By Grace S. Yung, CFP
It seems that more and more lately, people tend to have more month left at the end of their money—and unfortunately, that isn’t a very good strategy for investing for the future. Setting the course for a comfortable retirement—which includes having ample investments from which to draw income—starts by having good savings habits. Good savings habits start by living within your means.
Determining Needs Versus Wants
To truly live within your means, you need to spend less each month than what you bring in. But for many people, this is much easier said than done. In addition to basic living expenses, such as rent or mortgage, utilities, and transportation, there are usually a lot of other items that are vying for your money’s attention.
New clothes, a weekend vacation to Vegas, concert tickets—it all adds up. And while you might like to take part in all of the above, you really need to determine what is truly a need versus just a want.
Avoiding Debt—Your Biggest Enemy to Wealth
Over the years, retailers have made it easier to purchase things— whether we really need them or not. “Buy now, pay later” promotions, along with easy access to credit, have allowed people to rack up impulse purchases at an unprecedented pace. Unfortunately, this has also led to a substantial amount of debt.
According to credit.com, the average credit card balance sits at just under $3,800.1 But that’s just an average—which means there are many people who carry a significantly larger amount of high-interest debt. Without paying off credit cards in full every month, unpaid balances can literally snowball out of control if you aren’t careful.
Staying out of debt, however, means saving for big purchases rather than buying items today on credit. For example, instead of buying a $1,200 smart TV now, set aside $100 per month and purchase it with cash next year.
Living within your means also involves waiting for items to go on sale rather than buying at full price, using coupons, and shopping around. When you think about it, doing this can really add up. Even if you just save $20 per week on groceries or other items, that’s a savings of more than $1,000 per year. Those saved funds can then be invested for the future.
When paying down your debt, it’s often a good strategy to pay off the high-interest items first, ridding yourself of debt that is costing you more before moving on to the lower-interest obligations.
But even if you’re currently carrying a heavy debt load, there are still ways that you can start—or continue—to save for the future. By cutting out unnecessary expenses such as going out to eat, premium cable channels, and other extras—even if it’s only temporarily—you can shift those dollars over into more of a savings capacity. It’s amazing how much extra money can be “found” when we actually focus on finding it.
Live for Today, but Plan and Save for Tomorrow
While living in the moment is important, planning for the future is also crucial in order to ensure that you will have the financial means to pay your living expenses once your employer’s paycheck stops when you retire.
The best way to move forward is to have a well-defined plan. By setting specific goals, you will be better able to determine how much you need to accomplish your objectives. In the case of saving for retirement, you should initially get an idea of how much you may need in terms of living expenses. From there, you can determine what it will take to generate that much in retirement income.
For example, if you determine that you will need $40,000 per year (before taxes) in order to live the retirement lifestyle that you desire, then it would require approximately $1 million (in today’s dollars) in order to generate that.
Although $1 million may sound like a lot of money, it really isn’t. Because people are living longer than ever before, it isn’t unusual to see retirement last 20 or more years. With that in mind, $1 million may not even be enough for some people.
And because defined-benefit pension plans are quickly disappearing (and Social Security is actually becoming “Social Insecurity” for many younger folks), it’s clear that the earlier people start saving for themselves, the better.
One way to help yourself in planning for tomorrow is to take advantage of your company’s retirement plan—if you have that option. Many companies will also provide at least some amount of matching contribution for their participants. This is essentially “free money.”
Pre-tax retirement-account contributions will also help to lower your taxable income—yet another key advantage to these types of plans. And because the funds in these plans are allowed to grow tax-deferred, the power of compounding can essentially work exponentially on your invested funds.
One way to gauge approximately how long it will take your money to double at a given rate of return is through the Rule of 72. 2 The rule of 72 is a mathematical concept and does not guarantee investment results nor functions as a predictor of how an investment will perform. It is an approximation of the impact of a targeted rate of return. Investments are subject to fluctuating returns and there is no assurance that any investment will double in value.
Using this rule, divide the return into 72, and the result will be the number of years that it takes. As an example, if your investments are returning 7.2 percent, then it would take approximately 10 years for your money to double (72 / 7.2 = 10).
Taking the Right Steps toward a Prosperous Financial Future
While many people don’t realize just how much it takes in order to generate a comfortable retirement income, the good news is that if you don’t yet have enough saved (or if you are behind and need to catch up), there are a number of savings and investment vehicles and strategies available that can help.
For instance, depending on your income, putting money into a Roth IRA allows you to take advantage of tax-free growth, along with tax-free withdrawals in retirement. For those who earn over the income limit ($116,000 for singles and $183,000 for married couples filing jointly in 2015), there are Roth IRA alternatives that will allow you to deposit more than the annual IRA plan limit into an investment, and also take advantage of tax-free withdrawal methods.
The plan that is right for you should be based on your specific needs and goals, and should be developed with the assistance of a professional who can work with you on all of your potential options. Given the many changes with regard to marriage equality over the past few years, it is often best to work with an advisor who is also well versed in how the new laws affect the tax and financial issues of the LGBT community.
Grace S. Yung, CFP, is a certified financial planner practitioner with experience in helping domestic partners plan their finances since 1994. She is a principal at Midtown Financial LLC in Houston and was recognized as a “Five-Star Wealth Manager” in the 2014 September issue of Texas Monthly.
2 The rule of 72 is a mathematical concept and does not guarantee investment results nor functions as a predictor of how an investment will perform. It is an approximation of the impact of a targeted rate of return. Investments are subject to fluctuating returns and there is no assurance that any investment will double in value.