What Percentage Should You Save?

Posted On April 24, 2021 By Scott Stratton, CFP(R), CFA In Retirement Planning /

One of the key questions facing investors is “What percentage should you save of your income?” People like a quick rule of thumb, and so you will often hear “10%” as an answer. This is an easy round number, a mental shortcut, and feasible for most people. Unfortunately, it is also a sloppy, lazy, and inaccurate answer. 10% is better than nothing, but does 10% guarantee you will have a comfortable retirement?

I created a spreadsheet to show you two things. Firstly, how much you would accumulate over your working years. This is based on the years of saving, rate of return, and inflation (or how much your salary grows). Secondly, how much this portfolio could provide in retirement income and how much of your pre-retirement salary it would replace.

The fact is that there can be no one answer to the question of what percentage you should save. For example, are you starting at 25 or 45? In other words, are you saving for 40 years or 20 years? Are you earning 7% or 1%? When you change any of these inputs you will get a wildly different result.

10% from age 25

Let’s start with a base case of someone who gets a job at age 25. He or she contributes 10% of their salary to their 401(k) every year until retirement. They work for 40 years, until age 65, and then retire. Along the way, their income increases by 2.5% a year. Their 401(k) grows at 7%. All of these are assumptions, not guaranteed returns, but are possible, at least historically.

In Year 1, let’s say their salary is $50,000. At 10%, they save $5,000 into their 401(k) and have a $5,000 portfolio at the end of the year. In Year 2, we would then assume their salary has grown to $51,250. Their 401(k) grows and they contribute 10% of their new salary. Their 401(k) has $10,475 at the end of Year 2.

We continue this year by year through Year 40. At this point, their salary is $130,978, and they are still contributing 10%. At the end of the year, their 401(k) would be $1,365,488. That’s what you’d have if you save 10% of your 40 years of earnings and grow at 7% a year. Not bad! Certainly most people would feel great to have $1.3 million as their nest egg at age 65.

How much can you withdraw once you retire? 4% remains a safe answer, because you need to increase your withdrawals for inflation once you are in retirement. 4% of $1,365,488 is $54,619. How much of your salary will this replace? The answer is 41.7%. We can change the amount of your starting salary, but the answer will remain the same. With these factors (10% contributions, 2.5% wage growth, 7% rate of return, and 40 years), your portfolio would replace 41.7% of your final salary. That’s it! That could be a big cut in your lifestyle.

What percentage should you replace?

41.7% sounds like a really low number, but you don’t necessarily have to replace 100% of your pre-retirement income. To get a more accurate number of what you need, we would subtract the following savings:

You weren’t spending the 10% you saved each year to your 401(k)
7.65% saved on FICA taxes versus wage income
Some percentage saved on income taxes, depending on your pre- and post-retirement income.
Your Social Security Benefit and/or Pension Income
Have you paid off your mortgage, or have other expenses that will be eliminated in retirement?

Many people will only need 75% to 80% of their final salary in retirement income to maintain the same standard of living. If their Social Security benefit covers another 20%, then they would only need a replacement rate of 55% to 60% from their 401(k).

Time Value of Money

The biggest factor in compounding is time. In our original example of 40 years of accumulation, the final portfolio amount was $1,365,488. However, what if you only save for 30 years? Maybe you didn’t start investing until 35. Perhaps you want to retire at age 55 and not 65? Either way, at the 30 year mark, the portfolio would have grown to $666,122. By saving for another 10 years, your accumulation will more than double to $1.365 million.

Here’s a chart that is perhaps a more useful answer to the question of what percentage you should save. It depends on how many years you will save and what percentage of your income you want to replace.

Income Replacement	50%	60%	70%
in 40 Years	12.0%	14.4%	16.8%
in 35 Years	15.7%	18.8%	22.0%
in 30 Years	20.9%	25.1%	29.2%
in 25 Years	28.5%	34.2%	39.9%
in 20 Years	40.3%	48.4%	56.4%

How do you read this? If you want to replace 50% of your income in 40 years from now, starting at zero dollars, you need to save 12% of your income. Actually, this is pretty close to the 10% rule of thumb. But no one says “If you are starting at age 25 and are planning to save for the next 40 years, 10% is a good rule of thumb”. What if you are starting later? Or, what if you want to have your portfolio replace more than 50% of your income.

