In a recent post I reported that the Frugal family was nearly debt free. Well, we’ve crossed that pinnacle point, and are now enjoying life after debt. A comment from that post, and my initial experiences, have me wondering if life really is any easier after crossing over from being in debt to enjoying a life without it.

The first thing we did after reaching debt freedom was realign our financial goals. The first, of course, was to secure a fully-funded emergency fund, one that represented about six months of expenses. Admittedly, it was tough to keep up the same intensity towards saving money as we had for paying off debt. That brings me back to the thought-provoking comment left by Rob from PassionSaving.com. Here’s a portion of that comment that struck me:

If your experience is like mine, it won’t be all smooth sailing from this point forward. I say this not to be discouraging, but to point out what might be a basic reality of human life — it is a journey of ups and downs no matter how skilled one becomes at handling one’s money issues.

What I believe today is that accomplishing a big money goal like paying off one’s debt does not so much solve all your problems as open you up to a higher class of problems. The old problems truly are solved. But solving them provokes you into taking on new adventures, which lead to new problems. You will continue to find yourself frustrated and stuck and in pain and in fear in days to come.

My initial reaction? Yeah right! What could possibly be any more painful, financially, than going through the motions of paying off debt? What money struggles could we face that are even close to the struggles faced in the past? I suspect most people still deep in debt probably had that same reaction. But as I thought more about Rob’s comment, and began to experience life after debt, I understand his point.

Yes, we no longer have to contend with debt, but that doesn’t mean more daunting financial challenges aren’t ahead. My oldest child will soon be ten years old, which apart from terrifying me as a father, also serves as a wake-up call to get her college savings in order. Because we spent so many years toiling with debt and trying to get on solid footing, her college savings have suffered. The good news? Without debt we can afford larger contributions to her 529 plan, which should help us make up ground.

It’s a similar story for our own retirement plan. I diverted money we could have, and probably should have, used for retirement savings to pay down debt. Unfortunately, this means we missed a great opportunity to invest in our 20’s and let that money compound for a few decades. Are you reading 20-somethings? Make long-term savings a priority now!

In the final analysis, I would have to admit that yes, life is easier after debt. Paydays are now an exciting event because it means making more contributions to savings, rather than distributing most of your income to credit card and auto finance companies. But life after debt is not without challenges. And those challenges can conjure up the familiar fears and anxiety felt when looking at a pile of debt.

How will I even save enough to retire? How much will my kids need for college? Will I ever be able to save in taxable investments to chart a course to early retirement? I’ll approach these new challenges the same way I approached, and overcame, the ones related to debt. We’ll tackle them head on, and remain disciplined through the same frugal approach we take towards nearly all of life’s ups and downs.

I mentioned a while back that we enjoy gathering up loose change around the Frugal household, and the holidays are a great time to round up coins to put towards a little Christmas shopping. Because I’m lazy, I usually stop by Coinstar and dump my change to cash it in for a small fee.

After that post, Coinstar contacted me to let me know about the eCertificate option offered by Coinstar, and a special promotion running through December 6th that offers $10 to users who redeem $40 worth of change for a retail gift card. Naturally, I took them up on their offer to try out this option – especially when they were nice enough to send me $40 in change to try it out!

I waited for the last-minute shoppers to vacate our local Kroger grocery store and took my change cup with $45.53 in coins to the nearest Coinstar machine. After following the on-screen prompts I dumped in the change and Coinstar generated a receipt including an Amazon.com (the retailer I chose) gift card code.

The only bummer was that I now have to mail off a little rebate receipt to claim my $10 bonus gift card. But hey, it’s worth a little effort to earn a 25% return on my change! If you’re interested in a little Cyber Monday online shopping, now would be a great time to dig through the sofa cushions for extra coins, find the Coinstar nearest you, and cash in!

The Frugal Roundup

Is Coupon Clipping Worth It? Here is an interesting spin on coupon clipping. It really makes you think about clipping coupons online. (@Suns Financial Diary)

Put Your Finances on Cruise Control, But Stay Alert. With all of the talk about automating your personal finances, it’s always a good idea to keep your eye on what’s in front of you. (@Consumerism Commentary)

Banks Can Manipulate Your Transactions, Then Charge You 1750% Overdraft Fee. Ever wonder how they calculate your overdraft fees? (@Wise Bread)

College Students Arrested For Refusing to Pay Tip. What would you do if you had a mandatory 18% gratuity and your server was horrible? (@The Consumerist)

Best of the Rest

• My Up Close Look at Health Care
• Blockbuster vs. Netflix: Online DVD Rentals for Less
• 5 Reasons Why You Will Retire Broke and Unhappy
• Why I Don’t Buy Digital Media
• How Lease Payments Are Calculated
• Cleaning Out the Garage
• How to Score Big on Cyber Monday

Happy Thanksgiving to all! Don’t overdo the turkey, or the Black Friday shopping.

