During trying times I think it is very easy for many to get pessimistic with all the negative news and let their ultimate goals slip away. Simple rules to live by include keeping debt to the lowest level possible and having clear cut goals of where you want to be in 5, 10, and even 20 years. Wherever you are in life it is never too early or too late to decide what you want out of your life. Money should be a method of achieving your goals and not the ultimate purpose. Unfortunately many Americans live their entire life waiting for that far off day in retirement only to realize that life has passed them by. Why not enjoy life right now as well? As you may already know, I am pretty conservative in my investing style and the current state of our economy has only highlighted the worst in investing habits for the public. We collectively as a nation have become a debtor nation and that is a sure way not to reach your goals.

There is a positive article about a couple who saved up a modest amount of money and retired at the very late age of 38. I think this story is a great read and I found it over at Minyanville.

Retire (Very) Early

I want to go through a few points in the article and demonstrate that you may not need as much as you think to achieve many of the things you desire for your life:

“At 55, Billy and Akaisha Kaderli have been retired for 18 years, enjoying extensive travel in Asia, South America and throughout the U.S.

Their getaway plan was crisp and simple: They started saving and investing early and avoided debt. Unlike some people with lofty goals, they stuck to the plan.

“We’re more concerned about running out of time to pursue our dreams of traveling than we are about running out of money,” Billy says.

The couple lived in Santa Cruz, California in their late 30s. He worked as a stockbroker and she owned and operated a restaurant overlooking the Pacific. Not exactly the traditional rat race life, but at 38 they decided they were working too many hours, paying too much of their income in taxes and not traveling enough.

By 1991, they’d stashed about $500,000, including a $100,000 gain from the sale of their house. The couple never paid much attention to “stuff” — cars, fancy clothes and country club memberships didn’t interest them – so they put what few household goods they had into storage and took the first step in fulfilling a lifelong ambition to see the world.”

First, it is absolutely critical to get yourself into the belief that debt will take away from you reaching your goals. This couple had an extremely clear vision of what they wanted to do. They wanted to travel the world. They realized that too much of their time was spent working away and that was conflicting with their goal. Of course, you need money to travel so they decided to delay gratification today for a life that is actually very fascinating and flat out fun. They are living their dream and it didn’t take that much money. With $500,000, they have managed to conservatively take out a bit of money each year to finance their travels:

The couple invests in index funds and benefited from the 1990s boom. They try to limit withdrawals to about 3% of the gains each year. The money is taxed at the 15% capital gains rate - not the much higher tax rates of 25% to 35% on earned income. They haven’t touched their Roth IRAs because they’d get whacked with a penalty for early withdrawal.

The couple tries to limit living expenses to about $24,000 a year - not an impossible goal in parts of Asia and Mexico. But recently they’ve been hit with unexpected costs: a new laptop computer to update their website and dental work for Akaisha.”

You may be saying, “$24,000 a year?! There is no way I can live on that much.” You’ll be surprised that in some parts of the world including South America $24,000 will go a very long way even with our declining dollar. Plus, you need to realize that the cost of living for housing and other items is much lower if you are actually living in these areas instead of stopping in tourist areas where prices are inflated. Now I know many people will not want to travel and simply want more time for themselves, but really this is a crucial exercise in determining how much money you need to live on your most basic needs. Sometimes having this minimalist approach frees you up from the slavery of debt.

Have you really thought about what you want out of life? Even taking mini trips during the year can help you out and jolt your brain into figuring out why it is that you are trying to be financially prudent. I would venture to guess that you do not want money simply to say you have it but the freedom that it can offer once you get there. Sometimes the biggest perk of saving is that it keeps you from buying useless things that fill your life up because you are pushing off confronting the existential question of what kind of life do you want for yourself. Here is a basic step:

“The how is so basic many people overlook, or ignore, it: Develop a saving and investing plan in your 20s, stick to it and don’t go into debt. If you’re younger than 30, save at least 10% of your gross income. Boost your savings to 15% if you’re over 30 and raise the percentage with each pay increase. Take the money off the top each month. If you don’t, you’ll quickly discover that expenses rise to consume available income.”

