Saving money isn't any different than training for an athletic event. It's a set of behaviors. It's also one of those activities we tend to procrastinate
about, like going for a run when it's raining and cold.
Spenders vs. Savers
Since systematic saving has so many benefits, why is it so difficult? One reason is the rewards for saving involve delayed gratification. Spending
money feels good immediately. Another reason is no one sees the fruits of your labor when you save.
Also, many of our habits have been shaped by watching our parents, older siblings, friends, and colleagues. We often unconsciously mimic their behaviors
just because it's what we've always seen. It's like most people's eating and exercise habits. When a client of mine tells me she wants "safety and FDIC
insurance," it usually turns out her parents kept their money in Certificate of Deposits and savings accounts.
Let's figure out how your current situation looks, and identify any "trouble areas" you may have in your savings. I want you to begin to know the
answers to questions like: Where am I keeping my money? Is it the best place for me? Can it be redistributed better? Let's say you've got most of your
money in a savings account that's yielding 4%. Maybe it would make more sense to put that money into a tax-free account or perhaps a Roth IRA if you're
planning to use it for your retirement.
How to Save More Tomorrow
If you were to look at the assets that most people accumulate, it's fairly predictable what they are. Can you guess? It's their homes, retirement
plans, pensions, and Social Security. What do they all have in common? They all have what I call, "low willpower savings techniques." If you don't pay
your mortgage you risk losing the roof over your head, meanwhile pensions and Social Security payments you accumulate through years of service. The way
to wealth is by making saving as automatic and painless as possible.
There's a brilliant savings plan called "Save More Tomorrow" developed by Professor Richard Thaler from the University of Chicago. He had employees
from a company opt out of their 401(k) plan, then commit to saving a portion of whatever salary increases they got in the future. The results were
astounding! People who followed the plan increased their average savings rate from 3.5% to 11.6% over 28 months.
You can do it for yourself. When you find out you're getting a pay raise, right before you receive it, go to your 401(k) and increase your percentage.
Here's the reasoning, using another analogy. It's easier to commit to not eating a donut if you haven't seen it. Once it's on the table it's much harder
to turn down. The same is true of money you have already received: it's harder to give that up. So if your pay raise is 5% and you're contributing 8% to
your 401(k), switch it to 10%. Your paycheck will still be more money than before the raise because it will increase by 3% and you'll be doing something
good for yourself.
Other Painless Saving Techniques
Another way is to direct your money to an account that you can't draw from with an ATM or write checks on. Transfer a fixed amount to this account
from each paycheck. If you're paid on commission or your income fluctuates, shoot for 10% of your gross income as a good rule of thumb. Just don't
make the mistake I see a lot of people do. They set up automatic withdrawals and never change the amounts.
It's also important to spot ways that money is unconsciously flying out of your wallet. What you may not realize is how marketers can entice you
to buy without you being aware of it. Practice identifying ways that marketers are trying to entice you to buy. Then list ways you can protect
yourself from their efforts. Take a typical week and keep a log of examples of this in your life.
What Have You Done So Far?
In order to know which savings plan is best for you, first we needed to know how much you save in a year to determine if you're doing enough.
One of the benefits of putting yourself through this exercise is to help you find your "trouble spots." When we're talking physical fitness, there
are always parts of our body that we don't care for. The same is true of our financial fitness. What are your trouble spots when it comes to saving?
Some questions to ask yourself: Am I under-saving toward retirement or college education? Am I keeping my savings in an unproductive account?
You may be incredibly disciplined about saving money. You may avoid ATM fees by asking for "cash back" at the drugstore or grocery store. Maybe you
always request generic drugs and are very conscientious about grocery shopping with a list. All these good habits can do great things for you. But
it's just half of the equation. The accounts you use to accumulate savings are also very important. If you use the right ones, a little saving will
go a very long way! Otherwise, it's like putting in lots of hard work at the gym only to eat nothing but junk food when you leave. You're wasting all
of that good effort.
So, take inventory of what you have. Have you created your Net Worth Statement? Your savings will be everything that is listed under your assets
that are liquid. That means your money market and savings accounts, mutual funds, stocks, bonds, IRAs, and 401(Ks). Pages 132-133 of The Net Worth Workout
lists examples. Next to the balance of each account, write the current rate that you are earning in these accounts. Finally, write what you saved in that
particular account in the last year. Here's a time-saver hint, round your numbers to the closest $100 to save time.
