Ready For Retirement

How to Teach Your Adult Children to Plan for Retirement

November 14, 2023 James Conole, CFP® Episode 189
Ready For Retirement
How to Teach Your Adult Children to Plan for Retirement
Show Notes Transcript Chapter Markers

James walks through a framework of how you ensure that your legacy goals include more than just leaving a chunk of money to your kids when you're gone.

He explains the key concepts that can help your child develop strong money management skills. From starting early to diversifying your investments, learn how you can help set your child up for financial success

Questions Answered:
Why is it important to start investing for retirement early in life?
How does early investment preparation not only benefit your retirement but also your financial well-being in your younger years?

0:00 Intro
3:42 Here's where to start
7:36 Owner vs lender
13:46 Diversification
15:42 Starting early
18:26 Why it matters
21:53 Where are you investing?
25:11 Questions to consider
26:08 Outro

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Speaker 1:

In my job as a financial advisor, I am talking to a lot of people who are preparing to retire soon, and one of the things that I, of course, am asking them is what are your goals for retirement? What do you want this to look like Now? Not always, but frequently. People will often say that leaving some money to their kids one day is important to them. That's one of their goals. Depending on your personal philosophy, this can be a great thing to do, but as we get deeper into that conversation, I'll then ask them I'll say what would happen if their kids inherited all of their money today. Would that help them or would that hurt them? A lot of people will think about it and they'll admit that, while they have incredible children, they're not sure if their maturity or money management skills are yet to a place where they'd be okay to inherit this money. So they'll realize that financially supporting their children is great if done the right way, but only if they have healthy money management skills. So leaving a financial legacy to your children is more than just leaving an inheritance or helping with a home purchase or even just an outright financial gift. The best financial gift you can leave your children is an understanding of how to wisely manage money. So in today's episode, ready for Retirement, we'll walk through a framework of how you can think about doing that to ensure that your legacy goals include more than just leaving a chunk of money to your kids when you're gone. This is another episode of Ready for Retirement. I'm your host, james Cannell, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. Today's episode was prompted by a listener question, and this listener question comes from Tim. Tim says the following Hi, james, I've enjoyed listening to your podcast. They are very helpful. However, this question is geared towards my daughter, who will be graduating from college in December. She has offers, so she'll be jumping into the workforce right away. Very broad question what would the recommendation slash retirement strategy be for a 22 year old just getting started? Thank you very much, tim. Well, tim, thank you for that question. A lot of times we are so focused on our own planning, which is obviously good we want to make sure that we're in a position to have a financially secure retirement, to be able to do the things we want to do, to minimize taxes, to protect our legacy all these various things, and then we start to realize we've learned what we've learned over the course of maybe years and decades and, as our children are getting started, how can we get them a leg up in terms of understanding of what to do or how to prepare for certain things? And this is something I actually really enjoy talking about, because once you know what to do and you're starting early, there's no limit to what you can create for yourself in terms of the future you're trying to build. So, tim, thank you for the question, and this is exactly what we'll be talking about today. There's a few things that I think are important to cover. Now, when you're talking about financial strategy, what should you be doing? That very quickly becomes a broad question, with a hundred different things you could talk about. What I like to do is I like to start with the fundamentals of how can you cast a vision for what your future could be like if you begin doing the right things today, and how do you focus on those big rocks the big rocks being the things that are going to pretty significantly move the needle and then, once you have those big rocks in place, then fill it in and supplement it with other details. So, of course, we can't cover everything that I would tell a 22 year old just getting started, but we can cover the main things that would be most important in terms of casting vision for what's possible and then come on up with a game plan for how to start working in that direction. And the other thing that I'll add to that is, while these things we're going to talk about yes, maybe this is geared towards someone just getting started, but the reality is these are the foundations. This is the truth that all of our planning and investing in strategies based upon, and so sometimes even for those of us who've been doing this for several years and decades, even this is a good refresher. This is a good chance to recenter on why are we doing what we're doing, because that helps us even in our own planning. Here's where I'd start with someone getting started with investing. There's the question of what do I do with my money? Now, assuming you're not going to keep it in cash and maybe in a bit we can talk about how much cash is appropriate to keep but you want to invest it, and when you're investing, get, what you're doing is you're, of course, putting your money into things that you are expecting to grow for you. Now, there are a whole bunch of different types of investments