• Progress on client L’s retirement planing stalled out in the last month of the summer as he and I were on vacation and then dealing with the headaches of school start-up. To reorient us on what we need to do to he requested an e-mail that outlined the way forward. I’m posting a lightly edited version of it here in case it is of use to humanity.

Step 1. Nail down what you can/need to save and what rate of return you need. The inputs come from your current and estimated retirement budget. You need to plug those inputs into retirement calculators to estimate the average rate of return you require to meet your goal. Here are some relevant links with the details:

Step 2. Your required return gives you some guidance as to what your stock/bond asset allocation (AA) should be. You’ll want to set it for an expected return above what you require (i.e. with higher stocks, lower bonds) and then gradually trend it toward more bonds, less stocks over time. A reasonable real return for stocks is 5% and for bonds is 2%. So if you need a real return of 3% over the long term then setting an AA for, say 4% now might make sense. To do that you’d set stocks at 67% and bonds at 33% (*). Relevant links:

I break the stock portion of my portfolio into a 50/50 split between the entire US stock market and international stocks. That is, if my stocks are 70% of my portfolio then US equities are 35% and international are 35%. For the bond side an intermediate Treasury fund (or an approximation thereof) or a total US investment grade fund are fine. I use a 50/50 split between nominal and inflation protected Treasuries but that is a bit of a fine point.

Step 3. With your target AA set the next step is to select funds to accomplish it. Roughly speaking you want to construct from the funds available something that is representative of the total US stock market, something representative of non-US equities, and something representing all investment grade bonds or at least an intermediate term Treasury fund. Then you just combine those to match your target AA.

It sounds so simple, but this can be a big headache if you’ve got a lot of funds available and don’t really know what they are. What to do?

This problem can be solved in two ways. One way is to gather all the information necessary to figure out what what your fund options are. Which are stock, which are bond? What kind of stock funds? What kind of bond funds? What are the expense ratios? The details matter. Much of it can be found from fund administrators and Morningstar. This is the hard way.

The second way is easier: just gather the expense ratios and ticker symbols and put the entire question to the Bogleheads. There is no harm in doing this anyway, at least as a second opinion. The format to do this is at posted on the Bogleheads Forum. You’ll have to create an account on the Forum to submit a portfolio question. Feel free to tell them I sent you (my screen name there is “sewall”).

(*) This is a crude approximation since the return of a mix of asset classes depends on their correlation, which I’ve ignored for simplicity. Consult a more sophisticated retirement calculator for more precise planning.

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• I’ve had four meetings with a friend to help him organize and plan his financial future (posts about the first two meetings are listed under the Client L tag). Since I last wrote we’ve met twice. In that time L has completed a household budget. It revealed that his family has excess income that is not required to meet current consumption, even after accounting for current 401(k) savings. Therefore, L and his family can afford to put some more money away (in Roth IRAs, in 529 plans, and the like) for the future.

Using his current household budget, L and I worked out his retirement budget (see Estimating A Retirement Budget) and, with that, his need for income in retirement (see Need For Risk: The Details). The next step is to use the Ballpark Estimate calculator (or other retirement calculator) to determine what average rate of return he requires to achieve a level of savings that will support the retirement income he’ll need.

One can do more work to refine and tailor one’s risk/return trajectory over time (and I’ll describe how to do that in my investment planning series), but just doing the above is enough to get a rough sense of how to invest one’s funds. With this as guidance, we will begin to look at the options available at Fidelity and in L’s 401(k) plan. Likely soon he’ll be ready to select an asset allocation and specific funds.

Also, over the next week or so L will figure out whether he and his wife are eligible for establishing Roth IRAs. It is possible one or both of them may have to take advantage of the elimination of the AGI limits on Roth conversions in 2010.

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• I’m meeting weekly with a friend, "L," to guide him through the retirement investment planning process. (All my posts about my meetings with L are tagged "Client L".) At our first meeting we drew up a roadmap to guide our planning.

His homework for the first week was to start to co-locate funds at Fidelity and to play around with the retirement calculators on the Bogleheads Wiki. L made some progress on these assignments but didn’t complete them (that’s OK, I’m not in any hurry). Between our first and second meeting he obtained the paperwork to move funds to Fidelity. Before completing them he wanted to review with me the tax implications of moving funds from a former employer’s 401(k) to a rollover IRA. I explained at our second meeting that such a move is not a taxable event so he has nothing to worry about.

