Dollars and Sense

A lot of op-eds get written about the future of energy, but very few tables of hard data get published. Tables are certainly boring and easy to gloss over, but are probably much easier to understand and comprehend for someone who is motivated to learn.

I was able to find the above data online from the department of energy. The analogy I see here is back in the early 2000s when Netflix was shipping more data via mail then through their own servers. We currently ship more energy via gasoline than we do through our electrical grid.

The pattern between the two energy delivery systems is somewhat surprising. I would have thought the increased push for efficiency in automobiles as well as the increasing purchase of electric vehicles would have put downward pressure on gasoline in relation to home energy usage. I’m not sure how rooftop solar gets accounted for in these numbers, but perhaps that is what is driving this trend?

This data also suggests that in order for gasoline to disappear, the electrical grid would have to be able to provide roughly 125% more energy than it does today, assuming a 1:1 translation between the two. (Cursory reading of electric grid efficiency vs gasoline efficiency suggests this isn’t a horrible assumption) That seems like a daunting task that will take decades, regardless of the adoption rate of electric vehicles.

This is a common question faced by individuals and families, especially as they approach their 60s. The issue is compounded by the knowledge of increased longevity relative to 20, 40, 60… years ago. Additionally, our social constructs of elderly care is increasingly becoming less based on group social insurance (i.e. defined benefit plans) and society has in turn placed the responsibility on the individual through the corporations increase in defined contribution plans (401k/403b). This has in turn changed the way in which current generations have needed to address their retirement. It also created a situation where the child cannot ask the parent for advice. Therefore, the question of, how much money do I need, is compounded by the fact, how do I determine how much I need.

When planning for retirement, the first objective should be to determine at what age do you want to retire? The second objective should be at what age can you retire? The first question should be easy, or at least easier than the second. The second one will be difficult. Doing all the right things (planning appropriately, making appropriate contributions to our savings plans, understanding our risk appetites, etc.) is no guarantee for a sable retirement savings. We could do all these things and still end up with the short end of the stick. That said, in most cases, if you plan accordingly, make clear objectives, have contingency plans, and execute on your retirement plan, in all but the rare occasions, most people will retire with adequate levels of savings and be-able to live within their means. In order to start planning for retirement, this article will focus on estimated amount of money one should have at retirement.

If I were to ask most people what age they would like to retire at, I think the general response would be tomorrow; or at least at some point in the near future. Now let’s toss that aside, onto the second objective, at what age would you be able to retire?   For most people, a realistic goal will be somewhere between 55 at the absolute youngest, and 75 at the latest. To determine how much money you will need, it is important to understand how long you should expect to live. In order to give you a better idea, here is a chart for reference. It provides the estimated life expectancy for several ages.

* Based on the static SOA RP2000 table using the combined healthy mortality. Generational mortality, using scale BB would estimate an additional 12-16% increase in life expectancy.

From this information we will derive the estimated amount of money we will need to have at retirement to ensure that we can do everything that we want. It should also be noted at this point, the level and breath that we could go into this topic is extensive and I intend to write much longer and with more depth in future articles, but for the remainder of this article I will focus on retirement savings in static form.

Based on the estimated life expectancy provided above, I have computed the estimated savings needed on hand to retire at different ages. This information has been provided in the table below. In order to compute this information, I needed to include several assumptions. To start with, the inflation rate was set to 3.0%, the life expectancy is based on the static mortality table, we need approximately 70% of our final salary, and the information was rounded to the nearest $5k. This information has been estimated from a base salary of 50,000. Therefore, based on these assumptions, the amount need at retirement is:

We could have picked alternative assumptions and created a different set of realistic estimates for retirement savings which could be considered materially different from the information provided above. With this new set of information, we can now convert these dollar amounts into an estimated savings rate as a percent of current salary. This will help to guide our decisions going forward and ensure that we are not under saving for our retirement.

The tables provided below estimates the target savings rates by age we start to save and our after tax investment return. In order to construct this table I did need to make some additional assumptions. First, the assumed retirement rate of return after tax is 7.00%, the assumed retirement age is 65.

As you can see, the estimated savings rate is pretty steep. In most cases the suggested amount of savings is in excess of 20% and in some cases, is in excess of 30 and 40%. This suggests we as a society need to start planning for our future and need to start saving significant chunks of our paycheck.

Author Comments:

I am aware there are several assumptions in this document. I the author, believe all these assumptions are reasonable and applied appropriately. That said, I am also aware alternative assumptions could be applied instead of the ones picked by the author. These alternative assumptions could be considered reasonable and have a material effect on the information provided. I suggest you use the information to inform as you see fit, but do so at your own risk. I suggest you consult with the appropriate financial adviser before you make any decisions about money.