Photo by Clean Wal-Mart

No, I’m not going to list some new vocabulary words for you to use when your account goes down by 20%. Sorry to disappoint.

Instead, I’m going to share with you five 4-letter words that should be in everyone’s vernacular when it comes to their money and finances.

Take a look at the list and see if you are using these important 4-letter words!

1. Save

This should be a common word used in your household.

How much are we going to save and where are we going to save it are extremely important questions to be asking yourself regularly.

What this recent economic downturn taught us is the importance of having some savings built up in case a major crisis hits (i.e. job loss etc.).

The average savings rate has gone up to about 5% according to the Bureau of Economic Analysis.

This is a good trend especially when you look at the chart to see where the savings rate has been in the last several years – but there’s still major headway that could be made. Make sure that “save” is a regular word you’re using.

2. Give

Giving is a key part of being a good humanitarian.

You’ve heard the old saying, “It’s better to give than to receive”. Why is that? Because when we’re less consumed with ourselves and more concerned for the welfare of others it benefits them and brings us more joy!

The most miserable people in the world are generally the ones who are self-absorbed misers.

There are countless numbers of poor, weak and downtrodden folks who are waiting for us to be a Good Samaritan.

Whether you give money to the homeless, volunteer in a soup kitchen, give to organizations that provide relief for the under-privileged – you should find something that you are actively giving your time and money to.

3. Risk

Risk is a four-letter word that gets used often, but many times in the wrong way. What I mean is that most people often assume they are a riskier investor than they really are.

It seems like people love risk in a bull market and can’t stand it in a bear market.

It’s important to review how much risk you are willing to take so that you can create a well-diversified portfolio that should generate more consistent returns with less volatility.

4. Roth

If you qualify for a Roth IRA, this is one four-letter word you don’t want to ignore.

What exactly is a Roth IRA? Basically it’s an Individual Retirement Account with after-tax contributions and tax-free withdrawals.

Given where tax rates are currently (low) compared to where they’re going to be in the future (high), it makes sense to check this type of account out now and put it to good use.

5. Debt-Free

OK you got me, that’s two four-letter words put together, but the point is learning to use these words together will help you get on track for your financial goals so much more quickly.

Resolving to be debt-free is a decision you won’t regret. Sure, it’ll take some discipline, hard work and a lot of sacrifice, but it’ll be so worth it in the end.

How do you become debt-free? First you need to make a decision to go for it. Secondly, put a plan in place to cut back on expenses, increase income if possible and use as much discretionary cash flow as you can to start knocking out your debt!

There you have it. Five four-letter words that are OK to say in front of your kids and even better to implement in your personal finance journey!

The first step in retirement planning is to estimate how much money you need to retire. This is actually a fairly straightforward task because there are simple mathematical formulas and easy-to-use online retirement calculators designed to help you. The process is well understood and the tools are easily accessible on the internet.

What is less well known, however, is how these calculators work and the inherent problems involved in using them correctly. In other words, it is easy to create a retirement estimate but surprisingly difficult to do it accurately.

The reason it is difficult to create an accurate estimate for the money you need to retire is because the accuracy is dependent on the assumptions you use. Many people fuss over whether to use elaborate models like Monte Carlo or simple rules-of-thumb like the 4% rule, but that is missing the forest for the trees.

Huge differences in your retirement planning estimates occur when you vary the assumptions used for spending, income, inflation, and other required inputs. The unspoken truth about retirement planning is the validity of the assumptions used to determine how much you need to retire will make or break your financial security.

The Inherent Problem With Making Retirement Assumptions

Below are the six common assumptions required by nearly all retirement calculators to determine how much money you need to retire:

1. Annual spending budget
2. Estimated inflation rate
3. Expected lifespan
4. Annual income from sources other than savings
5. Estimated return on investment
6. Expected retirement date

As you read through this list of assumptions you probably realized something – they can’t possibly be answered accurately. Think about it. All but one requires you to predict the future—something no one can do reliably without a crystal ball. In fact, only one question can be answered with confidence because it is the only one you have any control over (number 6 in case you haven’t guessed).

