By eliminating what I call Million-Dollar Habits, (e.g., failure to exercise spending discipline, smoking or vaping, excessive dining out, etc.), almost all of us will rediscover a few dollars we didn’t know we had – enough dollars, at least, to initiate a meaningful savings program in advance of when most people start saving.
Shoot, I’ve had astute but cash-strapped young couples – particularly those with new babies or those buying odds and ends for apartments or first homes – tell me they easily save $100 a month by shopping at Goodwill. Not interested? Try it, you might like paying 10-15 cents on the dollar for virtually new items (toys, baby clothes, kitchen items, knickknacks, etc.).
The savings ingredient in investing is simple, yet critical. If you don’t start saving early in life, you miss the cornerstone of what makes The Amazing Power of Compounding amazing (for a more detailed explanation of compounding, go to my blog titled Before You Get Rich You've Got to Master the Basics). To demonstrate your potential loss, let’s resurrect my stale old example of saving $100 per month, investing it in a Total Stock Market Index Fund (hopefully in a Roth IRA), earning 7%, compounded quarterly, for 45 years. What does it get you? Close to $380,000 before inflation upon retirement. And that’s in addition to Social Security, your 401(k) and other shrewd investments you make along the way.
By the way, you’ll soon learn that I stress simplicity throughout my blog postings, but let’s be quite clear about simplicity. The simplest things in life are very often hard to do. And saving early and often is one of them. You’ll quickly learn why if you haven’t already experienced it.
In an early posting on my daughter’s blog, I introduced those very clear, very simple, very basic principles that I try to adhere to in my own investment program: the PDQ Principles. These principles hold to yet another important principle – that most successful investors are also reliable savers who adopt an investment strategy that combines patience with a portfolio of diversified, quality assets, and then dare to be average! I will devote a later, more detailed blog on daring to be average, where the term is applied only to investing. And, of course, the PDQ Principles strategy, like all savings strategies, requires discipline.
Humankind tends to complicate things far beyond what is usually necessary. Complex strategies are mostly devised by a group of folks I endearingly call the Ivory Tower Boys (Wazoos) who help the average small investor not one whit! And it’s the “small investor” I want to help, a category that includes me. This green eye-shade, Wall Street crowd devises complicated strategies to convince you that you need them to uncomplicate what they’ve creatively complicated. Granted, complex fortunes (the billionaires among us) require greater sophistication, but most of us don’t have complex fortunes. We save a few bucks a month to invest somewhere that, hopefully, over time will grow into a meaningful retirement fund. And the process does not have to be complicated. In fact, it can be quite simple…the simpler the better.
Don’t be fooled by all the bulls**t. And those green pastures (the internet) are littered with that commodity. Some facts are good to know, but you don’t have to possess a full vocabulary of buzzwords. Join me in this effort. Toss most of this recently digested hay aside, adopt a few basic principles of saving and investing, and over time, you will accumulate a nice nest egg for retirement. And yes, you do have the time. Question is, do you have the discipline? All it involves is spending less (saving) by simply delaying gratification – and avoiding those Million-Dollar Habits.
To sum it up, let me quote the small investor’s dearly departed friend and Vanguard founder, John Bogle who said, “Beating the market is a zero-sum game for investors. Money managers, as a group, must provide the market return, but that return comes only before their exorbitant fees, operating expenses, and portfolio turnover costs are deducted. The zero-sum game before costs becomes a loser’s game after costs.”
In his highly publicized support of index funds for the little guy, Bogle also wisely counselled, “Don’t look for the needle in the haystack. Just buy the haystack.”
“When there are multiple solutions to a problem, choose the simplest one.”
― John C. Bogle
I have repeatedly stressed the importance of three basic ingredients of saving for investment: time, money…and discipline.
The more time you spend saving, the greater your potential reward. That comes as no surprise. And the more money you save, the greater your potential reward. But without discipline, the simple act of tucking money into your savings account every single month, you WILL fail to achieve your optimal goal.
That’s not a criticism, that’s just a fact.
