be sure what you want to invest your money in that fits your tolerance for risk and goals.

The time is now to stop with the excuses and save for retirement. The sooner the better. Time is in your favor when saving for retirement if you start early enough. Social Security should not be considered at all when calculating how much you need to retire. The system is mathematically upside down now and will only get worse. Benefits will shrink and starting age will get older and older. If you do end up with a some social security money then you have extra. Pretend like what money you have will be all you will ever have and you will be covered!

What's in my portfolio?

Disclaimer: This is what my portfolio consists of and this is not investment advice. You should make your own educated decisions before investing you money in any way.

I realized that I talked a little bit about investing but never really divulged how I actually invest my retirement money. I am currently very passive about my investing. I will represent all of my portfolio in percentages to give a broad, easy-to-read picture. Luckily in my case it is simple!

I currently have 3 investment accounts: Taxable Brokerage, Roth IRA, and SIMPLE IRA (my work's 401 (k)-like plan). The majority lives in the SIMPLE IRA and all previous investments were rolled over and converted to my Roth as they were relatively small.

Portfolio Breakdown:

• Cash (Money Market): 0.19%
• GE (General Electric): 1.16%
• HYF (High Yield Bond Fund): 13.01%
• RIT (Real Estate Income Fund): 1.00%
• IWO (iShares Russell 2000 Growth): 2.43%
• IWN (iShares Russell 2000 Value): 3.26%
• IWF (iShares Russell 1000 Growth): 3.92%
• IWD (iShares Russell 1000 Value): 3.23%
• EFA (iShares MSCI EAFE Index): 3.02%
• EEM (iShares Emerging Markets Index): 7.08%
• VFIFX (Vanguard 2050 Retirement Fund): 61.70%

As you can see over half of my portfolio is in my company plan. I have been here 3 years and the 3%/100% matching contribution has really added up. My second largest holding is HYF which pays a large dividend that I reinvest. I hold GE with my "play" investing money and is a very small position that I set for dividend reinvestment. All other holders in my Roth. I diversified what little I had with iShares since I did not have enough at the time to buy into a single mutual fund. I will simply hold these until I retire or find a better alternative.

I am definitely taking the "lazy man's" approach here as I am focusing on debt elimination and don't have a lot of time to seek out the absolute best investment mix at this time. I am happy with the mix I currently have and will stick with it until I start more heavily contributing. All my investments are currently in the positive and I plan to keep going!

Rant: Calculating how much I need to "retire"

I am not a fan of the word "retirement." It has a bad connotation of working until you cannot work anymore to have enough money to live out the rest of your life. That doesn't sound very good to me. I prefer financially independent where I don't necessarily have to collect social security to stop working. I am currently working on my target net worth number to mark the day I quit working full time.

I have found that a lot of other things have to be considered than just the total amount. I also have to include:

• Expected income from investments
• Income from other sources (side work, contracting, etc.)
• What the other income sources are
• Cost to travel (I want to do this as much as possible)
• Expenses that have to be paid after I stop full time work
• Making sure I am happy with all the above choices

This seems simple enough but each of the above items has a lot of complexity. I have to make estimates on what I will earn from my investments. What sort of side work would I do, how often, and how much could it potentially pay? Travel costs fluctuate wildly. I have to decided where to travel, for how long, and get a reasonable estimate of costs. Expenses are the easiest to predict but not completely. And most of all I want to be happy with my choices and no stressing over these items all the time. Everything has to fit right!

As it stands now I am nowhere close to being able to say with 100% or even 75% assurance of what each in the above list should be. All I do know at this point is that I want to travel at least half the year to various countries worldwide. I have a good grasp on the home-side expenses but still working on the travel part. The expected income from investments is like trying to see the future. I know what sort of returns I would want but attaining them is another story. I am also working on ideas for side work, projects, and contracting to help me fill the gaps.

