Charles Farrell of “Your Money Ratios” Speaks! Part I

Charles Farrell

As I wrote in my review of “Your Money Ratios”, Charles’ book sings to me. Charles has the ability to simplify complicated financial topics for the average reader to understand. His book is seriously one of the best books I’ve read on personal finance in a long while.

One of the keys to progress is learning from experts in their various fields.  Charles is gracious enough to answer some follow up questions I’ve been burning to ask after reading his book.  This will be a two part post due to the 2,800 word length of the interview.  In part I, we discover Charles’ motivation for writing his book, strategies for early retirement, and his conservative and debatable 50%/50% investment split between stocks and bonds.  In part II, we discuss the much maligned 401K, personal income taxes, why Social Security will survive, and why the flat tax is the right way to go!  Please enjoy!

WRITING “YOUR MONEY RATIOS”

Question: Was there a particular lightning bolt reason why you decided to write this book? For aspiring authors, what suggestions do you have to get your worked published in this ultra competitive field of business?

Answer: I wanted to write a book that would help average readers understand the most fundamental and critical relationships among one’s income, capital and debt, and how those things must be managed throughout your working career to build financial independence. So I took what are often quite complicated topics and figured out a way to present them in a very simple format that anyone can follow. I would like more people to enjoy the benefits of financial independence, and I hope this book does that.

As far as writing, all I can say is write about what you believe in. Hopefully, if you believe in it strongly enough, you’ll develop some expertise and then seek out ways to spread your ideas. Try to develop some niche that is reflective of your expertise. So I developed the ratios and they came out of my background in tax, finance and also working with individuals.

Think about what you do that is a little different and try to focus on that unique nature of what you do. It is a tough slog because the field is very crowded and often the least valuable information gets the most press. But you have to accept that reality and still push ahead. And then you need a little luck. Your message has to somehow get into the hands of people who appreciate and understand it. And that is hard to predict, which means you need a little luck to get it out there. So if you are going to pursue that path, I think you need to accept those realities of the marketplace.

EARLY RETIREMENT

Question: There seems to be a big movement among the Gen Y crowd to “retire” earlier, rather than the traditional age of 60-65. For those who wish to retire by 45, what would you suggest their Capital To Income Ratio target be, as well as thoughts on getting into mortgage debt?

Answer: Retiring early is a great goal, and if you want to do so, here are some things to consider: Because you won’t qualify for a social security benefit at that age (and won’t accrue the maximum benefit as you are not working through age 65) and you won’t have medical coverage through medicare, you would need to bump up your CI Ratio to at least 16, which at a 5% distribution gets you to 80% income replacement at that age. But the math on those numbers is pretty tough. In your mid 40s, you’ve probably only been working for 20 years or so. Thus, it would be difficult to accumulate savings of 16 times pay after only 20 years of work once you factor in taxes. But if you have some sort of windfall event, like selling a business, getting fortunate with stock options, or an inheritance, then that would help.

Also, with respect to a mortgage, once you want to live off the returns on your financial assets (retire), you really need to be debt free. I can’t stress how important that is. Thus, by the time you stop working, you want to be out of debt. But, that doesn’t mean you should be a renter, because if you rent you are paying a “deemed” mortgage, meaning the mortgage of your landlord, and your rent will continue to go up year after year, so you never have a rent free place to live. Thus, if you want to retire early, you may need a mortgage to buy your house and then you need to work hard to get it paid off by your early retirement date.

Question: I have a fear that once I get to retirement, I’ll ask myself “Now what?” and “Is this all there is?” In other words, I’m fearful that retirement isn’t as fun as the journey to retirement. What are your thoughts, and are these fears irrational?

Answer. I think you are correct to be concerned about “now what.” You have to think of retirement as another phase of your life; one where the returns on your capital give you freedom to do things that maybe you couldn’t do when you didn’t have financial independence. Think about what you enjoy doing and who you enjoy working with or spending time with, and allow the returns on your capital to facilitate more of that lifestyle.

