This has been a rough year for almost every company out there.  Every company has to do banking, so even if they aren’t a publicly traded company, they are feeling the pinch.

My employer planned to expand their 401K plan for this year.  They sent a letter on Monday regretting that they would not be able to go through with it, and are stopping matching contributions for the remainder of the year.

I’m adjusting my contribution amounts accordingly.  Once they stop matching, I will put more money to max my Roth IRA instead.  Once my Roth IRA is fully funded, then I contribute back to my 401K, without the match.

Why? Because it is still tax advantaged.  I still benefit from the pre-tax deduction on my paycheck.  It is also good to have both a pre-tax and post-tax account for my retirement.  Since I get the pre-tax deduction now, it is more advantageous to still contribute to my 401K rather than a regular savings account.  This adds up to big savings.

The only thing that has really changed is the order in which I fund my accounts.  It goes Health Savings Account –> Roth IRA –> 401K.

Did your employer drop matching contributions? How are you handling it?

How Much Emergency Savings Should I Have? Should I invest in more stocks than bonds?

Every personal finance blogger has their own opinion about this. Most of them say you should have at least 3-6 months if you are single, and up to a year if you are married with children. The best strategy that works for me is the one from the New York Times in their story: Legacy of a Crisis: A Generation Shy of Risk.

Basically, it says that your investment risks should reflect more on what you do for a living than your risk tolerance or time horizon. If you work in a steady income, tenured field like teachers or government employees, then your investments can have more risk since you are less likely to lose your main source of income. Your raises are likely to be steady, but not earth shattering. If you work in a volatile field like banking or technology, then your investments should be more stable. Bankers and tech workers tend to have boom and bust incomes just like the stock market – time of plenty, and time of starving.

I fall into the latter category. I have done this intuitively for some time, but the NYTimes article is the first time I’ve seen it explained this way. I have a higher than normal emergency fund to cover basic expenses. I could stretch it out even further if I needed to. I have zero debts – no student loans, credit cards, mortgages or car payments. The reason is because the fewer liabilities I have, the less likely I am to run into trouble if I am laid off. It also affords me some mobility. If jobs dry up in Seattle, I can move where there are jobs. I save my money in cash until I can afford to buy a major purchase. This allows me to dip into the washer/dryer fund if I ran into a hardship year, instead of being saddled with a payment due for the washer and dryer.

My retirement investments are on the conservative side; index funds that are a mix of some stocks and mostly bonds. Once again, this is due to the volatility of my profession. If I end up on the wrong side of a down cycle at retirement like we’re seeing now, it could be disastrous for my plans for a cabana, botox, and leisurely days in Margaritaville.

I opt for a wealth preservation strategy while times are good. My skills could be completely obsolete in 20-30 years. If I end up in a down cycle year at retirement, I may have a very tough time even choosing to delay my retirement. Technology is an industry that favors the youthful, unfairly as it is. In order to keep my income growing, at some point I will need self sustaining income not tied to my employment. Thus, my retirement income is designed to be from more stable sources (not just 401Ks and IRAs), while my career is more volatile in my prime income years.

This is could apply to anyone, but if you work in a field with highs and lows, this is especially important. I’ve seen more than one tech worker surprised by a layoff with a nasty Audi payment and no savings.

The first thing to realize is if Smart Sally is out there right now doing this, barring any stupidity like getting entangled with a financially irresponsible boyfriend/spouse, she will always be younger, smarter and and probably richer than you. She has the advantage of time. You, Dan, can’t change the past, but you can change the now and the future. And you can lecture the whippersnappers like Sue to learn from your experience.

So congratulations, you’ve realized the error of your ways. You are going to be Smarter Dan. Download this Smarter Dan Spreadsheet. “Smartest Sally” never stops contributing every month, and increases her contributions by 5% every year until retirement. She has approximately $624,158,39 with 8% interest compounded over 40 years. (The 8% interest is a toy problem – we will discuss real world returns from index funds later.) What a nerd. <insert dripping envy here>

Dumb Dan – you blew it. You’re in the 30 something club with no real savings to speak of. The good news is you can still benefit from compound interest. You just have to put more money up front in a shorter period of time. If you start off by contributing $600 every month, then decrease your contributions every year, you can still end up near Sally’s balance at retirement. (“Decrease?! What?!” See note below.) You will have to delay buying your first home, drive a beater car, and take modest vacations. If you have a hardship year, you’ll have to sacrifice more. Yeah, $600 per month for the first year. $7200. That’s a lot of freaking money.

Sally will still be ahead of you. She will have earned more money that she didn’t have to put into her retirement funds and could invest the excess elsewhere, bought her first home with 20% down at 28, paid for her new $18,000 car in cash, and vacations in the Bahamas. If she had a hardship year, she had more money to fall back on.

I agree with Ramit’s point. If you’re a 20 something, be Smart Sally. If you’re Dumb Dan, be Smarter Dan. You’re just going to have to put in about 6 times as much upfront. It may not be possible depending on your income potential and obligations, and you’ll just have to adjust to realistic levels for you. If you missed out on your youthful compound interest years, it doesn’t mean that you can’t have a wonderful and meaningful retirement. Don’t compare your success with Sally’s. Be proud of your own accomplishments, the wisdom to recognize your past failings, and the smart decisions you’ve made moving forward.

Note: The point of this toy spreadsheet exercise is to show that even if you are starting late, it is possible for you to ‘catch up’. You just have to put a lot more upfront into it. The point remains the same – Sally benefits from compound interest with less upfront and lets time do its magic.

Read the full Review of Ramit Sethi’s Book: I Will Teach You to be Rich.

Update 3/23/2009: Corrected spreadsheet formula in C row.
Update 3/30/2009: Added link for book review.

The story says Smart Sally contributes $100 every month to a retirement account with 8% interest for 10 years, then stops contributing. She lets it compound for another 30 years until she retires. Dumb Dan starts contributing $100 every month for 30 years. The end result is supposed to show that Smart Sally still ends up with more money than Dumb Dan because of compound interest.

Here is Ramit’s table with the error:

The error is this. The compound calculation for Smart Sally never stops contributing $100 every month after 10 years. The total $349,856 is the approximate total if she had continued to contribute $100 every month for 40 years. The error for Dumb Dan is a little odd. The value $271,879 matches if the contributions for 30 years is adjusted to $182 per month, or $100 per month for 37 years.

I’ve attached a spreadsheet that shows the error calculation and what the numbers should be. Smart Sally should have $200,065 and Dumb Dan $149,036 if you follow the story.

Smart Sally vs Dumb Dan Spreadsheet

Read the full Review of Ramit Sethi’s Book: I Will Teach You to be Rich.

Update 3/23/2009: Corrected error in spreadsheet where Sally was still contributing $100 in the first month after year 10. Corrected formula in C row for consistency.
Update 3/30/2009: Added link for book review.