“What’s your best piece of advice for folks like us?”, Kevin asked after finding out I was a financial planner.
A few weeks ago, a group of us spent a Saturday making pizzas in the bowels of Lane Stadium to raise funds for our church. I had been chatting with the young man and his fiance when the subject of what I did for a living came up.
My reply to his question? Start saving now and save more than you think you can.
It’s easy to convince ourselves to put off saving money, telling ourselves that we’re still young and can start once we get our career established, furnish the apartment and replace that beater of a car. Besides, in a few years we’ll be making more money and be in a better position to save more of it.
There are a couple reasons this line of thinking doesn’t work. First, life happens. As we get older, our lives get more complicated and typically more expensive. We get married, buy a house, start a family, etc. And it’s human nature to quickly adapt our standard of living to match our rising income. Over time we cannot imagine saving more money as that would force us to give something else up.
The good news is it’s easier than ever to automate the savings process, and the earlier you start the more time you have for the “magic” of compound interest to work.
“I Wish I Had Saved Less”
I have yet to hear that statement from someone. To the contrary, I’ve heard a number of people wish they had save more. We all know the things we should be doing such as eating healthy, getting more exercise and spending more quality time with our loved ones. Unfortunately, knowing rarely turns into a lifestyle change. Good habits are hard to develop.
Saving more money, especially for retirement, is an easy habit to get into. Most good habits are hard to develop because they don’t have an immediate payoff and take self-discipline over time before they become a normal part of our life. The difference in this case is that making regular contributions to your company retirement plan (401K, 403B) or IRA account only requires a small amount of upfront activity to set-up. Money is taken out of your paycheck or bank account every payday and deposited into your retirement account.
Too Much Month at the End of the Money
Making a budget can help answer the question of how much you can afford to save. For managing expenses, however, they typically don’t work as well. Something always seems to come up which requires spending more than planned in one category or another. What ends up happening is that money earmarked for savings covers the shortfall. Successful savers ensure this doesn’t happen by having the money taken out of their paycheck or bank account on payday, before it gets used on other things. If you don’t see it, you won’t spend it. And it’s surprising how quickly you’ll adapt to having a little less money.
Another piece of advice I hear frequently on this topic is to start by saving a small amount and then increase it over time, such as when you get a raise or promotion. While that’s a fine strategy for future increases, I would challenge you to stretch a little and start with an amount that makes you a little uncomfortable. See if you can make that work for a few months. You might be pleasantly surprised. If after 90 days you find that it’s too big an adjustment, you can always back off.
Savings Over Time Works Wonders
The chart below shows the payoff of saving more in the early years. Let’s say you and your lifelong friend, both age 22, have just graduated college and landed great jobs paying $50,000 a year. The companies also have retirement plans that will match the first 5% of your saved income with an additional 4%. You’re both smart so of course you take advantage. However, while your friend does just enough to get the match, you decide to stretch and save 10% of your income.
Fast forward 9 years and now you’re both 30. Your friend has $60,293 in their retirement account (orange line) and you have $93,790 (gray line).
At that point life happens and you need to back off your savings. So you drop down to a 5% contribution. Your friend keeps contributing at 5% and you both continue that way until age 65.
At your joint retirement party, you compare accounts. Your friend has $2,037,444 and you show $2,532,699. That extra 5% saved in the early years has grown into almost $500,000 more. That’s the power of compound interest.