The Best Investment Advice for Every Decade of Your Life
In this episode of Motley Fool Answers, Alison Southwick and Robert Brokamp talk about the many different priorities we will have throughout our financial lives.
From our vibrant 20s to our golden years, financial goals and needs will naturally shift. For the best advice for every decade (the important mistakes to avoid) -- the Motley Fool has you covered.
A full transcript follows the video.
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This podcast was recorded on April 18, 2017
Alison Southwick: This is Motley Fool Answers. I'm Alison Southwick and I'm joined, as always, by Robert Brokamp, personal finance expert here at the Motley Fool.
Robert Brokamp: Well, hello Alison.
Southwick: Well, hello there. We're going to take our listeners on a wonderful journey through time and give you your financial priorities for every decade of your life. We're also going to answer your question about avoiding dividend stocks because of taxes. Should you? I don't know! Let's ask Bro. All that and more on this week's episode of Motley Fool Answers.
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Southwick: It's time for [Answers, Answers] and today's question comes from Anna from Twitter. She writes: "I'm 10 to 20 years away from retirement. Should I avoid dividend stocks in order to avoid the income tax?"
Brokamp: Well, that's an interesting question, Anna. I would say if you're going to avoid dividend payers, the problem, there, is you're actually going to have to ignore most of the market, because most stocks actually do pay dividends.
Also several studies have shown that as a group, dividend payers outperform non-payers over the long term, although that can change depending on the time frame you look at, like during the '90s. During the boom-boom years, it was actually better to have non-dividend payers. But, of course, that all changed. All those non-dividend payers didn't turn out so well in the 2000s.
But I will give you a real-life example of investing in a dividend payer outside of an IRA, because I just came across this when I did my taxes. So 20 years ago, when I was but a wee little Bro, or at least a ...
Southwick: Aw! Baby Bro!
Brokamp: ...a Bro with less hair. As a poor teacher ...
Southwick:Bro with probably more hair, actually.
Brokamp:Well, maybe more hair is what I meant to say. So as a poor teacher I was about to leave teaching to go to grad school, so I was not investing a whole lot. But I found out that Home Depot had what is called a direct stock purchase plan, or a dividend reinvestment plan. You can send the money directly to the company (so you didn't have to have a brokerage account [and] you didn't need a broker), and the minimum was $500. So this is 1996, 1997. I sent them $500.
Well, because it's not in my brokerage account, I also forget about it until tax time rolls around [and] they tell me how much I owe in taxes based on the dividends they paid me. So this morning I looked [at how much that is] worth now, because I really hadn't been paying attention. So $500 back in like 1996, 1997 today is worth more than $6,000.
Southwick: Oh!
Brokamp: Because the stock price has gone up [and] because I've been reinvesting the dividends to buy more shares and those dividends are growing. I don't have the information from when I first bought it, but I do have the information from the end of the year 2000. Back then, I had 29 shares and each share paid a quarterly dividend at the end of 2000 of $0.04 per share. Now I have over 40 shares and each dividend -- the last quarter's dividend -- was $0.89, so it's gone up from $0.04 to $0.89.
That's all good, but [Anna] brings up a good point, and that is while this has been growing, I have been paying taxes on the dividend ...
Southwick: Even though you've reinvested them, you still have to pay taxes on them.
Brokamp: Exactly.
Southwick: Ach!
Brokamp: That's a very good point. So if you're going to invest in dividend-paying stocks and you are also going to invest in non-payers, ideally keep the dividend payers in your IRA and 401(k). Use your regular, taxable brokerage for the non-payers, but don't not invest in a good stock just because it pays a dividend and you have to have it in a taxable brokerage account.
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Southwick: [Chorus from "Video Killed the Radio Star" sung by The Buggles] You're listening to WFOL Radio. We're playing the greatest hits from your decade, no matter how old you are. We've got the tunes and the financial advice that will be music to your ears. I can't keep doing that!
In today's episode, Bro is going to offer up the best advice for every decade of your life. What should be your top priority in your 20s? How much should you have saved by your 40s? And what is the biggest mistake to avoid in your 50s? Bro, we're going to do all that. We're going to actually take people all the way into post-retirement.
Brokamp: That's true.
Southwick: So let's start with our listeners in their 20s. Your 20s are an exciting time. You're starting to adult, you're shopping at IKEA, and you're thinking maybe you should maybe, at some point maybe kind of a little bit, start thinking about your finances some more.