that you can choose from, but in general, the big question is do I want to be an owner or do I want to be a lender? What does that mean? Well, if you own something so if you own a stock, for example, you own that company. So if you go out and buy stock in Apple, in Nike, in Johnson Johnson, in McDonald's, in Nordstrom, whatever you want to buy it in, you are a literal owner of that company. Now, it's you and millions of other people. So it's not as if you're making management decisions or executive decisions, but your value of your investment is based upon the value of the company. The company does better, you do better. If the company does worse, you do worse. So you are literally an owner of that company, and I think it's really important to remind ourselves of that when we buy stocks. So often we're looking at what the Dow Jones is doing or what the S&P 500 is doing or what the Nasdaq's doing, and maybe you see a big computer screen with all these flashing red and green symbols, and it seems not that far off from walking through a casino in Las Vegas and all these flashing lights. It's these things going up and down in value, and it seems like it's disconnected from reality sometimes. Well, keep in mind when you are buying a stock, you are literally owning a company, and if you're buying several stocks, you're literally owning several different companies. I'm going to come back to this later. So that's option one is you are being an owner, versus. Option number two is being a lender. So maybe you don't want to own companies, maybe, instead, you want to lend money to companies. Well, that's what a bond is. If you purchase a bond and a bond could be anything from buying a US Treasury bill to buying a bond in a big US corporation or international corporation what you're doing when you're buying that bond is you are lending your money to that government or to that corporation. Now, you're doing that because, in exchange for the privilege of borrowing your money, that government or corporation is going to pay you interest on your money and at the end of the maturity of the bond this could be after six months, this could be after 10 years At the end of that maturity, whatever it might be they're going to pay you back your money. So if I buy a bond for $1,000 and it's a 10-year bond and that bond is paying, say, 5% interest. I can expect $50 per year in interest, assuming this government or company stays solvent, and at the end of the 10 years I can expect my $1,000 back. So that's me being a lender. So the first decision you want to make is are you going to be an owner owning various types of stocks, or are you going to be a lender lending your money to various companies or governments? Now, there's huge implications for what you're going to choose, and here's why I want to start with this Long term. When you look at the performance of the S&P 500, and, by the way, the S&P 500, for those of you just getting started or teaching your children who are just getting started, it's just an index that tracks about 500 of the largest companies here in the United States. So if you want to say, how is the market doing? Well, there's thousands and thousands and thousands of actual indices or quote unquote markets that you could invest in. So there's not one singular market. All you have is a whole bunch of different publicly traded stocks that you can invest your money into. So you have these groups like the Dow Jones or like the Standard and Pours, where they will create an index, and the Standard and Pours 500 or S&P 500 is one of those indices. If you track the performance of that going back several decades, it's averaged about 10% per year growth. Now there's no guarantee that it's going to continue growing by that much going forward, but that's at least something that we can use as a baseline. So in that decision, do I want to be an owner or do I want to be a lender? Let's roughly use that 10% number as a proxy for what you could have expected, at least historically, for being an owner, assuming you purchased large companies in the S&P 500. Now compare that to being a lender. So if you're a lender, you're buying bonds historically over that same period of time, depending on what bond index you're looking at. But if we just look at a kind of a broad bond index, you can maybe expect to grow by about 6% per year growth. Now, when you're looking at that, to be very clear, you're not getting 10% every single year by owning stocks, nor are you getting 6% every single year for owning bonds. That's an average return, but you have a wide variation in the terms of the actual returns that you're accepting, year by year, more on that later. Now, as a beginner, you look at that and you might say that doesn't seem like such a big difference growing at 10% versus growing at 6%. Well, it might not seem like a whole lot, but let's take a look at the numbers. Let's assume someone's getting started and they're investing $5,000 per year for 40 years. One person decides to invest that money into something that grows at 10% per year and the other individual decides to invest that 5,000 per year into something that's growing at 6% per year on average. Well, after 40 years, both of these individuals they have put the same exact number of dollars into their portfolio. They both invested a total of $200,000. But let's take a look at what their portfolios were worth at the end of that time period. The individual that invested and grew at 6% per year. So by proxy, let's say, this person fully invested in bonds their money grew to about $774,000. So of that, $200,000 was contributions. The remaining $573,000 was growth on their money. If we compare that to the individual who instead invested their money in stocks so they chose to be an owner instead their money grew to over $2,200,000. So of that, $200,000 was what they put in and over $2 million was just growth on their money. So you can see how extreme those differences are. They have almost