Question: Do you think some people choose to not really care about their retirement? Perhaps those who retire with nothing are actually the luckiest people on earth? They were able to live life to the fullest for 40 years after college, and spend everything they earned. Using an extreme example, Bernie Madoff lived a life way beyond his wildest dreams. At 75 years old, an in prison, who really wins? Some would argue Bernie.

Answer: Yes, I think there are many people who just simply don’t want to plan. Some will get lucky and may do alright even if they don’t plan, just like somebody wins the lottery every week. But most who do not plan will experience lots of economic hardship as they age. And you just have to ask whether you want to run that risk.

INVESTMENTS

Question: You suggest keeping a fixed Investment Ratio of 50% stocks, 50% bonds from ages 25-59, and to 40% stocks and 60% bonds ages 60 and beyond. A number of readers, myself included wonder whether this is too conservative? Would your advice have changed if you wrote the book before the crash of 2008-2009?

Answer: I have always been a big advocate of balanced investing, meaning a split of your money between diversified stocks and very high quality fixed income holdings. I wrote the book before the recent market declines, it’s just that it takes awhile to get things published. The 2008 to 2009 decline just helped emphasize my point. So I have always pushed investors to adopt this approach.

Think about it this way, when you invest in stocks, your return is uncertain. There are no guarantees and past performance is not indicative of future returns (you’ve seen that warning before). And there are periods in modern markets where returns are negative for 20 or more years, Japan for example. So you can’t ignore that possibility. Now couple that with the fact that you will only live one historical cycle in the markets.

If you get stuck in a bad cycle, you may end up saving for 30 years and not have much to show for it. So I like to have a plan B, which is the interest return you get from fixed income investing. I lay this out in the book and go through the theory of why I think it’s important to have a plan B. And the amount in fixed income needs to be sufficient enough to make a difference, and 50% is, which is why I suggest people consider that type of allocation.

Basically, the interest payments from bonds serve to balance out the uncertainty of investing in stocks. And I think you need to build a base in high quality fixed income to allow you to invest and take the risk in equities.

But of course, every person needs to decide for him or herself how much risk they want to take. My feeling is that investors have been warned multiple times about the potential longer term risks of investing in stocks, and if they choose to ignore the warning, then they do so at their own peril.

Readers, feel free to share your thoughts on whether you think a 50/50 bond/stock split is appropriate throughout your investing life.  Don’t bonds look quite bubblicious right now?

Why does there seem to be a movement to retire early?  How feasible do you think it is to get a Capital to Income ratio of 16X?  Note: The CI ratio is simply the the amount of liquid assets you have to survive off of, divided by your average lifetime yearly income.

Stay tuned for part II where we can really sling some mud!

Keiju,

Sam @ Financial Samurai – “Slicing Through Money’s Mysteries”

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Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

  1. says

    Great interview. I think the push to retire early is related to a general “unhappiness” in our jobs. If you don’t like what you are doing you certainly aren’t going to want to do it until you are 60+. I know I don’t want to be doing my job for another 30 years. Most people take the thought process that they will just keep their nose to the grindstone and “hopefully” retire early.
    Why not find something you love to do and then you don’t think about just working for retirement, you are working at what you love.
    .-= Kyle C.´s last blog ..Frugal Monday Meals – Nachos =-.

  2. says

    I think boredom from jobs is a big issue. But I also think retiring early isn’t what it sounds. Most people would choose doing something they truly love over sitting around and doing nothing for many extra years. As long as people find projects they are interested in and motivated to do, they will work hard for many years. Too much of the same thing makes people feel like they are wasting their time and getting nowhere.

  3. says

    I have to agree with Kyle and Daniel on the early retirement issue. So many people I know who took the traditional work path dislike their jobs. Most of them have dreams of working for themselves, but that involves taking a big risk, and pay cut. I should know, I veered off that path before 30 and, from personal experience, it’s a more difficult one. However, I do believe in reinventing oneself, so maybe this early retirement push is really just a way for people to reinvent themselves with a little cushion (money cushion, that is)!

    P.S. Can I get a definition on Gen Y? I think I’m of the Gen X one. ;)
    .-= Little House´s last blog ..Making the Most of a 3-Day Weekend =-.