How Much to Save and How
A good rule of thumb: By the time you're 30 years old, 10 percent of your gross income should go to your long-term saving, retirement planning, etc.
If you're a woman then I would suggest that 12 percent is a better number to shoot for. The reason is that women tend to live longer, earn less, can be
out of the workforce taking care of their family (typically for 11 years), and take less risk with their investments.
If it's 10 or 12 percent, it's important that this is out of your gross income. So if you earn $50,000, save $5,000 toward your retirement. You
should not count whatever your company match is, since that didn't come from your income. I urge you to think of this as "free money" and this can
be a cushion should you not be able to contribute because of a job loss, disability, or some other difficult financial situation.
The other thing that is important to know about your saving is to always keep 3 to 6 months worth of living expenses in a savings account, CD,
money market, or some type of safe liquid vehicle. If you're self-employed or tend to be in a volatile industry, try to have a year of living expenses
stashed away. It may frustrate you that it's not earning a lot in this type of account, but if something goes wrong, the money will be there and you'll
have peace of mind in the meantime.
If you need one more reason to save more, think of it this way. If you spent $1 today it means that you're foregoing $6.07 in the future because
of the "opportunity cost" of what that dollar could have earned. I once discussed this concept with a client while he was drinking his $1 bottled
water. He eventually said, "I think I should start drinking water from the cooler!" Sometimes taking the right steps is that simple!
Deciding Which Savings Vehicle is Best For You
Let's concentrate on which vehicles can be the most helpful to you, particularly through tax incentives. These are IRAs, 401(k)s, other retirement
plans, college 529 Plans, and UGMA/UTMA accounts, just to name a few. Some are better than others. The most important thing to remember is that you
should align your savings equipment with your goals.Too often, low-yielding CDs are used for retirement accounts and savings bonds for Junior's college
fund. Once you're aware of what you need, you're most likely to see the best results!
Retirement Accounts
The most widely recognized savings vehicles for getting your financial muscles in shape are retirement plans, including IRAs, 401(k)s, 403(b)s,
pension plans, and other plans. The best thing about these products is that they can reduce your taxes today or when you withdraw the funds at retirement.
This is the general concept of how these retirement accounts work. Let's say you earn $60,000 a year and have elected to put 10% of your income
into a 401(k). Instead of your taxable income being $60,000, it's reduced by the $6,000 that went to this account. So now you pay taxes on earnings
of $54,000 instead of $60,000 and you have the $6,000 grow, tax deferred. When you're over the age of 59 ½ and withdraw the funds you'll pay taxes
then (which could be less if you happen to be in a lower tax bracket).
A Roth IRA is different. If you contribute $4,000 to a Roth you can't deduct the Roth from your income. However, everything it earns grows tax-free
and when you withdraw the money in retirement it comes out completely income tax-free. This benefit is enormous. Let's say you contribute $4,000 a year
for 30 years and it averages 10% a year. You've contributed $120,000 and it's now worth over $650,000. All this money can come out and you don't have
to pay any taxes, you get to keep everything you earned, a tremendous benefit! That's the financial muscle of long-term savings. Page 161 in
The Net Worth Workout for more information on these plans.
Saving for College
College 529 Plans are great vehicles to help you save for higher education. This means any higher education beyond high school. You can contribute
over $11,000 per parent per child with a maximum contribution of $300,000, depending on the state. These funds grow tax-deferred so you don't pay any
taxes while they're in this account. When you withdraw them to pay for college expenses they're federal tax-free. In some states they'll be exempt
from state taxes as well. The downside is, if you withdraw to say, buy a boat (i.e. anything not college-related), you'll pay a 10-percent penalty
and income taxes on any earnings above the principal you contributed. So it's really designed for higher education.
Discussion
- Who are some of the people in your life whose financial habits you've mimicked, and why is that? What would you like to change about this?
- When you took yourself through a typical week of the ways that marketers got you to spend your money, what surprised you? Why was that?
- What can you do differently when you go grocery shopping that will save money? (Or pick a category where you see the most room for improvement).
- List a few of the ways you are saving money, and what you are saving money for. For your own records, list every account you have, and the amount in there.
- Do you have any savings goals (like paying off a certain debt) that you haven't started saving for? How can you start saving for this additional goal?