We’re addressing two very important concepts here: (1). The Time Value of Money and (2). The Amazing Power of Compounding – concepts that are inextricably linked. Let’s use a simple example. If you save $100 per month for 45 years and hide it faithfully in a can buried in the back yard, you’ll end up with $54,000 at age 65, a tidy sum. However, if you save $100 per month and invest it in a low-risk, tax-advantaged investment account (a Roth IRA) paying 7%, compounded monthly for 45 years, you’ll end up with $384,000 at age 65.
Money held as cash, uninvested, has no worth beyond its moldy face value regardless of its time spent in the can (I could mention that it actually loses purchasing power due to Izzy the Inflation Monster but that’s a blog for another day). The same money invested at 7%, compounded monthly for 45 years clearly indicates The Amazing Power of Compounding over time. That’s why discipline is so important in any saving and investment strategy.
Save early, save often, do it without fail, and do a good job of investing it wisely. And please…please…avoid dipping into the till along the way.
During my previous blog posts, I’ve used terms and phrases that require some definition and clarification. Yes, you’ve heard them before, but I want to focus your attention on their importance in developing and carrying out a personal finance plan. I’ll list them in alphabetical order (ignoring the pronoun “The”).
Most financially successful people get that way not through business innovation but by optimizing compound interest on their savings and investments. An important lesson they learn early is that a saver can contribute less now than more later to enjoy the same ultimate accumulation of wealth. A simple example: If a 22-year-old invests $1,000 on January 1 at 7% per annum, next year the investor will have $1,070. The following year, the investor will theoretically gain the same 7% on the initial $1,000 plus the $70 earned last year, which would increase the investor’s balance to $1,145. In 10 years, the investor’s initial $1,000 would grow to $1,967. Upon retirement, at age 65, that single initial investment of $1,000 will have grown to $18,344. Alternatively, to achieve the same nest egg of $18,344 at age 65, a single initial investment at age 32 would need to be $1,967. The magic came from reinvesting the principal plus earned interest every year.
Next to saving, one of the hardest thing to accomplish as an investor is daring to be average. It’s an index fund’s essence, its overriding fundamental. Think about it, if you invest in a Total Stock Market Index fund, or less broadly, an S&P 500 Index fund, you’ve deliberately chosen to be satisfied with a broad market yield. “Why,” you ask, “would I want to just be average?” Truth be told, you’re not just being average. Study after study of index (passive) fund results show that over time, they outperform managed (active) funds. And those managed funds that outperform index funds represent a moving target from one year to the next. In short, here today, probably gone tomorrow.
Beating the market is hard to do. Accounting for what’s known as “survivorship bias” (the attrition rate of poor performing mutual funds), over a very recent 15-year period, roughly 92% of large-cap funds lagged the yield of a simple S&P 500 index fund. Mid-cap and small-cap funds lagged their benchmark indexes even more: roughly 95% and 93%, respectively. In other words, the odds that you’ll do better in an actively managed domestic fund (versus an index fund) are about 1 in 20. That’s why I dared to be average years ago! Certain “friends” told me that, in my case, being average probably came naturally.
An investment technique that involves buying a fixed dollar amount of shares of stock or units of a mutual fund on a regular schedule (say, the 15th of every month), regardless of the share price on that date. In short, the investor purchases fewer units or shares when prices are high and more units or shares when prices are low. A side benefit is that it just might reduce the inclination of an investor to make purchases in a frothy market or sales in a bearish market.
Behavior patterns that, if not modified or completely corrected, could wind up costing an individual hundreds of thousands if not millions of dollars over a lifetime. The most commonly abused such habit is Impulse Buying (more about impulse buying later).
The one-step formula used to estimate the number of years required to double invested funds at a given annual rate of return (i.e., if an investment promises an 8% annual compounded rate of return, it will take about 9 years to double the invested money (72/8 = 9). The Rule of 72 applies to cases of compound interest, not to cases of simple interest (see below). Alternatively, if you divide the number of years (within which you want to double your money) into 72, the result is the approximate yield you’ll need to earn to achieve your objective (72/9 = 8%).