  4. says

    One problem is we’ve all been brought up to believe in the past couple of decades that we can dream of being anything. The reality once you get into your 30s is even a pretty cool job isn’t likely to match your dreams, which is why so many productive people start up side hustles or take their foot off the pedal at work for families and hobbies, while others go extra hard to try to make early retirement an exciting goal.

    I sold out of a business a couple of years ago. It wasn’t anything like enough to retire on (well, not for more than year or two) but it was enough to pay for me doing nothing at all for a month or two.

    Pretty soon I was in despair. I missed the hustle of getting money and the purpose of doing something. True, I wasn’t on a tropical island, and this may have skewed my thinking, but who gets to live a good lifestyle on a tropical island 365 days a year when they retire? Anyway, I think I’d have been struck by the same thing sooner or later.

    I now plan to seek financial freedom and new projects, rather than retirement per se. I got interested in longer term investing and personal finance partly from seeing someone not being able to retire when he wanted (and needed to, for health reasons) but I realize now I took out the wrong message.

    As for 50/50 stocks/bonds — I certainly wouldn’t right now. Ben Graham suggested a max of 75/25, and I think that’s a lot more sensible (75% equities / 25% bonds) given the crazy price of bonds and the still fair value of equities.

    I get where Mr Farrell is coming from over the longer term though, for sure. Most people don’t want the best returns, they want *returns*.
    .-= Monevator´s last blog ..Playing chicken with house prices =-.

  5. says

    @Kyle C.
    I agree Kyle, that is the elusive dream of most. May you find your dream job!

    @Mike
    It’s really hard to find that dream job so quickly Mike. Maybe after several tries, who knows. Those who find it immediately should consider themselves extremely lucky and count their blessings.

    @Daniel
    A’ight that the truth. Wasting time and going nowhere is not a good feeling, and not something we should just accept. Frankly, doing anything for too long….. say 5-10 years gets tiring, wouldn’t you agree?

    @Little House
    Good for you for doing your own thing! That takes guts, and at the end of the day, you can always tell yourself you tried. Can start early doing your own thing, or late. Each has their own merits.

    I think Gen Y is 1981-1982 birthdate or later!
    .-= admin´s last blog ..Do “C” Students Deserve “A” Lifestyles? =-.

  6. says

    @Monevator
    Hey Mate, didn’t know you were an entrepreneur who got a nice windfall! Well done! You should write about that experience if you haven’t done so yet, or recently. I’d be fascinated to hear about the entre spirit, and decision to sell.

    Good point about taking the foot of the gas pedal in one’s 30’s, and seeking to do other new things. Perhaps an early retirement goal of 45 is exactly the kick in the pants one needs to keep the motivation up in their 30’s yeah?

    I just want returns too… forget great returns, just give me 5-7%/annum for 10 years and I’ll be pumped!
    .-= admin´s last blog ..Do “C” Students Deserve “A” Lifestyles? =-.

  7. Charlie says

    Good Q/A! I’ve definitely kept more fixed income in my portfolio since the big dip. I’m not sure I’d go all the way 50/50, but I’m much more comfortable with a higher percentage than 3 years ago. I can see the reasoning for having a plan B though as who knows what the markets will look like down the road.

  8. says

    @ admin
    It’s sad, but I think about ‘retiring’ in 20 years (after working in a 9-5 job) and all I can think of is ’20 years! Are you kidding me! That’s practically how long I’ve been alive!’ So yah 5 or 10 years seems like an eternity right now. Hopefully I’ll find someone more stimulating in the next few years.
    .-= Daniel´s last blog ..Personal Finance 101 =-.

  9. says

    In response to people who don’t think retiring young is a good idea… Why not retire early? Sure, in most cases you will want to get back to working, but if the opportunity is there I think people should aim for it. I plan on retiring in the next 5 years and I am 30. Why work until your too old to fully enjoy what you can when your young. Retiring young affords you this opportunity.

  10. neal says

    A great interview…no doubt. I have a very different take on some of these items:

    a. get into your own business — you’ll never want to retire when you are working for yourself.
    b. forget about the ratios – people don’t think or behave that way. Think about a savings goal per year given an investment return that is rational and then spend all the rest.

    This is a simple plan but at the end of the day, it works.