Being able to stop 100% relying on salary is a long process. I do know that saving as much as I can everyday will get me closer. I am a person who likes numbers and measurable goals so I am going to come up with a target and put 110% of my effort into it. I have a lot of variables to juggle. It's called life. I have to take a step back and not worry about every detail being hammered out. With plan A, B, & C I will make it work somehow. Time to get to work!

Retirement: My Vision

I saw this post over at Get Rich Slowly and it got me thinking about my own definition of retirement. To some it is a quiet small house in the woods or mountains. Some want to live on a beach in Florida or California. Others are happy just being near family and friends and taking up hobbies and volunteer work. My vision of retirement (which is the day I reach financial freedom) is sort of a mix of the above.

When I "retire" I actually mean that I no longer rely on a steady paycheck to cover my expenses. Ideally I would travel extensively and spend most of my time outside the USA. I see my self traveling in Asia, picking up volunteer work and/or teaching English from time to time. I am also considering owning my own bar in a nice beach town in Asia with friends (if they are willing/interested) as sort of a home base. My income would come from savings and investments.

I would have minimal material possessions. I would live out of a backpack and day bag most of the time. I wouldn't need a lot of money invested just enough to generate income for me to travel cheaply. I will take local transport and move slowly. I will stay for the duration of my visas to really get to know the place. There are enough places to travel too in the world that I could do this for the rest of my life.

I would also pick up contract and side work along the way to offset costs when I can. Teaching English is a very good option. I work in IT and some types of work can be done anywhere in the world. I have lots of options and will explore them fully. I am also not above hotel/hostel/bar work if it helps me break even on living somewhere for a couple months.

Getting out of the rat race and doing what I enjoy is my primary goal in life. Every day I work and every dollar I save ultimately gets me closer to this. I keep travel photos around my room so I can be reminded of what I am working for when I get down or stressed. I constantly remind myself of why and what I am working for. Without a sense of direction I will fail.

Which mutual funds should you choose?

Their is much debate on what types of mutual funds one should invest in. Their is also the debate of how much to put into small, medium, and large companies and also international versus domestic stocks. The same is true for domestic and international bonds and short, medium, and long term. It is a lot of information to take in on a very important subject. Our investment choices affect how and if we reach our goals.

Index funds are the best choice no matter what your goals are. They come with the lowest cost, follow the overall stock market, and you can quickly see how you are doing. Most other types of funds come at a much higher cost, cannot outperform the market in the long term, and frankly are a waste of money.

They key is to have a good mix. You first have to determine what mix of stocks and bonds is right for you. I will use 80% stocks and 20% bonds as an example. These two have to be broken down into subcategories. Stocks - International and Domestic. Bonds - International and Domestic. The exact percentages you will use are based on your beliefs and risk tolerance.

From here you have to break down each one into small, medium, and large cap stocks and short, medium, and long term bonds. This goes for international and domestic. Index funds do exist for all of these types. Vanguard is a good place to start looking. Index funds of the same type do not vary so you should choose based on expense ratio. Invest in the ones with the lowest expense ratio for each type.

Once you have your percentages set and your funds picked you are ready to being investing or adjusting your current investments to match. Once you have your plan in place you can adjust yearly as needed and re-balance. This part of the process takes a while but is the most important. Do your homework and you will be well on your way to meeting your goals!

Asset Allocation: The rule of 120

I get quite a few questions from friends and family of how much money should be invested in stocks versus bonds. Part of the answer lies in your own risk tolerance and preferences. I found a good rule of thumb that is based on your age and is a great starting point.

The rule of 120:

Basically you take 120 and subtract your age. If you are 25 years old the result is 95. This means that you should have 95% of your retirement assets invested in the stock market and 5% in bonds. This is not a concrete rule just some general guidance.

Using this rule is a good way to slowly make your portfolio less aggressive as you age. Once you hit at 65 you would be invested in 55% stocks and 45% bonds. This is a reasonable asset allocation for someone entering retirement. No matter your age you will have some money invested in stocks to outrun inflation.

This rule is good to use to get a basic idea of how to invest. Once you figure out your own mix you would need to invest in the correct mutual funds to cover all the bases. As long as you have a well diversified portfolio with low expenses you will be on the right track.