Amazingly, conventional retirement planning requires you to provide assumptions that are impossible to estimate accurately in order to determine how much money you need to retire. It is insanity. If you vary these required assumptions within a reasonable range of probable outcomes you will find the estimate for your retirement savings can vary by two to three times the original amount.

In other words, one set of assumptions might result in $750,000 of retirement savings needed, and an equally plausible set of assumptions might estimate $2,250,000 in required savings. The difference is huge, and yet both set of assumptions are equally likely to be true. The whole process can leave you wondering what is the real retirement number and how can you ever retire in confidence?

Below we will look at each of the assumptions necessary to accurately answer the question, “How much do I need to retire?” so that you can better understand the issues involved.

How To Estimate A Spending Budget For Retirement

Most traditional retirement planning models assume you will need 75% to 85% of your working income in order to maintain your standard of living after you retire. The idea is that you will save on work-related costs like commuting and a professional wardrobe, as well as the expense of raising children. The formulas also generally assume that your home will be paid for and you will enter a lower tax bracket.

The truth is every individual has a unique set of circumstances that affect retirement spending. Today’s retirees lead longer and more active lives driving up the total cost of living in retirement. The expenses of hobbies, leisure activities and travel can easily offset any decrease in work-related expenses.

Your health care expenses are also likely to increase as you age, not to mention the price of long term care if you don’t have insurance to cover that. If you still have a mortgage on your house or a child in college, your expenses during your first few years of retirement may be equal to or greater than before.

The reality is you must plan a personalized retirement budget that reflects your unique plans for retirement. Some will spend more than their current income during retirement, and some will spend less. The research on retirement spending indicates a wide variance in retirement spending patterns with most people reducing spending as they get older. Any way you look at it, the 75-85% rule-of-thumb is a dangerous assumption that is best ignored.

Reasonable Assumptions For Inflation During Retirement

Most retirement calculators assume a modest 3% inflation rate. This is based on recent history (the last 20 years or so) and implies that your spending in nominal dollars will roughly double every 24 years.

The problem is if inflation increases to 6% (not a far-fetched possibility) then your spending will double every 12 years instead. That obviously makes a very big difference in how much you need to save for retirement. Rather than watching your expenses double once or maybe twice during retirement you could see them double 3 or 4 times which would drastically affect what you could afford to spend.

Historically, inflation has fluctuated from negative numbers to double-digits during wartimes and has shown prolonged periods of higher rates than the commonly assumed 3%. Given current conditions with high government debt and deficits combined with entitlement funding problems, many credible economists predict increased inflation over the next 20 years.

So how much will you assume for inflation when calculating how much money you need to retire? A percentage point or two can make a dramatic difference. I suggest using a range of assumptions varying from 3% on the low side up to 6% on the high side depending on how conservative you want to be in your retirement planning.

How To Estimate Life Expectancy

Isn’t it amazing that retirement planning requires you to estimate your life expectancy? Talk about an impossible task.

Sure, you can estimate your lifespan based on family history and your current health and medical conditions, but no one can possibly know how long they will live with any confidence. There is zero actuarial validity to estimating a single lifespan. You are no more likely to live until age 80 than you are to die tomorrow. For any one person life expectancy is random. It is only a valid statistical concept when large numbers are involved – not individuals.

Yet life expectancy has a major impact on figuring how much to save for retirement. The reason is because funding 20 years of retirement is dramatically different from 40 years or more. In the first scenario you can spend principal and the effects of inflation are reasonably manageable, but in the second scenario you not only can’t spend principal but you must also develop a perpetual income stream that grows faster than inflation. In short, different life expectancies imply dramatically different retirement savings requirements.

The conservative solution is to assume the best and plan on a very long life – longer than the actuarial tables estimate. If you come up short the worst that will happen (besides dying early) is you leave a nice legacy behind. If you live a full, long life you will need every penny. Many complain that a long life expectancy pushes retirement savings goals out of reach, but the truth is roughly half those people will outlive the averages and require the greater savings anyway.

Estimating Income From Social Security, Pensions And Annuities?

While Social Security will not likely disappear altogether, the inflation adjusted value of benefits will almost certainly decrease – especially for those retiring behind the Baby Boomers. You can check your annual wage and earnings statement from the Social Security Administration to get an idea of how much you’ll receive when you retire. The younger you are today the greater the risk that the inflation adjusted value of your benefits will be less than currently estimated.