I think many financial articles do have salient advice. But what they miss is the psychological component of money. That is, people sometimes do not dig deep enough to figure out why they are saving the money for. What is the point or impetus to save if you have no long term goals or passion? In fact, the current credit debacle played on this psychological fear; that is people went into massive debt without looking at their ultimate financial goals. Buying a home and hoping it keeps going up is not a long term plan. Yet many in our country felt this was the main priority and unfortunately leveraged themselves to the point that all other life plans were put on hold.

First let us assume the most basic premise. Let us say that you can survive at a basic level on $20,000 a year. How much money will you need for this? Well if we assume a 5 percent return then we need a nest egg of $400,000.

$20,000/(5 percent return) = $400,000

You can play around with the numbers and adjust the percentage point or nest egg. The point of this is that you may not need as much as you may think. Now how quickly can you get to this point? If you start out with $1,000 in savings and save $1,000 per month you will have a $400,000 nest egg in 19 years:

Dollar Cost Averaging

Of course I am being extremely conservative in the rate of return above. The point of this is getting started now is the most important thing you can do because of the impact of dollar cost averaging and compound returns. First, the market is most likely to face harder times this year. That is why I do not recommend people putting their money in all at once. If you have $10,000 to invest, I would find conservative investment vehicles (I’ve mentioned a few on this site) and put in $1,000 a month until you finish the amount and keep the rest in a liquid and FDIC insured account. This way, if the market does correct you can pick up shares at a lower price which will balance itself out in the end.

$1,000 a month especially in a 401K/403B is not much especially since you are taking it out before taxes are taken out. If you gross $4,000 a month this is 25 percent of your income. Keep in mind that this will also force you to live modestly which will help if you are planning on living on a smaller sum of money. Normally in our lives we have to balance out time or money. Usually we have to choose between one or the other. Hopefully you’ll be able to realize that money itself is only a tool in helping you have a much more fulfilling life.

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One of the unintended consequences of this housing market is the punishment conservative savers are taking. Last month we had the rather astonishing release of data from the Bureau of Labor and Statistics telling us for the month, that inflation was at 0 percent. As disconnected as this is from reality, there is a reason the Federal Reserve is chopping rates even further and it is the opposite of what they are telling you. Behind closed doors, they are hoping that you go out and spend and go into further debt. In fact, they are setting up a system where savers are actually punished for not spending. This game and charade of course can only go on for so long. First, let us take a look at the current inflation rate and adjust it to an annual basis:

click to enlarge

The first thing I want to point out is the CPI. You’ll notice that last month, the reported inflation rate was 0 percent even though oil touched about $110 a barrel and has remained at those levels for sometime. Let us first calculate the current annual inflation rate based on the above numbers:

If we add up the previous five months of data, we get 2. Since this is five months of data we’ll have to adjust this for a 12 month calendar:

(2/5)=(x/12) gives us X as being 4.8 percent

So currently the annual inflation rate is at 4.8 percent. You will also notice that we have lost jobs in the previous three months to the tune of 76,000, 76,000, and 80,000. Keep in mind that during the previous three recessions, job losses during peak times reached over 300,000 a month even during the minor recession earlier in the decade. This can be looked at a couple of ways. Much of the data from the BLS lags the actual market. That is why people were predicting a recession in the middle of 2007 even while jobs were still being added. Keep in mind the way these things are calculated they leave out much of what the majority of Americans are facing on a daily basis. For one, the CPI does not calculate mortgage payments and taxes but owners equivalent of rent which understates the current burden of housing prices on many homeowners. Also, energy is blunted in the data so the rise in fuel cost isn’t reflected either. Then, you also get complicated uses of hedonics for healthcare, food, and education which again understate the true nature of consumer inflation.