What I plan to do once I stop working (full time)

This is a comment I posted on this post at Get Rich Slowly. I thought you may be interested in what my "light at the end of the tunnel" is for me. This is what keeps my going!

My retirement plans are already set. I absolutely LOVE travel and plan to travel the world–and see every country at least once. I would live only on what I carry with me. I would shed most of my possessions and hit the open road. I would arrive in a country and make it a point to stay the length of my visa. I want to see, smell, taste, and enjoy all the cultures I can. Some would say I am obsessed with travel. They are probably right!

I also think I would need some extended time of rest so I am considering the idea of eventually buying a place in another (cheaper) country on the beach. If I ever wanted a break from the road I could go there for a while with my own place and relax on the beach with a margarita. I could also come back stateside and stay with family and friends for a while too. Being a traveler makes things very flexible!

I would also have side projects that I could do over the internet and/or while traveling. My travel blog would certainly be one of them and I also like photography so I would spend time working on that hobby. I also see myself possibly doing some volunteer work as I go as my way of giving back once I retire. Maybe even write a book about my travels if I got the ambition and time to do it. I find with travel that you can certainly over-plan everything and then it becomes work. Just go where the road takes you! It’s about the journey not the destination.

If travel was not an option for some reason or another I would take my idea of owning a place on a foreign beach and open a bar/cafe too. It would occupy my time and in my mind be fun. Maybe I could even make more money!

I am sure as I go along in life circumstances and priorities may change and will alter this plan accordingly. I do know if I retired today I would be on the next plane out and take it from there. I am passionate about travel and do it every chance I get!

Don't count on Social Security benefits for retirement!

I believe that anyone under age 40 should not be counting on Social Security benefits as part of their retirement income plan. I am sure the politicians on capital hill will either revamp or replace it with a new system but I want to side with safety. The law can be changed at any time and I believe they will do just that to greatly reduce benefits.

I look at Social Security as a bonus during retirement assuming it even exists for me. I plan on covering all of my income needs using my own assets and businesses that I will have amassed by then. If I get extra money from the government each month then I guess I will be able to do more fun stuff than I had originally planned!

This of course means that those of us who were counting on that income have to re-evaluate our plans. You most likely will have to save more and/or make cuts in your retirement plans. It is also possible to retire later or find ways to reduce your retirement expenses. You are much better off planning for $0 Social Security now as opposed to falling short when retirement rolls around. We would much rather have saved too much rather than not enough!

Portfolio Rebalancing: Save on transaction costs

Everyone should be re-balancing their retirement portfolios once per year. This normally involves the sale of part of one asset and the purchase of another. One little trick to save on transaction costs is to have your re-balance scheduled for when you expect to receive a tax refund you intend to invest.

Example:

Your portfolio is overweight in stocks. They did well this year and you need to move some money to your bonds portion to get things back in order. Lets say the amount you need to move is $2,000. Lets also say you are also expecting an income tax refund totaling $2,000. It is best to wait!

If you re-balance now and sell off $2,000 worth of stocks and reinvest it into bonds you could be paying transaction costs for the two trades. If your mutual funds are no transaction fee then this does not apply. Either way it is easier to wait on your tax refund and the invest the new monies appropriately to get you back into the proper asset mix. Less transactions means less record keeping and hassle on your part.

This strategy particularly works well if you are invest in ETF's or in mutual funds that cost you for each trade. Keeping our portfolios in balance is very important but we also need to minimize our transaction costs and possible tax consequences (if trading in a taxable account) whenever we can. Taxes would not apply to IRA or 401(k) accounts but transaction costs are levied on all types of accounts.

The less we spend in transaction costs the more money we can keep invested and growing for us for the years to come. Try to select investments that meet your needs with the least transaction costs associated with them. Lots of brokerage houses have long lists of no transaction fee mutual funds and free dividend reinvestment. A little research can save a lot of money!

