Fix Bad Habits
Changing Bad Habits
In our experience, almost everybody wishes that they had saved more and started earlier by the time they finally stop working. However, a funny thing happens on the way to retirement. We place a higher importance on things that we want right now than we do on things for later. That shouldn’t surprise us. We do it all the time in other parts of our life. We want to lose weight, but that ice cream cone is just irresistible. We can diet tomorrow. So, naturally we go for the new iPhone, BMW, or long weekend away, even though we really want to retire in style later. We just seem to be hard wired this way.
It’s hard to change bad habits even if we recognize how harmful they can be—just ask any smoker. That’s why we advocate tricking ourselves into saving through some sort of automatic plan that makes us save first—it removes temptation.
Removing temptation is a good thing. If we send off part of paycheck before we ever see it, we can’t spend the money that has been automatically saved.
Perhaps the best thing about our 401(k) system is that for people who use it, it’s an automatic save-first program. After it’s set up, savings happen automatically every pay period, and the participant lives on what is left over. The participant doesn’t have to make the mental effort and exercise the discipline to decide to save and budget hundreds of times a day. The money is taken out of your paycheck before you ever have the chance to spend it.
If you don’t have a high-quality 401(k) or similar employer-sponsored plan to participate in, set up a payroll deduction plan with a good mutual fund company and have them automatically debit your checking account each month, putting that money in the retirement investment of your choosing. Any automatic savings plan has a much higher chance of actually working than trying to save what’s left over at the end of the month. Temptation being what it is, there will seldom, if ever, be anything left over.
In the end, it’s much less important whether we invest in an IRA, Roth IRA, 401(k), or taxable brokerage account than that we actually invest enough and early enough to meet our goals. The most tax efficient, effective, lowest cost investment plan won’t do you any good unless you actually contribute to it, and only you can make that happen.
We really don’t have much sympathy for the idea that you can’t save. Because the thought is so important, let us repeat something we said before: No matter how much or little you make, somewhere there is a person making only 80% of what you are, and they are living a full and satisfying life. So, you could save 20% and live a full and satisfying life, too.
However, there is a good chance that if you are not saving much or anything today, a 20% goal might not be possible at first. However, many 401(k) plans are helping their participants ease into savings painlessly by adopting an escalating contribution scheme. The employee starts off at some tolerable level of contributions; for instance, 3% of their compensation. But the brilliant part of the plan is that the employee agrees to contribute some portion (for instance, half) of all future raises to his 401(k). So, each time he gets a raise, his contributions increase, and he has more take home pay, too. Before long, the average employee is contributing 14% or so and not missing it. If your employer’s plan doesn’t offer this feature, which is often called “save more tomorrow” or a SMART plan, ask them to do so. If they don’t, you can do it yourself.
Now or Later
That’s the fundamental economic question. It’s been that way since the first caveman dragged home a gazelle. Should we eat it all now, or save a little for tomorrow?
It’s no different when it comes to your money. Do we spend (just about) everything we make now, or do we save (a lot) of it for later—so we can have the retirement of our dreams?
Retirement seems far, far away. Meanwhile, there are lots of toys to buy; fine meals to eat, and wonderful trips to take, and plenty of plastic with which to purchase them.
Temptation is everywhere. Advertisers create demand for junk, and the credit card companies enable our bad behavior (see Chapter 4, “Before You Begin Your Rescue Efforts: Things to Do to Make Sure You Don’t Make the Situation Worse”). So, as a nation we have a savings rate of close to zero, and 50 million families can’t pay off their credit cards.
It’s impossible to overemphasize the importance of starting early to save for retirement. You know that without being told. Retirement is expensive. Retirement planning is all about accruing enough capital to support us for what could be almost a third of our life without a paycheck. And just like any other venture, being undercapitalized greatly increases the chance of failure.
Here is another view of the importance of starting early. Let’s say you and your spouse both resolve to fully fund your IRAs each year. That’s $10,000 per year. If you contribute for 40 years and receive an average return of 8%, you will accumulate $2,590,565. However, if you wait five years to start, you end up with $1,723,168. The $50,000 you didn’t contribute in the early years ends up costing you $867,397!