So with that said, for someone to simply preserve their wealth in the current market they will need to achieve a return of 4.8 percent after taxes. Keep in mind that interest earned in CDs, savings, or money market accounts is taxed so a par rate of return is still not keeping up. But let us take a look of a few major institutions to show you how any saver in the current market is being punished:

The first one we’ll look at is Emigrant Direct. They have offered very competitive rates on their savings accounts and currently they are offering a 2.75% rate of return. You may think this is low but as we’ll show further, this is actually competitive for savings in the current market. The next place we’ll look at is ING Direct:

The current Orange Savings Account from ING is offering a rate of 3%. You notice that their CD offers a higher rate of return but let us look at what is required of this:

In order to achieve a yield of over 3%, you will need to deposit at least $50,000 or more. This isn’t even calculating the after tax amount you’ll be getting. We are simply looking at the current rates going for safe investments. When I say safe investments, I mean accounts that are protected by the FDIC which insurers individual accounts up to $100,000. The next place is your typical brick and mortar place that is also offering an online product like Emigrant Direct and ING. Washington Mutual is offering an online savings rate of 3.25% so long as you have a checking account with them:

You’re probably starting to notice a pattern here. The savings rate for many of these places hovers from 2.75% to 3.25%. Let us look at a different kind of account with Bank of American and their Money Market Savings Account:

Here, you’ll notice that the rates up to $10,000 will only yield you .35 percent. You will need $10,000 or more to get a rate above 1.24%. Bottom line is that if you stick your money into these accounts and let it sit, your money is actually eroding simply because the rate of inflation will eat it away. And this isn’t to say anything about a dollar that is also going down as well:

During the past two years, the US Dollar Index has decline by 21.7 percent. Given that many of the items Americans consume are imported, that means your purchasing power has declined by an incredible pace. If you have any doubts about this just take a trip to Europe or anywhere in the world for that matter.

There may not be a direct correlation from the Federal Funds Rates and the actual payments you make on mortgages simply because market risk is so high at the moment. But the funds rate does have a direct impact on the above savings rate on conservative accounts. What the Fed is telling you is that if you plan on saving your money in guaranteed accounts, you will in fact be losing money. Then you may be saying, what about playing the stock market. Let us look at the performance of the three major indexes:

Looking at these three even after the recent rallies and major intervention actions by the Federal Reserve they are still down on a year to date basis by:

DOW: -4.94%

S&P 500: -6.67%

NASDAQ: -10.60%

Clearly, the market is making it more difficult for people to protect their wealth. The places that have done well are in foreign currencies and commodities. Why are these doing well? Because they are simply reflecting the true devaluation of the dollar and the real rate of inflation that most Americans are feeling. Let us look at a few currencies:

The Japanese Yen is up 9.91% for the year against the dollar. This has a lot to do with the carry trade unwinding and also the extremely low central bank rates over in Japan. If you think we have low rates here, you just need to take a look over there. But there is more to this than just easy rates. In fact, the Euro is holding up strongly as well too because the ECB has held steady with their rates:

The Euro is up 7.68% for the year against the dollar. Now given that Europe may also be facing a credit bubble as big as our own by the reflection of recent writedowns on mortgage backed debt, their currency is perceived at least by foreign exchange markets as more valuable than the dollar.

The irony is that most Americans do not even have a tiny amount of money in commodities or foreign currencies to hedge their bets. Given that we are in a recession short of the technical definition, if the Fed cuts rates again expect the yield on the already inflation lagging savings accounts to go down even further and expect foreign currencies to go up and also, commodities. In this market, it is important simply to preserve wealth as many that are now seeing their equity evaporate in their homes are realizing. Even the stimulus checks that are coming out next month are not touted as savings checks but a way for you to spend even further. If anything, take those rebate checks and put them in a savings account or foreign currency. The Fed wants you to spend and be in debt since that is the last straw of our economy. Yet this is not good for you on a personal level. No wonder why Americans now have a negative savings rate. Conventional buy and hold investing styles are going to be proven extremely wrong in 2008 and if you want any more proof, just look at these scary charts. Be wise and don’t follow the advice of the Fed.

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