Brokamp: Maybe a little bit. The very first thing you should think about, because I'm the retirement guy at the Fool, is saving for your retirement, and if you start in your 20s you should be shooting for maybe 10% if not 15% of your income. That is how much you contribute to your accounts and you can throw in your employer match, as well. So if you're contributing 10% and the match is 5%, then you've hit that 15%. If you wait until you're in like your mid-30s to start saving for retirement, then you have to start targeting like 15% to 25%, so starting soon is definitely better.
The other thing you want to focus on in your 20s is paying off debt. Many people graduate with student loans. They might have gotten those credit cards in college that came with a free t-shirt and then maybe used them a little too much, so you want to focus on paying down that debt.
And one of the best things about paying off that debt is you will start building your credit score, and that is a third priority of your 20s. We've talked about this in previous episodes. Your credit score will determine so much about your financial life: whether you can get a loan, the interest rate on a loan, insurance rates, employers, and all types of things. So this is a time when you want to focus on building a great credit score and the most important thing about your credit score is basically making your payments on time.
Southwick: All right. How much money should you have saved for retirement in your 20s?
Brokamp: [For] the average person in their mid-20s, the average income in the U.S. is anywhere between $30,000 and $40,000. It's not a lot, [but] basically as long as you're starting, that's good. You want to target to have at least about half of your income in retirement accounts by the time you get to your 30s.
Southwick: And then what about a mistake to avoid? What's the number one mistake to avoid in your 20s?
Brokamp: I would say the biggest mistake is getting married too soon. When you look at divorce statistics, according to the Department of Labor, people who get married between the ages of 15 and 22 ...
Southwick: Yes, that's rough.
Brokamp:... the divorce rate is 58%. You wait until between 23 and 28, it is closer to 43%. Once you make it into your 30s or so, it's 36%. So I think the longer you wait, the better your odds that you will stay married.
Why is that good for your finances? Well, divorce is very expensive. It can cost anywhere from a few hundred dollars to tens of thousands. The average is around $10,000 to $15,000. You have to split up all your assets, and of course there's an emotional toll. So one mistake I think people should avoid is wait until you are absolutely convinced you have found the right person to marry.
Southwick: Let's head back on over to WFOL radio. And if you're in your 20s, then you might remember this song that was burning up the charts. It's the official song of summer for 2010. [Chorus from "California Gurls" sung by Katy Perry and Snoop Dogg]
Your 30s are an exciting time. You're hitting all the major milestones. Marriage, home ownership, kids, and a career. You're making a lot of decisions and because of those aforementioned kids, probably on very little sleep.
Brokamp: So true.
Southwick: So what should be your priorities in your 30s?
Brokamp: Well, you touched on it there. Number one is really your career, and that is being very strategic about your career. Your job is going to determine so much about your finances. Your income. Your benefits. Your retirement. The quality of your 401(k) and whether you have a pension will be a big factor in your retirement savings. And even, of course, your happiness. So you want to make sure you have a job that you enjoy, but I think it's very important to be strategic about it and to continually come up with ways to make yourself more valuable to your employer, to your colleagues, and to your customers.
Number two is to arrange your finances for a family. That has several aspects. First of all, it's a slightly bigger emergency fund. It's time to get life insurance. You probably haven't thought about that, but once you have kids you really need to get life insurance. It's also time to finally get an estate plan. The majority of people in America don't. According to a Gallup poll last year, only 44% of Americans have a will. But once you have kids, you need to set up your finances in a way to take care of them in case something happens to you.
And then the third priority in your 30s is to maybe buy a house.
Southwick: Maybe?
Brokamp: We've talked before about how it's maybe not the best thing in the world, but most people do, especially once they have a family. Just keep in mind that you want to be buying a house you're going to be happy with for at least six years and ideally a decade.
Southwick: And how much should you have saved for retirement in your 30s?
Brokamp: Once you're at around 30, you want to be aiming for about one-half of your household income. By the time you're in your mid-30s, you want to have about one to two times your household income stashed away in your 401(k)s and your IRAs.
You can also add other things to that. Maybe employee stock if you receive it. Maybe home equity if you plan to downsize when you retire. But for the most part you're really just looking at how much money you've saved in your retirement accounts.
Southwick: And what's the biggest mistake to avoid in your 30s?
Brokamp: I would say buying too much car and replacing it too soon. Remember when we're all in our 20s, we're driving a piece of junk. And finally once we're in our 30s, we have a little bit of money. We decide to buy a car. Maybe we buy too much of a car, or too nice of a car, and we sell it too soon.
According to IHS Automotive, the average new car purchased [is kept] for about 6.6 years, which is actually longer than it used to be. So people are getting this message, but the average life span of a car that's on the road, now, is almost 12 years. In other words, they could keep that car longer, but they choose not to. But you think of even just putting off a new car purchase a year what the average monthly payment is now -- between $400 and $500 --and that's several thousand dollars more you can save just by keeping that car for another year.