As you reduce the accumulation period, you need a higher contribution rate. For example, at the 50% replacement level, your required contribution increases from 12% to 15.7% to 20.9% as you go from 40 to 35 to 30 Years. And if you are planning to retire in 20 years and have not started, you would need to save 40.3%.

Similarly, if you want your portfolio to replace more than 50% of your income, the percent to contribute increases as you stretch to 60% or 70%. These figures are quite daunting, and admittedly unrealistic. But one thing that may help slightly will be a company match. If you contribute 10% and your company matches 4% of your salary, you are actually at 14%. Don’t forget to include that amount!

What can you do?

We’ve made some conservative assumptions and perhaps things will go even better than we calculated. For example, if you achieve an 8% return instead of 7%, these contribution requirements would be lower. Or if the inflation rate is lower than 2.5%. Or if you can withdraw more than 4% in retirement. All of those “levers” would move the contribution rate lower. Of course, this cuts both ways. The required contribution rate could be higher (even worse), if your return is less than 7%, inflation higher than 2.5%, or safe withdrawal rate less than 4%.

If you want to consider these factors in more detail, please read the following articles:

If you’d like to play around with the spreadsheet, drop me an email ([email protected]) and I’ll send it to you, no charge. Then you can enter your own income and other inputs and see how it might work for you. While our example is based on someone who is starting from zero, hopefully, you are not! You can also change the portfolio starting value to today’s figures on the spreadsheet.

The key is this: Begin with the End in Mind. The question of What percentage should you save depends on how long you will accumulate and what percent of income you want to replace in retirement. Saving 10% is not a goal – it’s an input rather than an outcome. Having $1.3 million in 40 years or $2.4 million in 35 years is a tangible goal. Then we can calculate how much to save and what rate of return is necessary to achieve that goal. That’s the start of a real plan.

You don’t have to try to figure this out on your own. I can help. Here’s my calendar. You are invited to schedule a free 30 minute call to discuss your situation in more detail. After that, you can determine if you’d like to work with me as your financial advisor. Sometimes, it isn’t the right fit or the right time, and that’s fine too. I am still happy to chat, answer your questions, and share whatever value or information I can. But don’t use a Rule of Thumb, get an answer that is right for your personal situation.

How to Save More Money

Posted On August 29, 2020 By Scott Stratton, CFP(R), CFA In Financial Planning /

Growing your net worth is the product of saving and investing. Sometimes, we assume this means we have to slash our spending to be able to save more. Sure, you want to have awareness and planning regarding your spending. But it’s not much fun to give up coffee or never take a vacation. There has to be a balance between sensible spending and your saving goals.

Luckily, there is another way to increase your savings rate: earn more. Especially for younger investors, as your income grows you will find that you can easily save more. This may take a number of years. But, as your career takes off, your income may increase at a double digit rate during your twenties and thirties.

So, don’t despair if you cannot save as much as you would like today! Focus on growing your career and increasing your income. Saving will get easier.

Hold Your Spending Steady

As you get promotions and raises, avoid the temptation to keep up with the Joneses. You will see friends and classmates who are buying fancy cars and huge houses. Good for them! But what you might not see is how much debt they have, how little they save, or their net worth. You won’t know how stressed they are about their finances. They may be two paychecks away from being broke.

Hopefully, your current lifestyle is enjoyable and you find happiness in your relationships and the things you do. Getting more expensive things is not likely to create lasting satisfaction. The temporary, but fleeting, pleasure from consumption is known as The Hedonic Treadmill. If your priority is becoming financially independent, using a raise or bonus to save more is a better choice than spending it.

Put Your Savings On Autopilot

As your income grows, save your raises. Establish recurring deposits to your retirement plans and other accounts, and increase them annually. If take this step when you receive a raise, you will not miss the extra money. Skip increasing your monthly savings, and you probably aren’t going to have extra money leftover at the end of the year. If it’s in your checking account, you will spend it!

For couples, a joint income is a tremendous opportunity. If you can live off of one salary and save the second salary, you will grow your wealth at an amazing rate. In some cases, this could literally be saving one of your paychecks. Or, it may make more sense to participate in both of your 401(k) plans, and save the equivalent of one salary.

Multiple Sources of Income

Given the economic fallout from Coronavirus, many people aren’t getting a raise this year. A lot of us are seeing that our 2020 income will be lower than 2019. Hopefully, this will be temporary, but there are lessons to be learned. It is a risk to have all your eggs in one basket with one job. If you lose that job, you’re really in trouble.