At our second meeting we also talked through how to rough out how much one should save for retirement. This is not a replacement for careful investment planning (see my investment planning series for that), but it is a useful place to start. Here’s what I explained:

In general, though not universally, one will need in retirement something like 50% to 70% of one’s current income. For simplicity, let’s take the number 60%. Thus, R = 0.6C where R is retirement income and C is current income (all in constant dollars). The amount of money one can safely withdraw from one’s retirement nest egg annually is, relatively conservatively, between 2% and 4% of the initial principal. Let’s take the number 3% as the safe withdrawal rate. Thus, R = 0.03P where P is one’s retirement nest egg on the day of retirement.

Using these two expressions for R (retirement income) we can solve for P (nest egg) in terms of C (current income): P = 20C. That is, a rough approximation of what one needs to save for retirement is 20 times one’s current income. If your current income is \$100,000 then you need \$2 million saved for retirement (in current dollars). Don’t panic! This is a rough estimate. Don’t rejoice! This is a rough estimate. It is possible for it to be off by a factor of two. One must do more careful budgeting and planning to obtain a more precise estimate.

L and I also played around with the Ballpark Estimate calculator. We were pleased to discover that he seems to be on track for retirement after all. He just needs to keep it up and to organize his finances so he can manage and track progress.

L’s homework for our next meeting is to complete the movement of funds to Fidelity and to draw up a current household budget, as described in Household Budgeting the Easy Way. That should enable us to get a much better sense of his ability to save and will serve as the basis to determine his needed retirement income. If he has more time I also suggested he open a Roth IRA at Fidelity for himself and his wife. Also, he might begin to find information about Fidelity’s funds and those available through his current employer’s 401(k), particularly their lifecycle and index funds. We’ll be needing to know his options after another meeting or two.

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• A friend I’ll call “L” asked me to help him think about his family’s finances. He wants to put in place plans for retirement savings for him and his wife, college savings for his two children, and an estate plan. He has helped me a lot with many other things so I am delighted to give him some suggestions about how to think about these personal finance issues.

We plan to meet weekly supplemented by e-mail communication. This week we had our first meeting. We talked through some of his current holdings, his goals, and the structure of the rest of our plan. We’re going to start with getting his retirement accounts in shape. Then we’ll tackle college savings and estate planning (for the latter I will mostly give him a book, which I will review on this blog later).

L has his retirement holdings at multiple institutions, which he finds inconvenient and confusing. He has no idea what his current asset allocation is or what it should be. He admits to not having saved enough for retirement. I can help him with all these things. We made a plan that will guide our future sessions:

1. Co-Locating Funds. L has to decide which company he wants to use for his accounts other than his current employer’s 401(k). He has some funds already with Fidelity and he will likely move his others there too. While I’d prefer Vanguard he may be locked in to Fidelity with a legacy 403(b) and I agree that it will be simpler for him to get everything at one company. His first homework assignment is to submit the paperwork to move funds to Fidelity.
2. Selecting Vehicles. L has no Roth IRA holdings. I recommend he open a Roth at Fidelity and begin to contribute to it. If it makes sense he will convert some of his rollover IRA holdings to Roth gradually (this is something I’m doing too and will blog about in the future). We will look at what is available under his 401(k) and Fidelity and decide what vehicle should hold what types of assets. I did not assign L any homework under this topic yet. We’ll work on it once he has all his funds moved (item no. 1 above).
3. Asset Allocation. Another of L’s homework assignments is to begin to work with one or several retirement calculators listed on the Boglehead Wiki. To use them he will need to estimate future earnings, for which I recommended he consult the Historical and Expected Returns page of the Boglehead Wiki. This exercise will begin to suggest what AA is sensible given what he can contribute. I expect it will also illustrate that he needs to crank up his contributions to be able to retire. I also expect he’ll be reading my current series on investment planning. It will also walk through how to rationally think about contributions and returns needed to meet a retirement goal.
4. Contributions. We will need to figure out what L can afford to contribute and what he should contribute to meet his goal. Of course this is related to item no. 3 above.

After we have his retirement investments on track we will discuss 529 plans for college savings and estate planning (life insurance, wills, and so forth). This will be a long process that I will document on this blog.

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