Asset Dedication Part II: Case Study“Millennial Guru” Bill
In this part, we will discuss how to apply asset dedication during the early accumulation period when no one thinks about retirement.
Asset Dedication During the Early Accumulation Period
Bill is 33 years old. He is a project manager with a high-tech firm with a gross annual income of $150k. He lives in San Jose, is married and has two children.
He is in an early stage of his accumulation period, and he has 30 years ahead until retirement. It’s hard to think about retirement planning. However, the simple math of compound interest and history of the stock market have proved that he must begin setting aside some funds as soon as possible, in order to maximize the amount available when he retires.
He understands the need to save for a retirement and he actually contributes 6% of his salary to an employer’s 401k plan annually (up to the employer’s match). Bill would like to save more by setting aside some money in a traditional or Roth IRA every month.
Setting a Goal
However, as with many young families, he would also like to save some funds for his children’s college education. This means he cannot determine his exact goals right now, but he makes a decision just to simply set a goal to have $100,000 in savings in 5 years.
How Much to Save
Using a compound interest spreadsheet (Table 1), he can find that he should save approximately $18,000 in a year, or $1,500 in a month, or $50 every single day, and invest it in a bond portfolio with an average yield of 5% after fees and tax. We assume that all savings are made in tax-sheltered accounts such as IRAs.
Then he should verify if he can afford such savings. As mentioned, his gross annual compensation is $150,000. He already saves $9,000 by contributing in his 401k plan. The total savings will be $27,000, or 18% of his gross payout. While it seems a hard task, it is in line with our recommendations that in a low return environment, people save at least 20% of their income.
If during an established five-year period, his payout is increased, but he keeps the same saving rate, an excess of savings could be invested in equities for potential long-term capital growth.
Again, historical returns from equities are twice as high as the return from bonds. However, there is no assurance that history will repeat itself.
Bill can reset his saving goals after 5 years, having initially saved $100,000 in his “pocket.”
Regardless of what happens with the stock market or interest rates during this 5-year period, his portfolio allocation is exactly set to achieve her $100k goal, and there is a guarantee that goal will be achieved.