How to start saving for the future

I read an interesting post over at Get Rich Slowly and it inspired me to write this article. It lightly touched on the idea of how you can start saving so I decided to explore the topic in more detail. This is a step anyone can take no matter how high your expenses are or how much debt you have. This is also how I got started!

Start of by saving 1% of your income. This can be via an employer 401(k) program or a savings account done via direct deposit. You could also set up automatic transfer at your bank so each time you get paid 1% of your income gets moved. This is only 1 cent on every dollar you earn so chances are you won't even notice it.

Over time you will see your balance increase. If you are like me then you will be motivated to try to save more. This can be done a variety of ways. You can put gifts, rebate checks, side work pay, and others into your savings. Pretend like you never had the money. You can then increase from 1% of your pay to 2% or 5%. Your savings will begin to snowball.

As you pay down your debts and have all of this "extra money" each month make the move to taking the same monthly payment amount in spread it among your savings. 401(k)s, Roth IRA, emergency savings, and other goals. You will soon turn from being the person "who could never save a dime" to "wow look at all the money I have put away!" No one saves a ton of money at once. It is built over time. Along with savings comes freedom. Freedom is priceless!

Which goals do we save for first?

The other day I wrote a post on what debts we should pay off first. I then started to think about what to start saving for once debts are paid? I have come up with a priority list as a general guideline of how we should earmark our monthly savings. This list makes sure we are on the right track to reaching our financial independence.

Savings Priority List:

1. Emergency Fund - Their are many schools of thought on how much this should be. It varies based on your situation but the best general guideline I found is 6 months worth of your average take-home pay saved. This is the most important. This trumps even retirement savings!
2. "Escrow" Expenses: These are irregular expenses such as bills that come once or twice a year. They include insurance, taxes, association dues, and many others. Work out a monthly amount to set aside for when the bill(s) comes due as part of your monthly budget. Use a savings or money market account to earn a little interest while the money sits there.
3. Retirement: The amount you save depends on how much you will need during retirement years. See my priority list of what type of retirement accounts to use here. This one comes after the above two are completely satisfied!
4. Future Big Purchases: I reserve this part for necessary purchases only. Examples: A replacement car, down payment for a home, new appliances, home improvements (mandatory only), and other big ticket items that you must have.
   
5. Fun Stuff: This is where we can use savings to work towards things we want. In this part I include vacations, weddings, holiday and birthday gifts, collectibles, etc. Once you get out of debt and start saving it is important to include fun things too!
   
6. Other Goals: These are goals that don't fit into the above categories and are of lowest priority. Examples: Charitable gifts, gifts for friends or family, Religious donations, etc. These are goals that would not affect your livelihood if not obtained. All of these goals would start with "It would be nice if..." and are completely optional.
   

Following this list should provide you with a good plan for the future and cover any financial emergencies that come up. Once we have an adequate emergency cushion and our normal expenses covered we can continue onto saving for retirement and other goals. Every dollar we save is another step towards our financial freedom. Let's make sure we put those dollars in the right place!

Making my goals public!

Today I have decided to make my goals public. The title and description of this blog give you some idea but not the complete picture. I am going to list my goals in this post and create a page to track them as part of this blog. I am forcing myself to be even more accountable!

Goals (in priority order):

1. Consolidate and accelerate debt payments (consumer debts, student loans)
   
2. Build adequate emergency fund (3 months for now but possibly up to 6 or 8)
   
3. Build side business and retirement savings (and hopefully be self employed)
   
4. Have enough residual income to work part time from anywhere in the world
5. Travel perpetually on the residual income

So far I have taken some steps towards all of the above as they are related to each other. I have now decided to tackle them in order so I can reach them faster. Item #1 is in the works and once I am finished with my house remodel I will have consolidated and paid a good chunk of my debts. I must first get my total monthly payments lowered so I can get to item #2.

Now that I have listed my goals I will give you the story behind them. Back in 2004 I took a 3-week study abroad course in Europe as an elective for my business degree in Finance. I immediately felt a passion for travel and wanted more. I finished college and did another 2-week backpacking trip in Europe in 2005 as a reward to myself.