As an entrepreneur, I have always had multiple sources of income. My financial planning business is diversified across a number of clients. I also sell insurance. I make music in a couple of orchestras and teach a few lessons on the side. Some of it is small, but having multiple sources of income gives me flexibility and safety.

Have you considered finding a side hustle, second income, part-time business, or online gig? Find something you enjoy and make it into a business. Find something people need and provide that service. You never know where that part-time work might take you. Maybe someday it will allow you to retire early or be your own boss! In the mean time, use your additional income to save more and build up your investment portfolio. Don’t give up your time just for the sake of buying more things.

How and Where to Save More

How much should you save? If you are saving 15% of your income, you’re doing way better than most people in America. Start at a young age, and a 15% savings rate will likely put you in a very comfortable position by retirement age. For those who are more ambitious, or just impatient like me, aim to save more than 15%. You could be putting $19,500 into your 401(k) each year ($26,000 if over age 50).

And you might be eligible for an IRA, too, depending on your income. Or, consider a taxable account, Health Savings Account (HSA), or 529 College Savings Plan. There are lots of places you could be saving! Put your savings on autopilot with recurring deposits to your retirement plans and other accounts. If take this step when you receive a raise, you will not miss the extra money, but you will be growing your wealth faster.

Do you need a reason to save more? The sooner you save, the faster you can achieve financial freedom. Even if you enjoy your work, it’s great to have the means to not have to worry about your job.

You can save more by spending less. That’s true, but you can only eliminate an expense once. Most people will have some tolerance for cutting costs, but austerity is no fun. Focus on increasing your income, hold your expenses steady, and increase your monthly savings. Put your energy into building your career, and aim for a high income. Couples have a great ability to save, if they can aim to live off one income. Look for creating a second or third income stream. A lot of the wealthy people I know have an entrepreneurial mindset. They have multiple income streams.

As your earnings grow, you will be able to save more and invest more. Most of my newsletters deal with investing, tax, or planning questions. But those benefits only accrue after you’ve done the first step of saving that money. It’s not how much you make that matters, but how much you keep!

How Much Should You Contribute to Your 401(k)?

Answer: $18,000. If you are over age 50, $24,000.

Those are the maximum allowable contributions and it should be everyone’s goal to contribute the maximum, whenever possible. The more you save, the sooner you will reach your goals. The earlier you do this saving, the more likely you will reach or exceed your goals.

At a 4% withdrawal rate in retirement, a $1 million 401(k) account would provide only $40,000 a year or $3,333 a month in income. And since that income is taxable, you will probably need to withhold 10%, 15%, or maybe even 25% of that amount for income taxes. At 15% taxes, you’d be left with $2,833 a month in net income. That amount doesn’t strike me as especially extravagant, and that’s why we should all be trying to figure out how to get $1 million or more into our 401(k) before we do retire.

I’ve found that most people fall into four camps:
1) They don’t participate in the 401(k) at all.
2) They put in just enough to get the company match, maybe 4% or 5% of their income.
3) They contribute 10% because they heard it was a good rule of thumb to save 10%.
4) They put in the maximum every year.

How does that work over the duration of a career? If you could invest $18,000 a year for 30 years, and earn 8%, you’d end with $2,039,000 in your account. Drop that to $8,000 a year, and you’d only have $906,000 after 30 years. That seems pretty good, but what if you are getting a late start – or end up retiring early – and only put in 20 years of contributions to the 401(k)? At $8,000 a year in contributions, you’d only accumulate $366,000 after 20 years. Contribute the maximum of $18,000 and you’d finish with $823,000 at an 8% return.

I have yet to meet anyone who felt that they had accumulated too much money in their 401(k), but I certainly know many who wish they had more, had started earlier, or had made bigger contributions. Some people will ignore their 401(k) or just do the bare minimum. If their employer doesn’t match, many won’t participate at all.

Accumulators recognize the benefits of maximizing their contributions and find a way to make it happen.

Become financially independent sooner.
Bigger tax deduction today, pay less tax.
Have their investments growing tax deferred.
Enjoy a better lifestyle when they do retire. Or retire early!
Live within their means today.
401(k)’s have higher contribution limits than IRAs and no income limits or restrictions.

Saving is the road to wealth. The investing part ends up being pretty straightforward once you have made the commitment to saving enough money. Make your goal to contribute as much as you can to your 401(k). Your future self will thank you for it!