A calculation of how much an individual can “safely” pull from a retirement portfolios on an annual basis without significant risk of long-term depletion. Fair Warning: you’ll get about as many answers to the “safe” withdrawal rate as the number of people you ask the question.
This simple maxim is attributable to those wise parents and financial planners among us. In any event, because Time is Money, it’s always wise to start saving as soon as possible… not when you’re hired part- or full-time right out of high school or college, but RIGHT NOW!
Used for calculating interest on investments where the accumulated interest is not added back to the principal (i.e., multiply the principal amount by the daily interest rate and by the days that elapse between payments). Yeah, I know, you learned that in grade school.
This simple maxim is often attributed to the wise and witty Benjamin Franklin. He reinforced its meaning by simply stating that if a person skips half a day of work, he forfeits half a day of wages. Let’s apply this maxim to a delinquent saver using The Amazing Power of Compounding above. Had our saver waited until age 40 (instead of age 22) to start saving, to reach the same goal of $18,344 at age 65, he would have to make an initial contribution of $3,380 instead of $1,000. In short, if you don’t start saving until later in life, your required initial contribution will necessarily be larger to reach the same goal at age 65.
This simple concept recognizes that cash in hand is worth more than the same amount of cash received a year from now. Why? Because cash in hand can be invested to earn income during that year (not sure how that applies to birds).
The U. S. Treasury Department’s Internal Revenue Service and its impulse buying sidekick, the U. S. Congress.
Another maxim often incorrectly attributed to Benjamin Franklin (and frequently used by my father), but first coined by William Lowndes, a long-ago Secretary to the Treasury of Great Britain who used pence and pounds. Impulse buyers might keep this old maxim in mind while shopping.
Those intellectual, highbrow, disdainful investment advisors who attempt to convince us that investing should not be simple; that they alone can introduce order to the market’s chaos with their complex investment theories.
This simple rule of thumb states that whatever your age is should dictate the percentage of your portfolio that should be in fixed income (bonds). The rest would be in equities (stocks). For example, a person aged 65 would have 65% of his/her retirement portfolio allocated to fixed income (bonds). I’m not completely sold on this formula because it exposes investors to the ravages of Izzy the Inflation Monster. There will be an upcoming blog on the long-term impact of inflation on saving for retirement. You’ll be surprised how damaging it can be.
The average family only saves a little more than a $100,000 or so by the decade leading up to their retirement.
When you associate that number with the fact that 50% of all individual Americans age 65 and older have annual incomes in the range of $24,000 – far less than what most need to meet living and healthcare expenses – it’s reason to wonder how they plan to financially navigate the 10-20 years many will spend in retirement.
In last week's blog - "Excuses for Not Saving in Your 50s" - I mentioned various options that delinquent non-savers might pursue to bridge the gap between a “no worries” and a “high stress” retirement resulting from a lifetime of deficient personal financial management. Today, I want to remind my readers, particularly the young ones, that there’s a better way. One that, in conjunction with an increasingly unstable Social Security program, should provide a more secure retirement (85% of Americans 65 and older draw Social Security that ultimately will require some political attention to ensure its long term availability).
The key to a secure retirement is not rocket science. You need a plan. And it’s never too late to develop a plan but right now is best. I’m talking in your 20s; certainly no later than your 30s. And build that plan around a simple set of principles – the PDQ Principles come to mind…Patience, Diversification and Quality. But first you must save. Once you develop the habit of saving on a routine and consistent basis, then you apply these principles.
As I’ve stated ad nauseum, keep it simple. Build your portfolio around a low-cost index fund (S&P 500, Total Stock Market, etc.). Such a fund automatically provides you with diversification and quality, and a steady and routine savings habit necessarily embodies patience. And remember, you need to employ all three principles together. Now, let’s provide a simple example that demonstrates both The Amazing Power of Compounding and the importance of Daring to be Average (an index fund, in essence, yields the market rate of return…no more, no less) .