Please note, the calculations above do not reflect current savings, impact of social security, defined benefit plan, etc. These savings rates could be reduced, possibly significantly, if any additional of the aforementioned benefits exist. For example, if someone is receiving a full social security benefit, they could reduce their savings rates by 20-45% based on income level.

It may be somewhat counter-intuitive, but many well to do folks carry debt. Even the world’s largest corporations carry debt. There are a multitude of reasons that these people do so, and one of these is called leverage.

The most prevalent form of leverage in the US is a home purchase. A home is a great way to store value, but most people don’t have enough cash to purchase one directly. In order to do so, they take money from a bank as a loan called a mortgage. This allows folks to purchase a home for somewhere between 3% and 20% of the total cost of the house. The ratio of the total cost to the money that you put in is called the leverage ratio. So for 20% down, that ratio would be 100% / 20% = 5. This is most commonly stated as 5x, or a 5 times leverage ratio.

Let’s see why this leverage ratio is important. If we buy a house for $100,000 with 20% down, we will have paid $20,000. This will give us a leverage ratio of 5x. If the house value increases by 3% to $103,000 and we sell it, we will pocket $3,000 in profit (ignoring transactional costs and loan interest). This profit, stated as a percentage of our down payment, is $3,000 / $20,000 = 15%. Notice how the 15% return is 5 times the 3% return of the actual house. This is directly related to the fact that we purchased the property with a 5x leverage ratio.

Of course, the reverse is also true. When the house loses value, the homeowner will experience the loss at a rate 5 times what the house experiences. So in this example, a total loss would be $100,000 or 500% of the $20,000 the homeowner paid.

So how do we use this to pay for a really large expense like college? Let’s say college costs $25,000 per year for 4 years. Let’s also say that houses can be purchased and rented out for a 5% profit per year. Then in this scenario, a house will have to be worth $25,000 / 5% = $500,000 to produce $25,000 per year to pay for college. We can then use leverage provided by a bank to purchase the house for 25% down, or $100,000. We still need $100,000 to pay for our kid’s college, but after 4 years, we will have a rental house producing $25,000 per year and a kid with a college degree instead of just a kid with a college degree. Additionally, the $100,000 will still be stored in the house’s value. This all works out because the leverage ratio of 4x in the example translates the 5% return of the house to a 20% return.

If you purchased a house at the same time you started a family and are then trying to send your kid to college 18 years later, there will probably be a significant amount of value stored in the home. You can unlock this stored value without selling your home with a home equity line of credit (or HELOC). If you use this HELOC as the down pay for the scenario above, you will have essentially paid for your kid’s college with no money out of your pocket.

This general line of thinking is called asset-liability matching. We are matching an asset (the rental house) to pay for a liability (cost of sending kid to college). By using leverage, we are able to greatly reduce the out of pocket cost of sending our kid to college. This is a very simple example and inherently carries various types of risk that are greatly magnified by the leverage. Every person’s situation is different and this may or may not be a good decision for you. Please consult with a professional before attempting anything like this.

There are many ways to do this and getting assets and liabilities to match sometimes requires a great deal of creativity and maneuvering. If you are really good at asset-liability matching, life insurance companies and banks pay top dollar for this type of talent.

If you are like me and live in the urban core or on the fringes of it for a large city, you will typically have a myriad of transportation options available to you. I have the options as varied as buses, express buses, subway, commuter rail, walking, taxis, cars, zipcar, lyft, motorcycle, and last but not least and my favorite, the bicycle. I’ve been commuting to work by bicycle since 2010 and it has become an enjoyable part of my daily routine. Some of my friends know me as the “triathlon guy” which usually translates into a fair amount of bicycling and swimming questions.

I’m writing this post as a reference point that I can point people to as a guide to getting started with biking. Biking is a diverse sport with many different disciplines so it is impossible to write a guide to encompass it all. So the target audience for this guide is someone who is thinking of using a bike as a supplemental or primary means of transportation, rather than any sort of primarily recreational purpose.

How the hell does this fit into my dollars and sense blog? Uhmmm biking saves you money. Totally. I promise. Pay no mind to the hundreds (thousands?) I’ve poured into my bike(s).

Step 1, the bike.

Biking is generally broken down into 2 categories, road bikes and mountain bikes. Any other sort of classification of bike is usually meant as some sub-classification of these two that is meant to serve some niche market. The following are 3 bikes that work as a good base for commuting and are relatively cheap.