Do You Hate Saving Money?

Posted On July 25, 2016 By Scott Stratton, CFP(R), CFA In Behavioral Finance / 1 Comment

Take your medicine. Make some sacrifices. Prepare for a rainy day. Tighten your belt.

Does this describe how you feel about saving and investing? Is it some sort of cruel punishment? Do you begrudgingly invest just enough dollars to get the company match and say that you “have a 401k”? You’re not alone. A lot of Americans feel the same. We are a nation of spenders, not savers.

The US household savings rate was 5.057% for 2015, according to the latest data from the Organization for Economic Development and Co-operation. Compare this to other developed countries: 8.563% in Australia, 9.668% for Germany, or 20.130% for Switzerland. The savings rate is estimated to be over 25% in China.

While the “average” household savings rate is 5.057% in the US, that average consists of a small number of people who save a significant amount of their income, and the majority of Americans who are living from paycheck to paycheck and save exactly zero. According to one study, 62% of Americans don’t have the ability to cover an unexpected $500 bill today.

I wish I could change people’s attitudes about savings. For some, saving money means buying an $80 sweater when it’s on sale for $40. But that is still spending money, not saving! Saving is setting money aside and having it grow. When you view saving as a negative – a chore that keeps you from having fun – your attitude may be the biggest roadblock to your own prosperity.

Saving and investing is the path to financial independence. Even if you don’t want to retire, we should still aim for financial independence, so you can work because you want to and not because you have to. Saving isn’t just for retirement planning, it’s developing a plan for financial security to free you from worry.

How can we make saving easier? What steps make you more likely to succeed?

1) Put your saving on autopilot through automatic monthly contributions. Whether it is establishing an emergency fund, contributing to a 401(k) or IRA, or creating a 529 college savings plan, making it automatic is the way to go.

2) Set goals. If you don’t have a finish line – a target amount for your nest egg – it’s hard to feel any sense of urgency to saving. When I was 30, I knew where I wanted to be at 50, which also meant I could determine where I needed to be at 35, 40, and 45. Those specific goals have helped me stay on track through the years. Without long-term goals, short-term actions often lack direction and a clear purpose.

3) Think big, not small. How many times have you read that you can fund your IRA by giving up your daily coffee fix. Forget that! If you get the big decisions right, the small stuff takes care of itself. Instead, be very smart, calculating, and objective on just two things: housing and cars. Those are the biggest expenses for almost everyone, and we have tremendous discretion in choosing how much we spend on these two categories.

If you want to jump start your saving, take a close look at all your recurring monthly costs: insurance, utilities, cell phone, cable TV, and memberships. Comparison shop, look for savings, and drop items you don’t use or won’t miss.

4) Focus on maximum saving. There is an oft-repeated rule of thumb that you should save 10% of your income. I am guilty of saying this one, too, especially as a “realistic” goal for new savers. However, there is nothing magical about the number 10%, and there is no guarantee that if you start saving 10% today that you will have enough money to accomplish all your financial goals. Instead, try to contribute the maximum to your 401(k): $18,000 or $24,000 if over age 50. And if you are also eligible for an IRA, fund a Traditional, Roth, or Backdoor Roth IRA. If you have self-employment or 1099 income, you may also be eligible for a SEP-IRA.

If it helps you to increase your saving, then let’s calculate each need separately and contribute to:
– Employer retirement accounts
– IRAs
– Health Savings Accounts
– 529 College Savings Plans
– Term life insurance policy
– Taxable brokerage account
– Savings for a first or second home down payment

Regardless of whether the market is up or down in 2016, I will have done my part by funding my accounts and accumulating more shares of my funds and ETFs. Over time, the returns will average out, but I accept that I have absolutely zero control over what the market does this year. What I do have control over is how much I save, and that’s more important.

I know a lot of millionaires who were great savers and invested in generic, plain mutual funds. But I have yet to meet anyone who has turned $5,000 into a million through their brilliant investing. Investing decisions matter, but you are likely to reach your goals faster if you can figure out how to save 50% more rather than spending your time trying to increase your returns by 50%, because it is not possible over any meaningful measure of time.

I feel great about saving and you should, too. It is empowering to see planning pay off when you have been diligent and consistent about saving. There is a lot of uncertainty and fear right now, and even as the market makes new highs, investors are very wary. If you want to become wealthy, divorce your feelings about today’s market from your feelings about saving. If you’re serious about getting to your goals sooner than planned, save more today!