At this stage of your career, time is your ally. The power of compound interest means that your early contributions will be much more valuable than later ones because they will grow to relatively large sums over the time until you retire. Take advantage of it.
The Safe Road to Take
It’s highly unlikely that you will be able to forecast a retirement budget when you are this far away from retirement. You will experience inflation and career progression, so it will be difficult to imagine a lifestyle decades in the future. However, you can set a savings goal so that when the time arrives to retire, you will have provided a nest egg to support yourself. Long experience shows that if you consistently save 20% of your income, you will achieve financial security.
Of course, each penny saved must be invested at the right level of risk for your stage of career and time to retirement. At this point, with so many years to retirement, you should be very comfortable with high levels of equities in your portfolio. The probability that you won’t be handsomely rewarded for bearing market risk over that time frame is very, very low. In fact, going back to 1926 (which is as long as we have good records), no one has ever lost money over a 15-year period in the stock market. So, you should be confident that stocks are the way to go during your early and middle career.
If you have been investing heavily in equities up until now, you might not be too pleased after the stock market meltdown of 2008. Looking at your portfolio today might give you a distinctly unpleasant feeling. It’s hard to see your account balance decimated by forces beyond your control. But, believe it or not, it’s a good thing for you. You should be dancing in the street. The world’s markets are offering you fire sale prices, which might very well be the buying opportunity of this century. Increase your savings to take advantage of the good deals. You will be glad you did at retirement time.
Odds and Ends
(Important) Odds and Ends
Watch those expenses. You should always be conscious of your investment costs. Remember our previous example where your IRAs grew to $2,590,565 over 40 years? If you lost just 1% due to investment costs and instead compounded your account at 7%, the total shrinks to $1,996,351. So, that 1% difference adds up to almost $600,000 over time. This is not pocket change in our house. That’s one reason we so strongly recommend low-cost index funds for your investment program.
The same math holds true for investment returns. If you lose 1% over your career because you invest too conservatively, you get the same disappointing result as if the investment costs were too high. Especially early in your career, it’s important to load up on global equities to get you the growth you need for your retirement lifestyle. Time is your ally here, as well. The longer you hold equities, the higher the probability that they will outperform the “safe” alternatives.
Changing jobs. Our fathers expected to have the same job for at least 30 years and to retire with a guaranteed pension. Today, the average job tenure is 3.5 years. That hurts in a couple of ways. First, you lose the eligibility to participate in your employer’s plan when you first join the company. Depending on how the plan is written, you might not be allowed to make a contribution your first year, and you won’t receive the company’s contribution, either. When you leave, you might lose all or part of the company’s contribution under the plan’s vesting rules.
A quick check of your company plan’s eligibility rules and vesting schedules might allow you to time your departure to preserve some of those benefits that might otherwise be lost. For an example, many plans require an employee to be employed on the last day of the year in order to participate or earn a year’s vesting. You might want to start that new job on January 2 instead of December 31.
So, make sure that you fully fund your IRAs or make other savings contributions in years in which you lose benefits due to job changes.
Whatever is left in your retirement plan when you leave your employer is eligible to be rolled over into an IRA. Some plans will allow you to remain in them, but most will want to rid themselves of the administrative burden of holding your account. (Our Web site at
www.Save-Retirement.com has some comprehensive articles covering your options when changing jobs.) You probably will decide to roll over into an IRA. This will allow you to control costs, administer all your accounts in a central location, and create the investment mix to meet your exact needs. Whatever you do, resist the temptation to take the money and blow it.
Systematically raiding your accounts is a ticket to poverty in retirement. Keep that money at work and keep time on your side.
Don’t lend to yourself. Borrowing against the pension plan is another variation on the theme of raiding your future benefits. Don’t do it unless your children are starving. We consider pension accounts to be sacred funds that should be treasured, protected, nourished, and allowed to grow so that you can enjoy the retirement of your dreams.
At this stage of your life, time is clearly on your side. Take full advantage of it