Southwick: Back to the radio, shall we? If you're in your 30s, you may remember getting motion sick and throwing up in your favorite yellow sweatshirt at the theater during The Blair Witch Project. Oh, it's so jerky, that camera action. I know. I sure do. You might also remember the song of summer for 1999. Yeah, it's that "Genie in a Bottle". [Chorus from "Genie in a Bottle" sung by Christina Aguilera]
Your 40s are an exciting time. Your kids are so busy with school and their friends that it gives you time to get to know you again. You'll do things like start a Styx cover band with your neighbors, and you'll lie to yourself and your friends that it's actually cool to drive a minivan. And it's practical, too, because of all those guitars and amps you'll have to haul around to open mic nights one day. Does that sound like your 40s, guys? Rush! Sorry. It's a Rush cover band.
Brokamp: No, Styx. Actually I was a big Styx fan before I was a big Rush fan.
Rick Engdahl: I just don't have time to practice my guitars.
Brokamp: Both of those work. Because Easter is coming up, at this point [my wife and I] we get the kids more little gifts than candy, and I got Styx' "Mr. Roboto" in eighth grade. My Easter basket. I still remember this many years later.
Southwick: Because it was the coolest thing ever.
Brokamp: Because it was the coolest thing ever. So 40s, three priorities. You want to be super saving for your retirement. And most people hit their peak earning years in their late 40s, early 50s. From the point from your 20s to your 40s, your income probably went up pretty significantly because you were climbing the corporate ladder. It starts to level off once you reach your late 40s, early 50s. You're about at where you're going to be, so you want to take advantage of that as much as possible. That's number one.
Number two is start planning for how you'll pay for college for the kids, and that means, of course, saving, but also arranging your finances to a certain degree for financial aid. You don't want to wait until the year before they go to college. You want to start doing that a good three years [in advance]. So if your kid is a sophomore in high school, you need to start thinking about arranging your finances for financial aid. And actually, even a freshman in high school is a better way to do that.
And then number three is to update your estate plan, which includes your life insurance. If you got your will and your life insurance back in your 30s when you first had kids and had your first house and all that stuff, a lot has changed since then. You might have had more kids. You've accumulated more assets. You probably own things that are not incorporated into your will. You're also earning more money, so you might need more life insurance. Now's the time of life to do that.
Southwick: And how much should you have saved for retirement in your 40s?
Brokamp: By the time you reach 40, ideally two to three times your household income. By your mid-40s you'll want to be around four times.
Southwick: Whoa!
Brokamp: Yes.
Southwick: Things accelerate.
Brokamp: And of course there's a lot of variation on this. It depends on your own situation. It depends on your income. It depends on whether you'll get a traditional pension or not. So these are rough guidelines, but they're good road signs along the way of whether you're roughly on track or not.
Southwick: And what's a big mistake to avoid in your 40s?
Brokamp: I would say actually spending too much on kids, as we've talked about. There was a good article in The Wall Street Journal last year about mistakes to avoid and it quoted a financial planner at Compass Planning Associates in Boston. Her name is Jennifer Lane. She recommends that parents pay no more than 10% of income on expenses related to kids. I'd never heard that guideline before, but I liked it. She also said that giving kids allowances actually helps keep costs down. Her quote was: "They'll choose not to spend when it's their money versus your money," which I thought was pretty good.
So it's very difficult. You want to give your kids all that they want. You want to send them to camps. You want to get them whatever when it comes to clothes, and toys, or even college (the situation I'm in with my kids right now). We've looked at two colleges so far this year. One was UVA as a Virginia resident. One was Duke. There's about a $40,000 a year difference between those two schools.
Southwick: Yeah, so I know where you're leaning.
Brokamp: Right. But you just have to put it in the context of your own finances. You don't want to compromise your own financial security because if you don't take care of your own financial security, if you don't take care of your own retirement, it's going to fall back on your kids at some point.
Southwick: Let's head back to the radio. If you're in your 40s, you also remember this iconic song from 1986, because the video pretty much blew everyone's mind and aired 100 times a day on MTV. Wubba wubba wubba! [Chorus from "Sledgehammer" sung by Peter Gabriel]
Your 50s are an exciting time. You're reaching cruising altitude in your career. The kids, who also work in your office, perplex you, but that's fine if they think you're the old, wise one in the office because you've learned the coolest thing you can do in life is not care what other people think about you. I'm looking forward to my 50s, I think, for that reason. So what should be your priorities in your 50s?