How America Saves

Posted On July 4, 2016 By Scott Stratton, CFP(R), CFA In Retirement Planning /

Defined Contribution (DC) Plans are the backbone of retirement planning in America. Vanguard manages DC plans for 4 million Americans, with over $800 Billion in assets. So, I am always interested to read their annual report, How America Saves, which offers a window into the state of retirement preparation in America.

Link: How America Saves, 2016 Report

Looking through this year’s report, I see both reasons for optimism as well as concern. On the positive side, 78% of eligible employees participated in their company plan. And the average account balance was $96,288. It’s great that a majority of employees are participating.

However, it is surprising to discover the difference between the average and the median. (As a quick refresher, the median is the data point that is exactly in the middle – with half being higher and half being lower than this point.) The difference between the average and the median scores in Vanguard’s report belies a growing chasm between participants who save the minimum and those who save as much as they can.

While the “average” account balance was $96,288 in Vanguard Retirement Plans, the median participant had only $26,405. That means that half of all accounts have under $26,405, and that the average is skewed higher by very large accounts of $300,000, $400,000 and more.

The problem is that many participants are simply not contributing enough. The average deferral rate is 6.8%, but the median again is lower: 5.9%. Disappointingly, the average deferral rate is down from 7.3% in 2007, which means that most people are saving even less than they were 10 years ago.

People really do need to save 10% or more for their retirement. Instead, many invest only 3% or whatever is the default minimum. That’s because many participants only contribute up to the company match. In fact, when I ran a plan for a small company with a dozen employees, all but two only contributed up to the match. When you contribute the minimum over the course of a career, you are not thinking in term of the outcome. Will I have saved enough to fund a comfortable retirement? Am I on the path to financial independence?

However, there are good savers out there. 20% of the participants in a Vanguard plan are saving more than 10% of their salary into their retirement plan. These are the accounts which are bringing up the median of $26,405 to the average of $96,288. And this is what you want to do -you want to be a savings overachiever!

Over time, compounding makes a huge gap between people who contribute the minimum versus those who save more. To examine this, let’s consider two employees: Minimum Mike and Saver Sally. They both have the same salary of $45,000 and earn 3% raises over the next 35 years. Mike contributes 3% to his 401(k) and gets the company match of 3%. Sally contributes 10% and also receives the 3% match. Both earn a return of 7% compounded annually.

Here are their account balances after 35 years:
Minimum Mike: $567,615
Saver Sally: $1,230,417

Saving 10% really does make a big difference over the length of a career. Although the news media would like for you to believe that your financial future hangs by a thread on the outcome of the Brexit, or the Presidential Election, or whatever new crisis is on that day, the reality is that the biggest determinant of your long-term wealth is likely to be the percentage you contribute.

Being average is still a lot better than being median. If you want to be above average, start by increasing your deferral rate.

There is still time to increase your 401(k) or 403(b) contribution for 2016. The maximum contribution is $18,000 for 2016, with an additional catch-up of $6,000 if you are over age 50.

Don’t Budget; Focus on Saving

Posted On September 14, 2015 By Admin In Financial Planning /

I used to feel a bit sheepish when clients asked about my personal household budget, because I don’t have one and never have. I always worried that I was being lazy and a poor role model for my clients. I’d see articles, books, or CFP materials touting the benefits of having a budget to be able to track your spending. Some said that without a budget, you would not be able to plan how to achieve your financial goals.

Eventually, I came to recognize that you don’t need to have a budget to accomplish financial goals and that creating a budget would be a waste of time. It’s true, I don’t know how much I spend on dog food, and I don’t have a set amount that I plan to spend on clothing, eating out at restaurants, or for car maintenance. Over the years, I’ve found that many successful investors skip making a budget and that it is not the prerequisite that many people would have you believe.

