An Introduction to Retirement Investing for Scientists

After spending a number of afternoons and evenings with friends and family over the last few months reviewing their retirement planning and investments, I’ve gone and done something a little bit crazy: I suggested to the GSC at Caltech that maybe I could give a talk on retirement investing to the grad student/postdoc population.  Incredibly, they thought this sounded like a good idea, and so now I’m scheduled to give a talk in a couple of weeks.  I’m going to try and write it up here in prose form first, to get it organized.  It’s gotten to be a bit long… so I’m going to break it up.

Main Points:

  1. Taking responsibility for funding your own retirement is arguably more important now than it has been for a couple of generations.  100 years ago we had much more in the way of traditional (family, community) support in old age, and the systems that we put in place after the Depression (corporate pensions demanded by organized labor, social security) show few signs of being fixed any time soon.  Generally today you do not even have the option of signing up for a “defined benefit” plan.  It’s a 401(k) or the highway.
  2. Investment returns are for all practical purposes random, unpredictable events, and because of this there’s really no such thing as an “expert investor” in the sense that most people selling their investment management services try and imply.  Nobody can reliably beat the broad markets, but you can do a perfectly good job of managing your own retirement funds if you’re willing to spend about 4 hours per year on it, say the other half of the day you spend doing your taxes.
  3. To maximize your chances of success, you must habituate yourself to spending less than you earn, making investing as automatic as possible, starting early and aggressively, and continuing throughout your entire career, regardless of what life and the markets throw at you.  Because returns are exponential and not linear, the difference between starting to save at age 23 and age 32, assuming roughly an 8% rate of return, can be on the order of a factor of two in the final value of your retirement funds.  Being comfortable living well below your apparent means makes it possible not only to save money now, but also reduces the amount of money you need in order to have “enough” in retirement, where “enough” means about 25 times your expected annual withdrawals, as you can take about 4% of your money out each year indefinitely.
  4. Maximizing the returns on your investments largely comes down to managing investment costs: how much you pay the people doing the actual investing (i.e. the mutual fund companies), and how much you pay in taxes.  The difference between paying 0.2% and 2% in fees and taxes each year might not seem huge, but over the course of 35 years of investing, it makes roughly a factor of two difference in the amount of money you end up with.
  5. The two most important tools you have in managing investment risk are diversification and asset allocation.  Diversification reduces the overall impact of many kinds of unpredictable events (high oil prices, the demise of the newspaper industry, war between India and Pakistan, collapse of the Icelandic currency… etc.) reducing the overall volatility of your portfolio.  Asset allocation (mainly the split between stocks and bonds) allows you to choose what kind of financial risk you are exposed to, and to shift it over time as you get closer to actually needing to live off your investments.  With stocks, you get the potential for future growth, at the expense of having to put up with wild fluctuations in their value.  With bonds, you get less price fluctuation and less potential for growth, but the ability to draw a reliable income stream.  With cash you get little to no price fluctuation, but essentially zero potential for real (inflation adjusted) growth.

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A Letter to David Bodansky

Hello Prof. Bodansky,

I’m a PhD student in geophysics, and I just finished reading your book, Nuclear Energy.  I appreciate the trouble you went to in the book to remain effectively neutral as to whether we ought to be pursuing the development of nuclear power.  While I can’t say that the book made me into a nuclear advocate, I am less opposed to it in principle now, and believe that it does represent a potential long term energy solution, albeit one with non-trivial caveats.  Then again, that seems to be the case with all of our options at this point.

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The Black Swan by Nassim Taleb

The Black Swan by Nassim TalebI finished reading Taleb’s second book, The Black Swan.  He openly admits that it’s not really a new book, but a re-writing of his first book, Fooled by Randomness, which I loved.  He’s gotten really incredibly lucky with the timing of his book releases… just before 9/11 and just before the stock market laid a giant turd on the doorstep of all the happytalk from Wall Street.  Especially lucky when you take into account the fact that The Black Swan was at least 15 months late!

Taleb really has just one big idea, and in his own obnoxious way, he’s humble enough to admit it.  His idea is that the world is less predictable than we think.  That “rare” events are both systematically more likely that we believe them to be, and that their consequences are disproportionately large.  He rails against the use of Gaussian distributions where they should not be used — against the mindless shoehorning of all kinds of processes into that bell shaped box, where they do not belong, and can do great damage.

I think the main differences between this book and his prior one are that in this book, he provides a few short words on how he thinks we should live and plan, given that we live in an inherently, and increasingly, unpredictable world.  That, and the fact that because of his prior book’s success, he was able to get away without having this book edited, apparently, at all (which I think may have been a mistake… but oh well).  Anyway, his advice in a nutshell:

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