three times as much money at the end of the day simply because they chose to be an owner as opposed to a lender. Again, there's no guarantee that happens going forward, but if we're using history as our guide, or if we're trying to understand the relationship between owning stocks versus lending your money to various institutions or governments, there's going to be a difference in terms of the return that you can expect at the end. Now you do need to educate people getting started that when you're getting that return, it's not happening like clockwork. You're not getting 10% every single year. You're not getting 6% every single year. In fact, the S&P 500, let's average 10% per year historically has never once returned exactly 10%. So expect a wide range of potential outcomes. You could be up 50% in a year. You could potentially be down 50% in a year. That's the price of admission. That's why you get a great return over time is you're accepting that short-term uncertainty of you have no idea what that market is going to do or what those investments are going to do in the short term. However, to me, that's the foundation of when you're teaching people who are just getting started to invest understanding the long-term differences between what you choose to invest in. Now I haven't even talked specifics yet of how much large companies or small companies or international etc. But just using that is a good foundation to see their significant differences between what you can expect your portfolio to do for you based upon what you're selecting as your investment and the reason. I emphasize that so much is. As humans, we have a tendency to invest in what we know. Here's a perfect example. I remember taking a class in college and in this class were a lot of young people, very bright people In fact this was at my MBA program so people that had some experience, who weren't brand new to this investing thing. And I had a class in fixed income, so bonds, and in this semester we spent the entire semester understanding how bonds work, how they're valued, what you can expect from them, and at the end of the semester the teacher went around the room and asked how much, based on what you've learned in the semester, would you personally allocate your portfolio to bonds? And I remember thinking this is kind of an absurd question just because we know a lot about something doesn't mean that it makes sense for us personally to allocate to, and I was expecting most people to say I wouldn't allocate hardly anything to bonds in my portfolio, given that all of us were relatively young. Here's the thing, though. I said no, I wouldn't allocate a single dollar to bonds, but most people I don't think there's a single other person in the entire class that said they wouldn't put any money into bonds of their own personal portfolio, and, in fact, the average person was saying they would allocate anywhere between 20% and 100% of their portfolio to bonds. And it struck me why on earth would people who are so young and have so much time until they actually need these dollars do anything with bonds? And the answer was because they had just learned about them. Now they felt really familiar with them, they understood the intricacies of them, and it showed me a very important lesson, which is we tend to put our money in things we understand, regardless of how appropriate that specific investment happens to be for our unique goals. So, as you're understanding this, as you're understanding the various options, don't just put money in things you understand. I don't care how well you understand real estate or bonds, or stocks or alternatives or anything. Understanding is just one part of it. What you really want to know is what's the best one of these investments to help me reach my long-term goals, and that comes from understanding what potential return you might receive from each of these investments and then calculating that out, projecting that out to see what will this do for me and is this the best thing for what I'm trying to do. So be an owner versus be a lender. That's the most important thing you can do. To start is understand what you're going to be, and, generally speaking, the younger you are, the better off you're going to be owning stocks as opposed to owning bonds. But again, that's always a personal preference. Hey everyone, it's me again for the Disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. The next thing I would talk to if someone's just getting started with investing is helping them understand the importance of diversification. Diversification sounds like one of those things that you do if you want to be boring and if you want to underperform the market. That's the general thinking about diversification and I push back against that whenever I can, because diversification is done to maximize your odds for potential success. And I say that because if you look at the market over the last 50 plus years, on average, two out of every three stocks in the market and by market I'm defining it in this case as the Wilshire 3000, so 3,000 stocks in the United States two out of every three of them underperformed the market. Yes, how on earth can that be? How can the average stock underperform the stock market as a whole? Isn't the average stock? It's gonna be 50-50, half outperformed, half underperformed. No, and the reason for this is the companies that do outperform. They tend to be what's driving the performance of the market as a whole. So if you miss out on those top performers because you're trying to pick maybe one or two or three stocks to be the entirety of your portfolio, you have a pretty significant chance of underperforming the market. So when I'm talking about the S&P 500, that's saying don't put all your money in one stock If you simply own one index. Now, all of a sudden, you're owning 500 plus stocks and there's actually 505 companies in that index. Don't even stop there. Do you put some money in smaller companies or