Let’s assume that you’re a 25-year-old high school or college graduate that earns $50,000 per year; that you save 10% of your after tax salary – about $400/month; that you create a Roth IRA and invest in a Total Stock Market Index Fund; and that the fund earns 7% per year, compounded quarterly for 40 years. Using a Bankrate calculator, upon retirement at age 65, your Roth would be worth $1 million before inflation. To demonstrate the amazing power of compounding, using the foregoing numbers, had you deposited the money in a bank account earning a fraction of 1 percent, you would have ended up with less than $200,000.
Everything discussed in this blog is “old hat”. We’ve been down this road before. My point is simply this. Based on statistics year-in, year-out, folks keep arriving at retirement’s doorstep financially ill-prepared for 10-20 years of retirement living. There’s a better way.
My example is strictly hypothetical, but it’s a gentle reminder that, while young, with a bit of prior planning and by developing a few good habits (no, not those million-dollar spending habits), an individual can enter a “stress-reduced” retirement phase of life simply because of good financial planning.
Try it. You might like it.
I’ve spent three recent blogs discussing the various excuses made by the 20-, 30-, and 40-something age groups for not sufficiently saving for retirement. I now introduce the reasons that 50-somethings don't save and what it means for them if they only have $100,000 or so socked away right before their 6th decade of life - with retirement right around the corner. I'll pause here while you watch the video that features those excuses...
As mentioned, for the most part, the average family had socked away little more than a $100,000 or so by the decade leading up to their retirement. And how inadequate that sum of money would likely be – in combination with Social Security – to navigate perhaps the 15-30 years many folks will spend in retirement. So what do these delinquent non-savers do to bridge the gap between a “no worries” retirement and one filled with the stress and strain emanating from poor financial management during those earlier years?
The first thing that pops into my head is to suggest that these “late savers” keep working beyond the normal retirement years. Some folks do this anyhow because they enjoy what they do and have no desire to hang up their spurs. But so often, these are the very people who do not need to continue working. In any event, to keep working is a choice many people will have to make. That’s assuming it remains a viable option. Studies show that over half of retirees actually quit working earlier than expected because of ill health, layoffs, or the development of unexpected responsibilities such as taking care of elderly family members. The list of reasons forcing early retirement are many and seldom anticipated. As insurance against the unexpected, a backup plan to the “work option” is always wise.
It’s not uncommon for those with inadequate savings to enter the retirement years saddled with a mortgage on their home. A home in which they raised their family, but an empty nest that is now too large for an aging couple or a surviving spouse. And even if a mortgage no longer exists, upkeep and property taxes continue to take an outsized bite from those Social Security checks and what little income (or some small portion of the principle) their savings produces. Still, downsizing can often reduce the carry on a home both in maintenance costs, utilities and property taxes – unless the aging seniors suffer the misfortune of living in an area where a newer, smaller home can cost as much as a larger, older home. In short, downsizing is not foolproof, but it’s an option particularly when one considers that age and/or infirmities ultimately become factors in caring for a home. And remember, those savings resulting from downsizing, like yields on investments, compound over time.
While speaking of mortgages, folks approaching retirement with inadequate savings should pay particular attention to debt (and living expenses in general). Any family, young or old, carrying too much debt is less likely to save enough for retirement. And once a family reaches that “decade before retirement” threshold with inadequate savings, it becomes extremely important to concentrate on debt reduction, particularly credit card debt. An effective way to do this is to get out those scissors. Cut up the cards. Or at the very least, pay off the balance(s) each month. In short, fine-tune that monthly budget (assuming you have one). Be ruthless in cutting back on needless purchases. For starters, quit dining out so much. Cut back on movies or those monthly subscriptions to all of that fine TV entertainment. How about slimming down the travel budget or eliminating those low-probability lottery tickets? And do you need the very latest in electronic gadgetry? In short, take another hard look at your Million Dollar Habits… the very habits that might have contributed to your unfortunate financial predicament in the first place.