If you follow these three steps, you won’t need a budget, either:

Put your saving on autopilot. Figure out how much you need to save to accomplish your goals. Set up your contributions to your 401(k), IRAs, and other accounts. If you are saving your target amount (or more), don’t worry about spending the rest of your income. I think of this as reverse budgeting. Save first, and then whatever is leftover is yours to spend.
Don’t ever deplete your cash. While I don’t have a set monthly budget, I am aware of our spending and follow our credit card transactions weekly. We pay our credit cards every month and never carry a balance. In months when there are large expenses, we can always reduce discretionary spending or postpone other purchases. We keep an emergency fund, but after 17 years of marriage, we’ve never touched it. We won’t make a purchase if it requires dipping into the investment portfolio; we will have to build up cash in checking before making a large purchase, such as a vehicle.
Live frugally. Luckily, I don’t enjoy shopping, so I am not often tempted to buy new things. When I do want to make a purchase, it is never an impulse buy. I’ll do my homework, research online, and make sure we are getting a good deal. For me, the knowledge of how $50,000 could grow over the rest of my life is much more attractive than a $50,000 boat. So, I’m not sure I’ll ever be willing to sink huge amounts of money into depreciating assets.

I know that for some people, spending is like a gas that will expand to fill whatever space you allow it to have. For these folks, creating a budget is helpful so they actually know where their money is going. Many people have benefited from having a budget, and if it has benefited you, that’s wonderful. I am all about empowering people to take control of their finances and make informed changes for a better life. My point is not that no one should have a budget, just that not everyone needs to have a budget if you are meeting your savings goals without one.

Not sure how much you need to save to reach your financial goals? Check out the Savings Goal Calculator on Bankrate.com. Enter your current portfolio value as the “first deposit” and your ending goal under “How much do you want to save?”. Want a more sophisticated analysis to consider market fluctuations? Contact me for a consultation; we have terrific goal-based financial planning tools!

Can Being Frugal Make You Happy?

Posted On August 24, 2015 By Admin In Behavioral Finance, Financial Planning /

Gen Y is bringing frugality back in style. As a financial planner, I’m delighted to find frugality is cool now. I’ve read their blogs (where else would they write?) with fascination and appreciation for their candor. I’m calling this the New Frugality, and you’ve probably heard or read about some of these ideas, including the Tiny House, where people live in a home often smaller than 200 square feet. Others are embracing Minimalist Wardrobes, creating a personal, seasonal clothing uniform (think Steve Jobs with his jeans and black mock turtleneck). This past week, there was an article in Forbes about the Frugalwoods, an anonymous Boston couple who is saving 71% of their income so that they can retire at age 33 and move to a Vermont homestead with their rescue Greyhound.

In these blogs, the authors are never afraid to share their personal stories, from big-picture motivations and life philosophies, to the smallest minutiae of their daily decisions. Along the way, we invariably learn of their challenges, missteps, and triumphs. The blogs are part diary, part instruction manual, and part entertainment for their friends and fans. Even with different goals and approaches, there are common beliefs.

The New Frugality believes that less is more, and does not buy into the modern American idea that “buying more stuff” can make you happy. They have a maturity (which takes some people 70 years to develop) that recognizes that happiness comes from rewarding experiences, positive relationships, and a work/life balance that includes a higher purpose.
They want off the financial treadmill. Some had large student loans or crippling credit card debt before having an epiphany about becoming debt-free. Others found their corporate careers unsatisfying and were brave enough to recognize that spending the next 40 years in a job they hate isn’t worth it just to be able to afford a big house and a fancy car.
While others may view their frugality as a sacrifice, they often find that simplifying their lives and eliminating clutter brings a clarity to their sense of what is truly important to them.

The New Frugality is about seeking the quality of life you want today, rather than believing you should wait until some future date, i.e. retirement, before you can really do what you want. It’s an implicit rejection of the old notion of working 50 hours a week until age 65, then never working again.

[In case you are wondering, I contrast the New Frugality with previous beliefs about frugality which were created by those who lived through The Great Depression and who raised their children in a different, frugal manner. While both the old and new approaches want to stretch each dollar, the old frugality was characterized by self-reliance, never throwing away anything you might need in the future, risk avoidance, and mistrust of financial systems. Some of those traits were largely fear-based, which does not resonate with the abundance mentality I embrace and believe is required to be a patient and successful investor.]

Does frugality make you happy? I think the most literal answer is no. By that, I mean that if you are unhappy, spending less won’t make you happy. If you really enjoy going to Starbucks every morning, cutting out that $5/day habit isn’t automatically going to improve your satisfaction, even if it enables you to save $1,825 a year. Frugality works for these bloggers because they were willing to embrace changes to their habits even though society was telling them to spend more money instead. There’s no doubt that frugality is financially beneficial, but the sources of happiness include a lot more than just your financial situation.