This second trip only added to my "travel bug" and all I could think about was getting back on the road. I was working full time at a local financial advisory (independent) firm and saving heavily. I was laid off just before the holidays in 2006. I was very upset about it and started looking for work. I soon decided that now was a great opportunity to go travel more. I left in December 2005 for the open road.

I ended up traveling around the world (literally) for a total of 18 months and covered 25 countries. I had some savings but also credit cards. I was on the road living it up and ended up running high balances on my cards. As they started to dry up I decided I better get back to the USA and figure out what to do. Bankruptcy did cross my mind and I seriously considered it.

I got back home in May of 2007 and did a full personal review of my financial mess. My minimum payments were quite high and I was 2 or 3 months late on some of them. My family stepped in and bailed me out. It was hard asking for money but they paid off all of my cards and I am to this day paying them back each month. They really saved me a lot of stress and interest. I also negotiated with the credit card companies to take off the late payments on my credit report if I paid them off today. It worked.

I found a job about 2 months later and that is the job I am still currently working as an IT project manager. It allows me to travel domestically for work and I am able to travel abroad using my skymiles for my vacations. I of course want to travel a lot more but I have to take care of finances first then the fun stuff. My financial situation has drastically improved since May of 2007.

Today I am working hard to pay down my debts. I have generated some side income which for now I have been putting in my emergency fund. Given the current state of the economy I feel it is worth it to have at least some money for emergencies. I also just bought a house in July 2009 that needed a lot of remodeling (it was a foreclosure). Between my Dad and I we can do most of the work ourselves. As of today it is about 80% complete.

I will also get the large tax credit from the government next year and will have a lot of equity once the remodel is finished. I should be done by mid-October. I have again borrowed money from family to do this remodel (they offered!) and will get an equity loan to immediately pay them back and to refinance some other debts to a lower interest rate. I can then work on the emergency fund to an adequate level and then accelerate the payments on this new loan.

My long term vision is to build wealth and work until I have enough fixed income to live life on the road. I want to travel and see everything the world has to offer. I plan to live out of my backpack and experience the food, people, culture, history, architecture, and simple life that traveling the world provides. I will stay in cheap hotels or hostels, eat street food, and live like a local. My income requirement will be hopefully lower or at least equal to what I earn today. I have the travel bug and it never goes away!

In order to reach this vision I will build my savings to the appropriate level and sell everything except for what I intend to take with me. This makes my situation different as I will not own any real estate at "retirement." I will have no need for it as a traveler. The only exception is if I decide to have rental property as part of my income. Based on these facts I calculate my net worth accordingly. I still have to decide exactly how I plan to generate this income. This will be more concrete after my debts are eliminated.

Why do I (or we) save money?

A lot of personal finance bloggers spend a lot of time and energy on how to save and cutting expenses. I personally think we do not write enough about why we save. Most of us need to see a "light at the end of the tunnel" to keep us on track. Today's post is intended to do just that!

Why do I save? Here is my list of reasons in order of importance:

1. Emergencies - I need to be financially prepared for most emergencies that can be thrown at me. These include: job loss or downsize, medical emergency, large unexpected expense, uninsured loss (deductilbles), and any other financial hit
2. Retirement - I plan to be off the job market and enjoying life as soon as possible. The more I save the sooner I can get there. I have dreams of traveling the world and I need a residual income to fund this.
3. Vacations - I put high value in this. I work hard for my money and everyone needs a break in order to stay sane. I use Delta Skymiles to book my flights and save enough for my room, entertainment, etc. This is my one "luxury" per year where I can let loose and have fun without worry.
4. Self Employment - I want to eliminate debt and become a consultant so I can work when I want too. This requires a bit more savings in the bank to pad the lean times in the market. This is lowest priority for now.
5. Larger Purchases - I currently have no large purchases in mind but I use this for cars, appliances, home repairs, or other more expensive needs that may come up over the years.