Pensions, particularly private ones, are also proving to be less reliable than they once were. Fewer companies are offering pensions in the first place, but even those with longstanding traditions of fat pension benefits are backing out of those obligations – just ask airline employees.

Sure, there are protections in place to ensure you don’t completely lose out on what was promised to you, but underfunding is a serious problem with the recent market declines. Should your company default on its pension plan you could be left with a reduced payout. If your pension is frozen, you will still be entitled to benefits already earned, but you will stop accruing additional benefits.

In other words, Social Security and pension income may not be as dependable as you thought placing a greater burden on your retirement savings.

What Will Be My Investment Return During Retirement?

Most traditional retirement planning formulas assume long-term historical returns from a traditional stock/bond portfolio of 7% to 10%, decreasing to 4% to 5% after retirement as you shift away from equities and toward fixed income.

The problem with these estimates is they are derived from super-long data periods irrelevant to most retirees. What retirees care about are 15-20 year periods – not 100 year market history – and the surprising reality is how variable the returns can be over 15-20 year time spans. Negative to flat returns are entirely possible but are wholly unexpected when using traditional retirement assumptions – just witness the last 10 years for the U.S. stock averages.

This is incredibly important because even small changes in return on investment can dramatically alter your retirement security. It is not realistic to blindly assume long-term historical returns when your investment time horizon is significantly shorter than the data assumes.

When Can I Retire?

Finally, a question you can answer accurately. You choose your retirement date and you are in full control of when that occurs. If you are somewhat flexible in deciding when to retire, you can significantly reduce the amount of money needed to fund your golden years. Working just a few more years allows you to continue building your portfolio while at the same time putting off drawing down your savings. If retiring is not optional, however, due to medical or other reasons, plugging this known figure into your retirement calculator will send you on your way to determining how much you need to save.

In Summary

The key point to notice from this discussion is retirement planning is not nearly as simple as the financial calculators would lead you to believe. Sure, it is easy to create an estimate when saving for retirement, but creating an accurate estimate is an entirely different matter.

The fact is you need to make six different assumptions when calculating your retirement number; yet, only one of the assumptions can be estimated with any certainty. The rest require you to predict the future which is unknowable and impossible to do. Even the experts can’t do it – and neither can you or your financial planner. If you believe otherwise you are just deceiving yourself.

This is a big problem because the answers you assume to these questions will dramatically affect how much money you need to save so that you can retire with financial security. A small change in just one answer can vastly alter the resulting retirement savings requirement. In fact, I highly recommend you test this using your favorite retirement calculator and prove it to yourself. Don’t take my word for it.

Start varying the three most important and difficult assumptions – return on investment, life expectancy, and inflation – and you will be amazed at the dramatic impact it has on how much money you need to retire. Now, imagine if your estimates are off on all five of the variables—your retirement savings could be wildly off target forcing you to work longer, cut back on your lifestyle, or worse, run out of money before you run out of retirement.

What you will see when you complete this exercise is the traditional approach to estimating how much money you need to retire makes you completely dependent on how well your assumptions reflect your future retirement reality. In other words, you have to be able to forecast 20-40 years into the future. This makes the apparent scientific precision of retirement calculators far less scientific.

You might be paying a very high price for the work you do. In fact, it might make a lot of sense for you to take a lower paying job or stop working all together.

This thought occurred to me recently while I visited my daughter in Israel.

She’s a student and she’s also working part-time. I’m a huge fan of working through college but the next 6 months are really critical for her future.

You see, she’s studying for an exam that will determine what she’ll be able to major in. That in turn will have a huge impact on what career she’s able to pursue later on. You can see that it’s very important that she do as well as possible on that test.

I suggested that she quit her job and let me kick in a few shekels each month. She in turn would be able to devote all her attention to the exam in March. She’s a proud kid and very independent. She told me she’d consider my offer and get back to me.

If she does accept the help, it could be a huge win for all of us and I personally think it’s a no-brainer. The amount of money she needs to support herself is very modest. She doesn’t need the support for very long and the payoff could be huge.

Why am I sharing this with you?

Think about how you spend your day. Is it the highest and best use of your time? Is it consistent with your long-term dream? Do your daily activities get you closer or further away from your ultimate goals?

Let me give you another example.