international companies, and what you're doing is you are both removing some of the risk from your portfolio, but you're also increasing your return potential. By not just owning one thing or two things or three things. You're increasing your odds of success over time, which is so important to do as a young person getting started. The next thing I would then talk about is the importance of starting early. We just went through that example where we said what would happen if, for 40 years, you invested $5,000 per year and grew at 10% per year. You saw that money turned into a lot more money. That took the portfolio value to over $2.2 million after 40 years of doing that. But the pushback and this rightfully so, maybe from younger people getting started is why on earth would I be thinking about retirement? You know, I maybe have student loans to pay off. I just graduated. I want to have some fun, I want to be able to save for a home, I need to purchase a car, I need to have some money to live on All valid points. But here's where I like to show people when you're saving money for retirement, it's not just for your 60 yourself, for 65 year old self or 70 year old self. It's also for your 30-year-old self, your 40-year-old self, something that seems a lot closer, a lot more tangible. People say well, what do you mean by that? When I'm putting money into a 401k or Roth IRA or whatever it is, isn't that money for retirement? Yes, that money is for retirement. But here's what I mean. Let's take a look at example. So, tim, you mentioned that your daughter. She's 22 years old and she's getting started. I don't know how long she wants to work when she wants to retire. I guess she probably doesn't even yet at this point. Most people getting out of college have no idea the day that they actually want to retire. But let's walk through an actual example here, tim. What if you walked your daughter through this and said look, let's just assume for a second that you're going to work until 65, just to use that as a starting point and I'm going to make the assumption that you get out of college and you are earning $50,000 per year, just to use a nice round number and I'm going to assume that you're saving 10% of your salary for retirement. Now, I don't care if this comes from your contributions or an employer's contribution. You know, for example, maybe you're putting 7% into a 401k and an employer's matching 3%. However, you get to that 10% I'm just assuming to fix $5,000 per year being saved for your retirement from age 22 until 65. Now, on top of that, I'm going to make the very conservative assumption that you never get a raise ever in your life. So you make $50,000 today, you make $50,000 next year, five years from now, 20 years from now, et cetera, et cetera, et cetera. So essentially, what I'm saying is these numbers are going to be very conservative. What if you just saved $5,000 per year, never increased it from the age of 22 until the age of 65? Well, if you did that that's 43 years you would have put in a total of $215,000. Your portfolio I'm assuming you're going to be an owner in this case. I'm just going to use a long term return of the S&P 500 as the proxy here. If you grew by 10% per year, your portfolio value would be $2,962,000. So almost $3,000,000 in your portfolio. Here's why that matters. I know you're probably not thinking about life as a 65-year-old, yet If you're 22 years old, you got a lot more stuff on your mind than what am I going to be doing when I'm 65. However, let's look at the alternative. Let's say you do graduate, you do get that job paying $50,000 per year, and you say you know what? I'm not going to start saving for retirement quite yet. I'm going to focus on having fun. I'm going to focus on saving for a car, for a home. I'm just going to spend that money on whatever I spend that money on. And you do that for the first, let's say, 13 years out of college. So one day you wake up and you're 35 years old and you realize I haven't started saving for retirement. Okay, I'll get started now. I still have 30 years to go until I turn 65. Well, you might look at that and say you missed out on 13 years, but no big deal, you're still saving for the next 30 years. Well, let's look at what happens If, at 35 years old, you now start saving $5,000 per year over the course of your working career. So from 35 to 65, you've put aside $150,000, but the ending value is only $822,000. Compared to the previous scenario where you had almost $3 million in your portfolio because you started early. So if you're looking at that, you're now 35 years old. You're not going to be nearly on track to have the portfolio value that you would have had if you had started saving at 22. Now let's add on to that what do we have to do to make up for lost time? So now you're 35 years old, you've got to kickstart your investments. You now see that maybe $5,000 per year isn't enough to get you where you want to go. So you start to ask yourself you say, okay, well, now I need to save more each year to make up for lost time. How much now would I need to save or invest each year, assuming it's grown at the same rate of return, to get me to that $2.96 million that I would have had if I started at age 22? Well, if you run the numbers, you would need to invest over $18,000 per year from the age of 35 until the age of 65 to make up the same amount of money that you would have had if you had simply invested $5,000 per year starting at age 22. Now I'm using a somewhat simplistic example here. Everyone has their own unique circumstances and can save a certain amount depending on what's going on. But what that's showing is, by starting saving for retirement early, it's not just benefiting you at 65 and 70 and 75, which is hard for someone just out of college to even wrap their minds around. It's benefiting you in your 30s. Think about this Now, in your 30s. In this specific example, you don't have to save $18,000 per year to be on track for your retirement