The bottom line here is: the reason we all need to save is to be able to do what we want more often (freedom and independence), not have to worry about where our food money will come from in later years (security), and to feel we are working towards a tangible goal and not just working to live (sanity). If you keep a clear vision such as mine above we can all have a better life and breathe easier each day. I look at savings, especially for retirement, as: The more I save today is me buying back my time in the future to do what I like to do. I don't want to work forever and the only way to stop working is to save today!

Why do you save and what for? Are you in line to meet your goal(s)?

Target Date Mutual Funds: Cheap and easy retirement investing!

With the vast majority of people not having the knowledge or time to research the stock market need an easy option to save for retirement. A lot of the major mutual fund companies have come up with a solution: The target date retirement fund. They can be useful tools for long term investing.

These are obviously for the passive investor. You simply pick the fund that is closest to your expected retirement year (such as 2030) and you invest your retirement savings in the fund. It is automatically allocated to a basket of funds that keeps you diversified. As the date approaches it automatically moves your savings toward income assets.

I must add that these funds are not for everyone. If you are more risk adverse than the allocation of these funds then they may not be a good fit. They start out quite growth-oriented and high risk and move towards a more conservative portfolio over time. If this is the case then you should create your own mix of funds and rebalance manually over time.

Another issue is that you are letting the fund manager how to invest your money. If they decide to change the allocation you may not even know about it. It could be changed to taking more risk than you can stomach or possibly even less than you desire. You have no real control over where the money gets invested.

Target date funds can be useful tools to some investors. I use them as a benchmark for my own investments to see if I can do better than the "pros" do in asset allocation and investment choices. If you do decide to use these funds then consider splitting among 2 different companies to achieve more diversity of allocation and investments.

The road to financial independence

I realized that I have written quite a few specific posts and tips for getting ahead but have yet to write about the big picture: Becoming financially independent. It is a long process that will not occur overnight. It takes discipline, determination, and focus to achieve.

Firstly, I want to define financial independence and what it means to me. I believe that financial independence is being able to live life doing what I want, when I want, and how I want without needing a full time job (salary). It is being able to live off of my savings (and earnings from those savings) to cover all of my expenses. This does not mean that I will not work it just means I don't have to work.

Secondly, everyone will define financial Independence differently. The basic idea is to be able to do what makes you happy without having to rely on another person or business for your livelihood. I personally want to travel the world and to do that I need passive income and cannot work full time (in one place). Becoming financially independent is the only way I can make that happen.

Their are many steps to becoming financially independent. I have summarized them here:

1. Pay off all debts and build emergency fund. I must attack each balance until they are all gone. I must also keep an emergency fund of at least 2 months living expenses so I don't fall back into the debt trap in the case of an unforeseen event.
2. Save, Save, Save! Once debts are gone I will channel the monthly income used to pay them into savings, investments, and business opportunities. In that order. I need to minimize tax liability and maximize returns on my savings and investments.
3. Re-balance and shift investments. Once I have saved a large portion of my goal I need to start moving out of growth and into income generating investments. At this point I will look at it as income replacement. I foresee this beginning around the $500,000 savings mark where I need to take less risk.
4. Achieving independence. I will be near my goal of $1,000,000 in net worth and begin the shift from saving to living off of the assets. I might work part time or run my own business to supplement income and unexpected expenses.

The above is very generalized and non-specific. This is the formula everyone should use to reach retirement (financial independence). There are lots of specifics that go along with each step which I will cover at some point on this blog. I have been focusing on step 1 thus far as I am in debt elimination mode and want to get to step 2 ASAP. Step 2 is the longest step in the process and the sooner you get there the longer your investments can grow. This also means you will need to save less in the long run as your savings will have more time to earn returns.

Everyone's road to financial independence is different. Life has a way of tripping up our financial well being but with good planning and an emergency fund we should be able to handle anything it throws at us. The top areas that must be focused on at all times are budgeting, saving, and self control. Without these we will be slaves to the paycheck for our entire lives. Do you still want to be working when you are 80?