Reading their blogs can help you appreciate your own spending more as well as to feel good, and not alone, when you do choose a frugal approach. We are continually bombarded with advertising that suggests we’d be happier, cooler, and more attractive if we had the right car, clothes, or beauty products. We’re told that our current life would be better if we had a bigger home, nicer furniture, or luxury vacations. Of course that’s not true. We know that spending to increase our satisfaction is at best a fleeting pleasure which can leave consumers addicted to living beyond their means. Unfortunately, there are so few voices pushing back on the advertisers’ message to consume.

Even if you don’t want to live in a tiny house, reduce your wardrobe to a few pieces, or bike to work, you can still take frugal steps to ensure you are working towards true financial independence, which we define as working because you want to and not because you have to. Here are six lessons to take away from the New Frugality:

Beware of lifestyle creep. Many of us were very happy in college, even though we may have had a rickety car, tiny apartment, and slept on a futon. It doesn’t take long after graduation to discover the urge to “keep up the Joneses”, as friends buy big houses and fancy cars. How can they afford it? Oftentimes, they can’t and they’re up to their eyeballs in debt. They’re more concerned about their image than their net worth, and that’s not something to emulate! If you increase your living expenses every time your income goes up, you aren’t ever going to become wealthy.
Save at least 15% of your income. Set financial goals, including a “finish line”. If you are highly motivated (or just impatient, like me), you will realize that the more you save, the sooner you will reach your finish line. Saving then is not a sacrifice, but the fastest, most direct way to achieve financial independence. When your goals are more important to you than a new (fill in the blank), your spending decisions become much easier.
Avoid impulse buys and emotional shopping, that is shopping to distract you from sadness, frustration, or boredom. Never buy on credit; if you don’t have cash to pay for something, it’s not worth going into debt. Be conscious and intentional about your spending behavior. Do your choices reflect your goals and beliefs?
Buy used. There is a growing market for used items, often selling at a small fraction of the cost of new items. This is the Craigslist economy, which is growing around the country. You can often buy what you need without paying full retail prices.
Savor success. There is a great deal of intrinsic satisfaction in becoming financially independent. Even taking the initial steps towards creating a positive cash flow are great confidence boosters because people feel empowered when they take control of their financial life. As every financial planner will tell you, the more you need to spend, the larger the nest egg required to be able to fund your future needs. Therefore, when you reduce your spending, you not only can save more, but you also reduce the size of the nest egg you will need to replace your income.
Reduce stress. While money is not the source of true happiness, there is no doubt that being broke, in debt, or just knowing you are not setting enough aside for the future, can be a significant source of personal anxiety and marital friction.

As a bonus, you will find great common sense financial planning tips on these blogs. What are the Frugalwoods doing with the 71% of their income the save? They maximize their 401(k) contributions and invest the rest in the market. They write: We’ve done well because we invest in boring index funds and we don’t sell when the market is down. That’s a great recipe for success!

Reading about the New Frugality is entertaining because many authors are willing to take their frugal habits to quite an extreme. Even if we don’t adopt their spartan lifestyle, they can remind us that we don’t have to spend money to be happy.

Deferral Rates Trump Fund Performance, Rebalancing as Key to Retirement Plan Success

Posted On March 16, 2015 By Admin In Retirement Planning /

A study by the Putnam Institute, “Defined Contribution Plans: Missing the forest for the trees?” contends that while a number of variables, such as fund selection, asset allocation, portfolio rebalancing, and deferral rates all contribute to a defined contribution plan’s effectiveness — or lack thereof — it is deferral rates that should be placed near the top of the hierarchy when considering ways to boost retirement saving success.¹

As part of its analysis, the research team created a hypothetical scenario in which an individual’s contribution rate increased from 3% of income to 4%, 6%, and 8%. After 29 years, the final balance jumped from $138,000, to $181,000, $272,000, and $334,000, respectively.

Even with a just a 1% increase — to a 4% deferral rate — the participant’s final accumulation would have been 30% greater than it would have been using a fund selection strategy defined as the “Crystal Ball” strategy, in which the plan sponsor uses a predefined formula to predict which funds may potentially perform well for the next three-year period. Further, the 1% boost in income deferral would have had a wealth accumulation effect nearly 100% larger than a growth asset allocation strategy, and 2,000% greater than rebalancing. Of course these results are hypothetical and past performance does not guarantee future results.

One key takeaway of the study was for plan sponsors to find ways to communicate the benefits of higher deferral rates to employees, and to help them find ways to do so.

