Put Your Financial Adult Pants On
- Written by Candice Elliott
The future is creeping up on all of us. If you’ve been avoiding thinking about it, it’s time to get serious about retirement and your goals.
The Future Happens With Or Without You
Some of us put off worrying about money for a long time. When you’re in your twenties and thirties, retirement seems so far away that it’s not worth thinking about. But the clock is ticking and you are wasting the most powerful thing in personal finance, the power of compounding interest. The longer your money is invested, the more it grows. There is no substitute for the power of time.
Whether you think about the future or not, it’s happening. Well, there is no time machine to take us back and invest our money earlier but if the best time to start investing was when you were 18, the second best time is now.
Know Your Number
Another reason people don’t give too much thought to retirement savings is that they have no idea how much money they need to save for retirement. You need to know your number. But which number? Most people want to know the number they have to have saved to retire. But there is a more important number; your savings rate.
There is a calculator you can use to get the percentage of your income that you need to save to retire in X number of years.
The calculator assumes that you have $0 in savings and $0 in debt so you’re starting from a blank slate. That isn’t the case for most of us so you can use the number you get as a ballpark.
The average US Savings rate is 6% of income. By saving just 6%, you will have to work for 62 more years before you can retire. A savings rate of 27.4% means you need to work for 30 more years.
A savings rate of 53.6% means you need to work for 15 more years.
Okay, good. Now we know how the percentage of our income we need to save to retire in X years. But how can we come to the big number, the total we need to save before we can retire? There are lots of complicated theories and formulas about how to arrive at your retirement number but LMM likes to keep it simple. That’s why we like the 4% rule.
The first thing you need to do is estimate how much money you will need a year during your retirement to pay your expenses, all of them, housing, utilities, food, travel, etc. For many people, living expenses decrease during retirement. We may downsize our home as we become empty nesters or will have paid off our mortgage.
We are no longer tied to an area because of work. You might have lived in and worked in a city because that’s where the higher paying jobs were but you can live anywhere you want in retirement and that might mean a place with a much lower cost of living then you were living in during your career. You won’t have the expenses associated with having a job and hopefully will no longer be supporting children.
Come up with a number you can live on each year and then maybe increase it a little to error on the side of caution. Now we can employ the 4% rule to know how much money we need to have in our retirement pot.
The 4% rule is a benchmark that can be used to calculate how much money you can withdraw from your retirement accounts every year for your expenses for at least thirty years without depleting those accounts and outliving your money.
Here’s how the 4% rule works. You withdraw 4% of your retirement money each year to live on. If you have $500,000 saved, you would withdraw and live on $20,000. But you need to account for inflation too so you increase the amount of that first withdraw ($20,000) to reflect the impact inflation has on your buying power.
If annual inflation is 2%, the second year of retirement, you take out $20,400. The next year, $20,800, and so on. You continue these 4% withdrawals and the extra amounts to preserve your buying power no matter what the market is doing or how your portfolio is performing. Adding in the amounts to account for inflation will ensure that you have the same purchasing power in your first year of retirement as your last.
Getting There Is Not Half The Fun
Figuring out your numbers is the easy part. Getting to that number takes a little more work. If you’re young, time is on your side. Start investing now. Don’t do research, don’t hire an advisor, don’t talk to your parents. Just open a Betterment account and set up automatic contributions every month. How much? Decide how soon you want to retire and plug your numbers into the calculator we linked above. The number it spits out is how much.
While your Betterment account is percolating away, you can take some time to educate yourself so that you can become a more successful investor and possibly retire even earlier. You might branch out from market investing in real estate or buying rental property yourself.
If you are not so young and have not started saving for retirement, you’re going to have to play catch up. You need to grow your income, destroy any outstanding debt, and cut costs. This is not going to be fun but it will be more fun than working until you drop down dead or having to live with your grown children one day.
Because of longer life expectancy, the definition of retirement has changed. Some of us may live decades after we retire, especially those who retire before the traditional retirement age of 65. Decades is too long to golf every day (unless you’re POTUS I guess) or sit around in a rocking chair yelling at the neighborhood kids to get off your lawn.
Retirement can be filled with travel and adventure. It can mean going back to school. It can mean starting a whole new career, maybe the one you would really have liked to have but it didn’t pay well enough. Or it can mean devoting yourself and your time to causes that you care about.
There is nothing stopping you from continuing to work during retirement. But you no longer have to work in order to pay your bills. You might start a business or continue to consult with your current employer or within your current industry. So if you’re getting up there in age and your number isn’t close to what you want it to be, it doesn’t necessarily mean you will have no money coming in during retirement.
Retirement is the ultimate long term goal but it doesn’t have to be the only one. Do you want to buy a home, have a kid, send that kid to college, travel? Those are long term goals too but the money you are saving for them should be entirely separate from your retirement savings.
Nothing touches the retirement savings. Some parents who understandably don’t want to saddle their kids with student loan debt, raid their own retirement to pay for college. Don’t do this. Your kid has a lot longer to work to pay off student loan debt than you have to save for retirement.
If your long term goal is less than five years away, in terms of investment timelines, that’s not long term. That money should just be parked somewhere safe like your checking or savings account. If the timeline is beyond that, you can invest the money but do not co-mingle it with retirement savings.
Boss The Future
To drift is hell, to steer, heaven. Nothing feels worse than not being in control of your future. But you are. Who else possibly could be? If you’ve been drifting, here’s how you can grab the wheel.
Automate your retirement savings. Some of us can’t be trusted with extra money because it burns a hole in our pockets. If you’re not already, participate in your employer’s 401k. Set up an IRA. The current max is $5,500 per year. If you have that much now, just put it in their now so it’s done and the money is out of reach. Set up automatic deposits into your Betterment or Vanguard account.
Another place to invest is in your career. Hate what you’re doing? Go back to school and learn to do something else, start a side business, take a risk and go after a dream job that you might not be qualified for.
In an industry, you like but not making enough money? Start networking, work on your resume, move to where the money is. In a company you like but not moving up the ladder quickly enough? What additional skills or certification could you get to change that? Is there someone who would be willing to mentor you?
The Big Goal
Do you have one? It’s not a requirement. You should still keep money in a separate pot for a goal you might not have clearly defined yet. Or for an opportunity that presents itself. Maybe a friend will ask you to join them on the vacation of a lifetime. Maybe you’ll get fed up with your job and decide to go back to school or start a business.
You never know what might be around the corner and you don’t want to pass up a great opportunity or to raid your retirement account to pay for it.
Weather the Risk
A little risk into every life must fall if you want to live a full life and to reach your goals whether they be early retirement or starting your own business. You can take some risks without careening into uncertainty. Taking calculated risks can pay off no matter what your goals.
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