Let's go back in time 20 years and imagine two sets of retired couples. Both couples have fully grown children and a gaggle of young grandchildren. Both couples are well-educated and dynamic. Each household is fun-loving and enjoyed an impressive income during their pre-retirement years. But when it's time for two parents, five kids (myself included), a dog, and two cats to pack into a rumbling 1977 Volkswagen Vanagon to visit the grandparents, the announcement of one destination brings rounds of cheers, while the other destination causes a yelp or two.
That's because one set of my grandparents understood that there were little details about retirement planning that were worth figuring out and putting into practice. This made for a rollicking household when their retirement years arrived. I remember it clearly: all the hot chocolate and presents in the winter, and all the lemonade and badminton and croquet and pool games in the summer.
The other household, however, did not pay as much attention to those little details. And even though we were kids, we knew somebody had fallen asleep at the retirement-planning wheel. The heat was always turned way down to save on energy costs. If there were presents, they were usually something wrestled away from the dog and wrapped up with newspaper comics. In the summer, the only outdoor fun we had was a good, old-fashioned game of stare-at-the-sun. And occasionally, we'd go double or nothing on a game of chew-the-bark-off-the-tree.
Little key No. 1: What to do with a windfall, and when to do it.
My grandfather was a remarkable man in many ways: Harvard class of '38, World War II fighter pilot for the Royal Air Force, cattle farmer, part-time newspaper columnist, and West Virginia state politician. Yet he failed with every single investment he ever made, bar none. One mind-boggling story involves him spending his entire $8,000 inheritance in 1950 on a board game called "Hugs and Kisses." He came across the game at a town fair, played it a few times, and convinced himself that it was poised to become a national craze, and that he had to act fast.
I can't help but thinking that if he had invested one-quarter in the game that later proved to be a massive flop and put the remaining amount in some bellwether stocks of the day such as GE (NYSE:GE), DuPont (NYSE:DD), and Ford (NYSE:F), by 1985 -- in addition to having a lot fewer of those games stacked up in closets and crawl spaces -- he would have had hundreds of thousands of dollars of accumulated wealth.
But you really can't blame my grandfather. He didn't have a trusted resource to show him what to do with a windfall, and when to do it. A recent issue of just such a resource, Motley Fool Rule Your Retirement, shows that getting money in the market as soon as possible yields the highest return. But it also increased the risk of the portfolios.
So the strategy you choose should be based on how much volatility you can stomach and your confidence in your options. If you suspect that an investment might be a bit overvalued -- or a tad speculative, as in the case of "Hugs and Kisses" -- you might nibble at it by buying a one-quarter position and then waiting and seeing what happens. For a potentially overvalued investment, if it takes off, you at least have some of it. If it declines or stays flat, you buy another quarter. For a speculative investment, you're better off waiting to see if it will succeed, and to what degree, before plunking down any more money.
When it comes to retirement planning, there are literally dozens of these little decisions that you're faced with that can, and will, end up having a profound effect on your lifestyle during your retirement years.
Little key No. 2: How to manage adjustable-rate mortgages (ARMs) in a rising rate environment.
These days, more than a third of all mortgage applications are for ARMs like those you'll find offered by lenders such as Fannie Mae (NYSE:FNM). That's the highest level in a decade, and is up from roughly one in every 10 back in 2001. As the name indicates, interest rates charged on ARMs vary. Some change rates every year, while others have fixed rates for a period of time, such as five years, then adjust.
With mortgages rising from 5.3% to 6.4% over the past year, people are jumping into ARMs because the initial rate is lower than rates charged on a 30-year fixed mortgage. But beware: Once that fixed period is over, the rate on the mortgage could rise quickly, significantly increasing your monthly payment. If you're considering getting an ARM for either the purchase of a new home or to refinance a current mortgage, ask yourself this: When will I move from this house? If you know you'll move within five years, for example, then a 5/1 ARM (which charges a fixed rate for five years, then adjusts annually) can save you thousands of dollars.
Now let's examine how that kind of savings can add up. If you bought $2,000 worth of PepsiCo (NYSE:PEP) stock in 1980, that investment today is worth more than $150,000. If you'd invested $2,000 in Philip Morris (NYSE:MO) 25 years ago, it would be worth just under $300,000 today. Finally, $2,000 invested in Johnson & Johnson (NYSE:JNJ) in 1980 would be close to $140,000 today. If you had purchased all three companies, making a total investment of just $6,000 in 1980, today you'd be sitting on a portfolio worth close to $600,000!
It's easy to see how a little decision can have a massive impact.
Little key No. 3: Cutting your tax bill by making sure you have the right assets in the right accounts.
You can reduce your taxes by maximizing the benefits of IRAs and employer-sponsored retirement accounts. As an example, let's look at the tax considerations of income-producing investments. But please consider the following as a guideline only, because your specific situation may require a more personalized strategy.
Dividends are taxed at 5% for taxpayers in the 10% or 15% tax bracket. They are taxed at 15% for all other taxpayers. However, not all dividends are eligible for those favorable rates. (Motley Fool Rule Your Retirement shows you which dividends are eligible for favorable rates.) Generally, investments that yield dividends which qualify for the 5% and 15% rates should be kept in retirement accounts if you're still several years away from the big day. As you near and begin retirement, however, keep dividend-paying investments out of your traditional IRA or employer-sponsored plan, since distributions from those accounts count as ordinary income and can be taxed at rates as high as 35%. And you don't want pay 35% taxes on an investment that could be taxed at just 15%.
Interest on most bonds and savings accounts also are taxed as ordinary income at both the federal and state level. In your saving years, keep these investments in your retirement accounts and get the full benefit of tax-deferred growth.
Government securities give up a little yield in exchange for some tax benefits. The interest on Treasury securities is free of state taxes, and the interest from municipal bonds offered by states, counties, and cities isn't federally taxable and isn't usually taxed by the state for residents. Putting these investments in retirement accounts negates those benefits because withdrawals will be taxed as ordinary income at the federal and state level.
The Foolish bottom line
When it comes to planning for retirement, nearly everybody thinks they're going to retire and live on a golf course, or next to the ocean, or on a lake. But only people who have prepared for it can have that lifestyle. Fortunately, if you're a healthy and hard-working person with the right kind of resources -- a resource like Rule Your Retirement -- you create your own economic reality.
Good preparation begins with things like 401(k)s, IRAs, and savings accounts. But from my experience, it also needs to include the little details like cutting down your tax burden, lightening your insurance load, having the right debt-to-income and savings-to-income ratios for your specific age, and literally dozens of others. I'm talking about the kind of little details that most people don't bother figuring out. This decision will really take a toll, given the compounding effects of time. I saw it firsthand. That's why I've dedicated myself to figuring out and employing the little details that will add up with the compound opportunities of time.
I can just about hear the kids and grandkids cheering now as their 2031 Volkswagen Hydrovan hums up the driveway toward our home.
Do you want to try coasting during retirement? Let us help you. Sign up for a free 30-day trial to Motley Fool Rule Your Retirement by clicking here.
Beirne White does not own shares in any company mentioned in this article. The Motley Fool is investors writing for investors.