needs. You can just save, quote, unquote, just save $5,000 per year, which means that extra $13,000 that you otherwise would have had to save to get to the same ending value. That's money that can be used to pay a mortgage. That's money that can be used to start saving for kids college. That's money that can be used to go on more trips. That's money that can be used for whatever you want. So by starting early, it's not just because we're so myopically focused on our long-term goals. It's also because we want to give ourselves some breathing room in our 30s and 40s and 50s, to not have so much pressure to have to really turn our savings into overdrive to catch up to where we otherwise would have been. So that's how I like to frame the importance of saving early, not just to prepare for retirement, but also to prepare for all the other goals that are going to come along over the course of our lives and our careers. Now the next and kind of final piece of the big rock decisions that I would say is where are you investing that money? If you put all this money so that $5,000 per year that we're talking about and if we again go back to the example $5,000 per year into some type of an investment, for 43 years, growing at 10% per year, you have almost $3 million in your portfolio. Well, let's assume that all of that money is inside of a traditional 401k. You put $5,000 in every single year, you get the tax break and then, when you get to retirement age, you have $3 million. But that's all pre-tax Meaning. When you start pulling money out of that portfolio in retirement, you owe taxes on the entire amount. Well, think how cool it would be if that almost $3 million was completely tax-free. That's what a Roth IRA can do for you. So when you're just getting started with investing, it's not just how am I going to invest and what's the right type of investment to use, it's also where am I going to invest. So is it a 401k, is it a Roth IRA? Is it a brokerage account? There's a lot of details and nuance to this, but, generally speaking, the younger you are, the lower the tax bracket you're in, the lower the tax bracket you're in, the more it's going to make sense to use a Roth IRA as opposed to a traditional IRA or traditional 401k. So if you can not only think about investing the right way but doing it in the right account, that's a powerful thing that can save you tens or hundreds of thousands of dollars in taxes over the rest of your life just by making that simple decision when you first get started with investing. So here's the general thing I would typically recommend to people. If you have a 401k at work and that 401k is going to give you any type of a match, take it. If, for example, you can put 3% into a 401k and your company will match you 3%, that's the equivalent to getting a 100% rate of return on your investment the day that you make it. You're not going to get that return anywhere else in the stock market. That being said, once you've taken advantage of that match, try to see if there's a Roth option available to you. This is more nuanced and this has tax considerations, and so ideally, you're talking to a financial professional or at least doing some research to see what makes the most sense for you. But as much as you can do into a Roth. Your future self will thank you. It will minimize the taxes that you'll have when you start to withdraw this money in the future. On top of that, more and more 401ks are now offering a Roth feature, where you can do a Roth 401k as well as a traditional 401k. Other episodes talk more about this, but you're going to have a separate contribution limit for your Roth and traditional 401k than you will for a Roth IRA or traditional IRA. But in general, get started early, decide whether you're going to be an owner or a lender and put that money or invest that money in the best type of an account that's going to save you as much in taxes as possible over time. That's the best place to start. What that starts to do is cast a vision for your children of wow, what is possible if I just get started investing now Not only possible for future benefit by 40 plus years out, but also possible 10 years out, 20 years out, when I'll have more cash flow freed up to do other things because I don't have to play catch up as much with my retirement. Now, that's just the beginning. On top of that, you want to help to understand how much cash should I have for emergency? How much cash should I have for future things I'm going to be purchasing? How do I protect myself with different types of insurance? Should I pay off student loans versus invest? All those are very important questions, but I would say they fall under the umbrella of just understanding and having that vision for what's possible when you invest correctly and then working backwards into the right portfolio for you. So, tim, I hope that is helpful. I think that, as we're teaching our children about investing, it's one of the most powerful things that we can do because, again bringing this back full circle, if you're planning for your retirement and you might potentially have any type of an inheritance that you leave to your children, this could be a home, this could be a portfolio, it could be anything that you have. You want to know that that's going to be managed well and be a benefit to your child, as opposed to being something that might cause a lot of chaos and overwhelm and poor decisions being made because they don't have the money management skills that you have. So I hope that's helpful. Tim, thank you for your question. Thank you everyone, as always, for tuning in and I'll see you all next time. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how Root Financial can help you implement the techniques I discussed in this podcast, then go to rootfinancialpartnerscom and click Start here, where you can schedule a call to one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.

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