  11. says

    @Mr. Finance
    Sounds like a plan to me, retiring at 35! Was it an age goal or a money accumulation goal that led you to the decision?

    @Daniel
    Yes, 10 more years seems like an eternity… but time accelerates, so maybe it won’t feel too long!

    @JB @The Genius
    I wouldn’t invest 50% of my liquidity in bonds either. Maybe 20% at these levels. Instead of bonds, I’m happy with 4% yielding long term CD’s, b/c I just want to preserve capital.

  12. says

    Interesting to hear all of your thoughts about early retirement. As I mentioned, I think the issue of retirement is more about achieving a level of financial independence, where you can choose how, when and with whom you want to work. As we live longer, the issue of boredom is something we have to confront. You want to stay intellectually engaged all throughout your life. The purpose of the ratios is to help set some basic benchmarks for analyzing your progress toward financial independence. If you get there earlier, that’s great, and it just means you have many more choices about how you want to spend you days.

  13. says

    I noticed a number of you had some questions about the allocation of stocks to bonds. While it is difficult to get into an elaborate discussion of the issue here, the book takes you through the risk management items and helps you understand why I think it is important to have both a plan B and plan C for your investment holdings. And a good part of that comes from the interest or cash flow you get on your securities if you use a balanced approach. While there are concerns about rising rates, if you follow a passive, laddered approach to bonds (let’s just assume U.S. Treasury bonds here – as I do in the book), then you have the ability to capture a current rate of interest and primarily ignore the price movements that result from interest rate changes.

    But this is a technical issue, and it’s a good idea to make sure you know how to structure this or work with someone who does. Every person will need to determine how comfortable he or she is with the risks they are taking, but in my opinion, fixed income is incredibly important to managing risks and capturing a positive return through the interest payments on a portion of your account each year.

    For instance, a few of you mentioned CDs, which are a type of fixed income security. So if you are comfortable using say FDIC insured CDs, instead of say Treasury bonds, then that would also fall into the bond side of the equation. The key is to consider high-quality fixed income, such as U.S. Treasury bonds. And so when people mention the bond market, it is made up of a number of different kinds of fixed income securities. The real issue is what sort do you own and how do you go about owning them.

    It’s important to understand what makes up the bond market, and it is probably the least understood investment class for individuals.

    As I do in the book, I recommend that investors seek qualified assistance prior to making any of these investment decisions.
    .-= Charlie Farrell´s last undefined ..If you register your site for free at =-.

  14. says

    @Charlie Farrell
    Charles, I think I know where you’re getting at regarding CDs and insurance, given the $250,000 current cap. Some of us do have more than $250,000 in cash savings… hence, the simple solution is to spread say $1,000,000 between 5 different banks at $200k/each.

    It’s a little more paper work, but it gives you peace of mind, and a 4% return to boot on 5 yr CDs for example. Whatcha think about that strategy? Of course, you can just put $333K in 3 banks or whatever the case may be.

    I’m not investing more than 20% in bonds right now vs. CDs at 4%. The 10 yr yield is sub 4%, so why bother? I don’t.

  15. says

    I’m a little late weighing in on this one, but I think a 50/50 and 60/40 split between stocks and bonds is a little too simplified and conservative. You own some rental properties, which I’m sure you consider an investment – where do you factor that in? And what about Treasuries for the over-60 crowd? I do agree that owning bonds is a good hedge though.

    If young people are thinking they can retire at 45 I would bet money they don’t have kids yet. If you’re a single guy making good money and living in an apartment, or a couple of DINKs with no debt you may think this is feasible, but kids will put a serious debt in your retirement plans. Plus a 16X CI ratio is going to be difficult to accumulate in that short of a period of time, and if you make $50k and save up the requisite $800k is that going to last you until your 100? As I mentioned in Part 2 of your interview our whole concept of retirement is going to have to be completely reevaluated. I think your idea of working for 20 and switching careers to something more satisfying and less stressful is a better option.
    .-= David @ MBA briefs´s last blog ..Easy ways to improve your memory =-.

  16. Andy says

    How is the view for bonds now? Most people can practically only invest in bond funds anyway, since the pricing is so variable for individual bonds.

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