Let’s say your dream is to become an attorney (if so, may the Lord have mercy on your soul). In order to that, you have to go to law school of course.

But let’s say you don’t have any outside support possibilities.

Assume you have to continue working as a receptionist in order to keep a roof over your head. Are you doomed to spend the rest of your life with a headset strapped to your scalp?

No way.

You can still apply these principles.

You may not able to quit work and devote all your energy to law school, but if you want to be an attorney badly enough, you could look for higher paying work that will allow you to pursue your dream.

You might become a food server in a classy restaurant for example. That might give you the money and time you need. Of course, you might have to start out as a lowly dish washer and work your way up. That might bruise your ego. But in this case, it could make more sense to be a dishwasher (at lower wages) than to continue your work as a receptionist. Make sense?

Have you ever voluntarily gone a down a notch economically in order to pursue a better future for yourself? Are you willing to do it now?

We have moved and settled into our home – well, at least we’ve moved! It will be a while before we unpack the last box, especially since I went back to work today and left a house full of boxed up stuff for the family. Pretty sad when you go back to work to rest up!

Over the weekend, while packing, I came across a handful of change. With my coin jar already packed, and time running out to move, I felt like tossing the change in the trash bag and moving on. But that would have really hurt me!  After all, the $1.30 I collected under sofa cushions represented about a year’s worth of interest on a $100!

Can you believe some people actually throw money away? Don’t believe it? Check out the fifth article below.

The Frugal Roundup

7 Critical Ways You Need to Take Your Life Off Autopilot. Here is a great list of things that you should really focus on. (@ My Super-Charged Life)

Redbox Testing $2 Per Night Rentals. Redbox has started testing $2 per night rentals. Will you still rent from them with that type of increase? (@Your Money Relationship)

A Little Food Planning Goes a Long Way. It’s always a good idea to plan your meals ahead. You can save a ton of money and always have what you need. (@Million Dollar Journey)

Master Your Money with a Financial Health Day. When you have your financial health day, make sure you involve you spouse in the decision. (@ Get Rich Slowly)

Why Throw Money Away? Yeah, this person really throws money in the trash. Seriously. (@The Suns Financial Diary)

How to Become a Successful Secret Shopper and Supplement Your Income. Need some extra cash to beef up your budget? Become a secret shopper! (@Generation X Finance)

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• Frugal Ways to Celebrate the Holidays
• Have You Ever Taken Risks to Try and Improve Your Career?
• What’s Luck Got to Do With It?
• 31 Days of Organizing for a Better 2010
• Interview Your Interviewer
  

Several weeks ago a young couple visited my office. Their situation wasn’t all that unique.

He’s a teacher and she’s a CPA. Together they take home about $100,000 a year – not too shabby.

They had a little under $10,000 in credit card debt – mostly from their wedding. They also had a $20,000 car loan and $65,000 in student loans. Not the end of the world.

They had about $20,000 they saved since before they were married. I suggested they take $10,000 and get rid of the credit card debt pronto. They agreed to do this.

Up until this point of the story – I liked what I was hearing. After all, they are a young couple with plenty of upside income potential. I wasn’t crazy about the credit card debt they had accumulated but it only came about as a result of the wedding – not a slow creep of living beyond their means on a monthly basis. I wasn’t too concerned.

However, I started to sweat when we went through their monthly expenses.

While they were in deed paying down their debts, they had the option of doing so much faster and weren’t taking advantage of that opportunity.

Instead, they were spending $400 a month on personal trainers and a whopping $1200 a month on dinning out with friends. This $1600 was only the tip of the ice berg. Together we figured they could easily cut a total of $2500 off their monthly spending.

I showed them that once they did that, they’d be completely out of debt (including the student loans) in about 3 years. Then we looked at what their financial life would look like if they continued to save that $2500 a month. The picture looked very rosy.

So why was I sweating it?

Because they didn’t seem all that interested.

They came to me looking for a solution to their debt problems. I showed it to them and they shrugged. I just didn’t get the feeling they were willing to roll up their sleeves and really do the work.

Forgive me, but I think part of it has to do with their youth. They were enjoying life and maybe they figured they could always get out of debt and cut their spending “manyana”.

This was frustrating to me because I know that for many people, “manyana” never comes.

I couldn’t find the right words to get them interested in taking action to get out of debt and on the path to financial freedom.

Was there something I could have said? What would you have said in order to motivate this couple? Is it a case of leading a horse to water and therefore, a lost cause? What’s your take?