A common surprise is that, despite the government charts, many retirees underestimate their longevity – their time spent in retirement. And along with that underestimation comes a plethora of other surprises… often ordinary but very inconvenient costs. Just because you’re older doesn’t mean the AC won’t go out, a termite invasion won’t occur, the washer and/or dryer won’t quit, or the house won’t need a fresh coat of paint. Nor does it mean that an elderly parent or an adult child won’t need financial help. Or that a bright young grandchild won’t need some assistance in meeting tuition payments. Even for those who did a good job saving for retirement with IRAs and such, reaching age 70½ can have some unexpected negative consequences. I’m talking about those Required Minimum Distributions (RMDs) that must be withdrawn whether or not needed to buy groceries. Although RMDs are always nice sources of retirement income, they shove a surprising number of retirees into higher tax brackets (yeah, I know, you thought your tax rate would go down with age). And because of those myriad stealthy Obamacare taxes, RMDs too often translate into increased Medicare Part B premiums, which are tied to annual income... another serious bite out of those Social Security checks.
In summary, the point of trying to catch up after entering the fifth decade of your life can be a painful process, but it’s time to stop kidding yourself about your true financial situation. Lay your cards on the table as you consider the available options. They may or may not be realizable options. You may not be able to work due to health issues or the lack of available opportunities. You may not be able to gain much ground by downsizing. Maybe you’ve already slashed your debt and expenses to the bone. Point is, you need to do something and a good place to start is to develop (at last) a plan… a budget you actually follow… a practical approach to the last third of your life.
And remember, It’s Never Too Late, But Right Now Is Best.
It seems reasonable to assume that most 40-somethings are individuals in their prime. Folks with 15-20 years of work and life’s experiences. Folks who’ve paid their dues and have incomes that reflect this experience and know-how. And hopefully, the college graduates among them have finally paid off those hefty student loans, freeing up disposable income for other purposes – including saving and investing, perhaps?
Oh, no! Here comes a new set of excuses. The mortgage payment is bigger because they bought a larger home in their late 30s or early 40s. And why? Well, an extra kid popped up and/or friends were buying larger homes. Must keep up with the Joneses…the Johnsons…the Jacksons. Also, those darn older kids need their own transportation – and the oldest one is heading off to college with the middle youngster already a junior in high school. And some of those Million Dollar Habits still lurk in the weeds.
Predictably, our 40-something seldom savers are far behind schedule in the median savings category with an estimated balance of barely $60,000 – not even approaching the old rule-of-thumb bromide of needing to save at least three times one’s salary by age 40. Fidelity recommends that individuals have savings of three times their annual salary by age 40. So, if your salary is $55,000, you should have a balance of $165,000 already banked; at age 45, four times their annual salary; and six times that level by age 50. Read more in The Average Retirement Savings by Age | Investopedia. Whether a family is behind schedule or not (being a bit of a pessimist, I’m guessing they’re behind), it’s time to start maxing out those 401(k) or 403(b) contributions. And while they’re at it, open one of those Roth IRAs and max that sucker out, too. To reach Fidelity’s benchmarks, consider putting salary increases toward retirement savings. And after paying off student loans, commit those payments to the retirement nest egg as well.
Did I hear you say, “Yeah, sure.” Well, just remember, you’re way behind schedule and the catch-up years are disappearing fast. In 2019, the maximum contribution to an IRA is $6,000. So, just do it! Get in a hurry. And quit smoking and impulse buying. You’re certainly not getting any younger and time is of the essence. Yes, you have good and valid reasons not to save – bigger mortgages, kids in or heading for college, and car payments stretching out beyond seven years, etc. But you also have good and valid reasons to save… and fewer years to do so.
Using the same assumptions as in previous blogs (saver invests $440 per month at 6.45% compounded annually) except for the new start date of age 40, here are the numbers: the median savings of the 40-something group is $60,000 versus the early saver’s group of $212,500; at age 50, using the new numbers, the savings of the 40-something group is $185,600 versus the early saver’s group of $470,500; and at age 65, the savings of the 40-something group is $605,700 versus the early saver’s group of $1,333,200.
The value of starting to save early in a career and the associated value of compounding bigger numbers for longer periods of time really does make a startling difference in how financially comfortable you are in retirement. In this hypothetical case, over $727,000 worth of difference. Holy Molyl! If only…