Brokamp: Well, it's the time to do some great retirement saving.
Southwick: I said it was an exciting time.
Brokamp: So take advantage of the higher retirement account contribution limits. For example, this year if you are not 50 and older, you can only contribute $18,000 to a 401(k) or $5,500 to an IRA. But if you're 50 or older, you can put an extra $6,000 into the 401(k) and an extra $1,000 in the IRA. So take advantage of that.
Number two is take advantage of the extra money you have since the kids are out of college and out of the house. I've talked to many subscribers to my Rule Your Retirement service about how surprised they were at how much money they had once the kids were gone. But the problem is some people then use that money to buy a second house, or a boat, or something. And if you're behind in your retirement savings, what you should be doing is really getting it into your retirement accounts.
And number three, take a good hard look at your retirement projections. I'm a big fan of retirement calculators, but honestly if you're using them in your 20s and 30s (and maybe even your 40s), there's so many variables that you have to guess at they're probably not going to be totally accurate. But once you're in your 50s, you really have to start looking at whether you're on track and a good retirement calculator can actually get a relatively accurate projection of whether you're headed in the right direction.
Southwick: And how much should you have saved?
Brokamp: Around age 50, maybe five to six times your household income. Once you're in your mid-50s, you really want to be 6 to 7 times.
Southwick: And what's a mistake to avoid?
Brokamp: I would say ignoring debt. One trend that we've seen over the last few decades is people entering retirement with more debt. So according to the Federal Reserve, back in 1989, only 11% of people in the 65 to 74 age group had a mortgage. Back in 2013, that was 43%. So almost half of people 65 and older having a mortgage.
I've talked before on previous episodes how I think it's a great idea to go into retirement without a mortgage or car loans, or any other kind of debt because it lowers your expenses. You don't have to take so much out of your retirement account once you get into your 50s, especially when you're supposed to be playing it a little safer with your portfolio. The safe investments these days are cash and bonds, which no one likes. Use some of that money that would be considered "safe money" to pay down debt.
Southwick: If you're in your 50s, all I have to say is "epic sax solo", and you'll know what I'm talking about. It's this hit from 1978. [Sax solo and chorus from "Baker Street" sung by Gerry Rafferty] Your 60s are an exciting time. These are the years where you transition out of being a workaday Joe and it gives you time to, you know what? Get to know you again. Again! You and your neighbors try to get a Troggs cover band together and end up playing Friday nights at the country club. Not bad! So what should be your top money priorities in your 60s?
Brokamp: So we're thinking, here, in terms of the early 60s. Obviously it's time to get ready for retirement. What that means is really learning a lot about Social Security and Medicare, because these are two programs that are going to have a big influence on the quality of your retirement.
Number two is to learn how to turn your portfolio into an income-generating machine. Up until now you've been spending decades learning how to accumulate money, but it's a little different in terms of using a portfolio to generate income. It might be the first time in your life that you've ever actually looked at bonds, for example. So learn about how to make your portfolio generate income.
Number three, I would also say it might be time to visit a fee-only financial planner. You might have had a financial planner all along, but if you never have, this is such an important transition with so many moving parts. It's time to get a good, qualified second opinion on when you actually can retire. And you want to get someone who provides holistic advice. A lot of people who call themselves financial advisors just really provide advice about your portfolio, but don't really know that much about Social Security, Medicare, and things like that. You want to get a good, fee-only, comprehensive financial planner.
Southwick: How much should you have saved for retirement in your 60s?
Brokamp: By age 60 you want to be shooting for eight to 10 times your household income.
Southwick: And what's a good mistake to avoid?
Brokamp: Retiring too soon. A lot of people retire just because, for example, they're eligible for Social Security at age 62. They think, "Well, I can take it now. Why shouldn't I retire?" But that doesn't mean that really all their finances are ready for retirement.
We're all aware that many of the studies indicate most people aren't prepared, but if you look at what people can do to improve their chances of having a secure retirement, it basically means retiring closer to age 70. It's more years of contributing to your accounts. More years of them growing without you touching them and years of maximizing Social Security by putting it off to age 70. If you think of everyone retiring at age 70 in this country, the vast majority of people are actually pretty prepared for retirement.
Southwick: All right, let's head on over to the AM dial. Does that still exist?
Brokamp: It does!
Southwick: Great. If you're in your 60s, you'll probably remember this classic that is so saccharine sweet you'll get a stomach ache. [Chorus from "Cherish" sung by The Association]
Our 70s and beyond are an exciting time. Your years of saving and planning are paying off. You get to volunteer your time, travel, and spoil grandchildren. Sure, your body aches a bit and you've got some sunspots and some laugh lines around your mouth, but they are all signs of a life well lived. So what should be your priorities in retirement?