Schwinn Men’s Volare 1200 700C Flat Bar Road Bicycle, Blue/Black, 18-Inch
This is the bike that I started commuting on (or at least the 2010 version of it) This is a solid bike that is really suited for folks between 5’6″ and 6’1″ and is sturdy enough for up to about a 180 pound rider. If you aren’t in that category, you might want to try one of the other bikes below. This bike comes in only one size.

This bike is a hybrid bike, which is a type of road bike built for a more relaxed upright seating position and slightly wider tires for durability and comfort. It is rather heavy and has only 21 gears, but these drawbacks aren’t going to be deal breakers when it lets you get into a bike for about $300 brand new. This really represents the bare minimum quality of bike I would recommend if you are going to rely on it for transportation. There are cheaper geared bikes out there, but the couple of bucks you’ll save will be eaten up the first time it leaves you stranded with a mechanical malfunction.

I even raced this bike in my first triathlon. It is a cheap, durable, dependable bike. All great qualities for a first bike.

Critical Cycles Fixed Gear Single Speed Fixie Urban Road Bike
This is a single geared road bike, more commonly referred to as a fixie. These things are quite a craze among hipsters. The real reason I’m recommending this is because if $300 for the volare is too expensive, then this lets you get in for a bit cheaper at $220 without sacrificing quality. Instead, this bike sacrifices quantity. As a single geared bike, it does not need a whole list of parts that the geared bike has on it necessary for changing gears as you ride. This will be a good alternative if the areas you bike in will be incredibly flat. Gears primarily come into play to help climb hills and without the mechanical assistance of being able to switch to a lower gear, the fixie will be tougher to get up hills. As you ride more and develop leg strength, hills that were once insurmountable will be less of a challenge. Worst comes to worst, you may have to walk it up the tougher hills, which isn’t the worst thing in the world.

Other benefits of losing all the gear parts is that you won’t have to maintain them, which on a cheaper bike is a constant ritual. Just clean the chain every once in a while and replace the brake pads as they wear and this bike should give you good service for as long as you enjoy riding it. If you are going to go this route, I highly recommend adding a front brake to the bike as that will drastically increase your braking power and allow you to stop significantly quicker.

Nashbar AT2 Mountain Bike – 15″
Out of the 3 bikes, this is the only mountain bike. If you are serious about making a bicycle your primary means of transportation, then you will want something that is going to serve you well in all types of climates. This particular mountain bike is equipped with disc brakes while the other two bikes are equipped with rim brakes. The performance of a rim brake will deteriorate significantly in inclement weather such as rain or snow. A disc brake doesn’t have this issue due to its design. This is a rare and and expensive item on road bikes, but fairly common on mountain bikes.

If you are dedicated to riding your bike rain or shine, then this will offer better performance in less than ideal conditions at a still affordable $300.

Step 2, Safety First! Wait, why is it step 2?
A helmet is necessary in most places. The only difference in helmets as you go up in price are style, brand, and performance (aerodynamics for the real speed demons out there). There is absolutely no difference in safety characteristics.
Schwinn Thrasher Adult Micro Bicycle black/grey Helmet (Adult) is a $18 helmet that’ll be just as safe as the more expensive helmets. If you ever get caught riding in the dark, you’ll need some lights as well. CatEye HL-EL135N/Omni 3 TL-LD135 Combo is a good basic choice.

Locks are a bit of a personal choice and depending on where you leave your bike, you may need more security or less. I’m lucky enough to be able to park my bikes in pretty secure areas. I use Kuat Bottle Lock (Black) to keep my bike secure, but you may want to invest in a more heavy duty lock. If you use a lock that comes with some sort of bike protection guarantee, keep in mind that they require proof that the lock was broken and various other things that make it nearly impossible to actually file a claim.

Step 3, Tools
The following is a list of basic tools that should be part of any commuter’s kit. Bikes aren’t immune to flats. These tools will help when you experience your first flat. It might be a good idea to watch some youtube videos on how to fix a flat as well. If you order your bike online, the Alien III tool and a bike pump is enough to assemble your bike when it arrives.

Step 4, Comfort
If you made it this far and are still interested in commuting with your bicycle, here are some items that can make it more comfortable. These are just a few items as suggestions, but the value of these things will really depend on your preference. There is a wide variety of products that meet these needs so you might be better off researching something that suits your own taste.

Axiom Journey Uni-Fit MK 3 Rear Rack: Aluminum – Racks have a lot of different designs and are not compatible with all bikes. Do your research before picking a rack. I like this rack because it is compatible with most bikes used in commuting. With or without eyelets, rim or disc brakes, skinny road tire or fatter mountain bike tire, this thing has a lot of compatibility. Not sturdy enough to tour on, but definitely sturdy enough for commuting duty.