Brokamp: Number one, you want to ensure your portfolio will last as long as you do, and that is understanding safe withdrawal rates in retirement, which is one of my favorite topics.
Southwick: Yeah. I know.
Brokamp: You know. And most people think of 4%. That's a classic rule of thumb, and it's a fine rule of thumb, but most people should be taking out either a little bit more or a little bit less depending on your circumstances starting, for example, with your age.
The studies that determine that 4% safe withdrawal rate assume you'll retire at age 65. But what if you're 55? What if you're 75? You really need to learn about how all that goes. I would recommend the three people to read to learn about this type of stuff is David Blanchett at Morningstar, Michael Kitces, and Wade Pfau. If you want to learn a lot about safe withdrawal rates in retirement, go check out those guys.
Number two, you want to learn how to sell investments in a tax-efficient manner. You're now in this situation where you are selling assets to generate income. One rule of thumb is if you have a taxable account, a traditional tax-deferred account, and a Roth; you drain your taxable account first, then the traditional account, and then the Roth. It depends on your circumstances because it might be better to touch the Roth a little bit sooner to avoid huge withdrawals from traditional accounts when you have to take money out at age 70 1/2. So there's some stuff to learn about that, but there are lots of ways to reduce the tax bill on how you turn your portfolio into an income-generating machine.
And then the third one is managing healthcare costs. For retirees, most of their expenses actually go down as they get older. The one exception is healthcare. So for someone who's 65, on average they spend about 10% of their budget on healthcare. Eighty-five year olds spend about 20%. Of course, you first want to make sure you're taking care of yourself so you don't have to spend so much on healthcare. But then understanding the healthcare system, Medicare, and all that so you can manage those costs as well as possible.
Southwick: And how much should you have saved once you're in retirement? All of it? One hundred percent?
Brokamp: As a good rule of thumb, you should have 12 times your annual income before you retire. And then beyond that it depends on your age, but 12 is a good rule of thumb. If you have a lower income, or a lot of your income will be provided by Social Security and a pension, you can have less. If you had a higher income throughout your life, Social Security is not going to replace as much of that, so you might need something like 14 times your income before you retire.
Southwick: All right, and this is a tough question, but what do you think is one of the biggest mistakes to avoid in your retirement?
Brokamp: I would say not preparing for changes in your ability and availability to handle your finances. And what I mean by that is as we get older we may not be as sharp as we used to be. A month ago we had a [professor from Georgetown] by the name of Dr. Sumit Agarwal [talking about behavioral finance]. In one of his studies he concluded that our peak age for making financial decisions is 53.
It turns out that our raw intellectual power (our IQ) peaks pretty early in life, like in our 20s, but it's compensated by wisdom and experiential learning. Once we hit age 53, that might be the peak, and for some people it goes down considerably to a point where as many as half of people in their 80s and 90s have some sort of cognitive difficulty handling their finances. Not everyone. Warren Buffett's in his 80s and he's doing just fine.
But you have to prepare for that possibility. That means getting your estate plan set up and thinking about who's going to handle your finances if either you're mentally not able to do it or if you're the person in this married couple that handles the finances and you die before your spouse. It could be one of your kids that you trust, or it could be you start a relationship with a good financial planner who can handle that for you later in life.
Southwick: We'll trot over to WFOL one more time before signing off for the day. If you're in your 70s or in retirement and took a Motley approach to your finances, you're no poor little fool like the one in this summer hit from 1958 by Ricky Nelson. [Chorus from "Poor Little Fool" sung by Ricky Nelson] This was fun!
Brokamp: It was fun. So nostalgic.
Southwick: Any time we can music work into a show, I get excited because I love music. It's funny how all of these songs that were like the big summer songs or the big songs of the year -- a lot of them didn't really last that long. Like there weren't a lot of Beatles songs and stuff like that. It's kind of weird. Whatever.
Engdahl: People are fickle.
Southwick: I guess so. So that's the show. I don't have any postcards to talk about this week. Womp womp. I will tell you that this show is edited nostalgically by Rick Engdahl. Our email is Answers@Fool.com. Of course drop us a line, or follow us on Twitter, or join our Face group. Facebook group. Face page.
Brokamp: Face thingy blobber blah blah.
Southwick: Whatever. We're done. For Robert Brokamp, I'm Alison Southwick. Stay Foolish, everybody.
Alison Southwick has no position in any stocks mentioned. Robert Brokamp, CFP owns shares of Facebook and Home Depot. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool recommends Home Depot. The Motley Fool has a disclosure policy.