Retirement Savings Tips

The Employee Benefit Research Institute reported in 2014 that 44% of American workers have tried to figure out how much money they will need to accumulate for retirement, and one-third admit they are not doing a good job in their financial planning for retirement.² Are you? If so, these strategies may help you to better identify and pursue your retirement savings goals:

Double-check your assumptions. When do you plan to retire? How much money will you need each year? Where and when do you plan to get your retirement income? Are your investment expectations in line with the performance potential of the investments you own?

Use a proper “calculator.” The best way to calculate your goal is by using one of the many interactive worksheets now available free of charge online and in print. Each type features questions about your financial situation as well as blank spaces for you to provide answers. But remember, your ultimate goal is to save as much money as possible for retirement regardless of what any calculator might suggest.

Contribute more. At the very least, try to contribute enough to receive the full amount of any employer’s matching contribution. It’s also a good idea to increase contributions annually, such as after a pay raise.

Retirement will likely be one of the biggest expenses in your life, so it’s important to maintain an accurate cost estimate and financial plan. Make it a priority to calculate your savings goal at least once a year.

Today’s blog content is provided courtesy of the Financial Planning Association.

Source/Disclaimer:

¹Putnam Institute, Defined Contribution Plans: Missing the forest for the trees?, May 2014.

²Ruth Helman, Nevin Adams, Craig Copeland, and Jack VanDerhei. “The 2014 Retirement Confidence Survey: Confidence Rebounds–for Those With Retirement Plans,” EBRI Issue Brief, no. 397, March 2014.

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.

How to Become a Millionaire in 10 Years

Posted On January 26, 2015 By Admin In Behavioral Finance, Financial Planning / 2 Comments

Answer: save $5,466 a month and earn 8%.

I thought about ending the article there, because that’s all you actually need to do. Investing is simple, but it isn’t easy. No one likes the answer above, even though it really is that simple. When confronted with a difficult task, our brains are wired to look for an easier way, a shortcut. Many investors waste a vast amount of time and energy trying to improve their return by timing the market, buying last year’s hot fund, or day-trading stocks.

Unfortunately, these attempts at finding a shortcut don’t work. It’s like someone who wants to run a marathon but not train for it. There isn’t a shortcut, you just have to do the right things, stick to the training schedule, and put in the miles. You have to earn it. Yet there are entire magazines, TV networks, and firms who make their living from telling people that the shortcut is to trade frequently, and that beating the market is the sure path to prosperity.

The truth that no one wants to hear is that investors would be more successful in achieving their financial goals if they instead focused on how much they save. Let’s step back and consider what we actually can control when it comes to our investment portfolios:

how much we save and invest
our asset allocation and diversification
investment expenses
tax efficiency, which can reduce (although not eliminate) taxes

We cannot control what the market will do this month or year, so ultimately we have to accept the ups and downs of each market cycle. We have many studies which consistently show that the majority of active fund managers under perform their benchmarks over time. We also have compelling evidence that the average investor significantly lags the indices due to poor decisions and fund selection.

Few people are able to save $5,500 a month. It’s not easy, but that is the way to get to $1,000,000 in 10 years. For a family making $200,000 a year, this would require you to save one-third ($66,000) of your pre-tax income. Again, not easy, but possible. After all, there are many families who are able to “get by” on $134,000 (or much less), so it is certainly possible for a family with an income of $200,000 to save $66,000. While there are many families in Dallas who make this amount or more, saving is viewed by some negatively, as a sacrifice, rather than with pride and recognition that it is the key to accomplishing your financial goals.

If you did the math, saving $5,500 a month, or $66,000 a year for 10 years is asking you to save $660,000 over 10 years. So even at an 8% return, the market performance is not the main source of your accumulation. Your saving is the main driver of your accumulation.

However, in the next decade, after you have achieved your first million, things become much more interesting. Compounding is your new best friend. At $1 million, an 8% return means you’re up $80,000, and you’re now making more from the portfolio than you contribute annually. Continue to invest $5,466 a month for another 10 years at 8%, and you’re looking at a portfolio with over $3.2 million.

And that’s why I get very excited talking about saving with high-income professionals. If you can commit to that aggressive level of saving, your success will be inevitable. Is an assumed 8% return realistic? No one knows for 2015, but I think 8% is likely to be attainable for 10 years and almost a certainty over 20 years. 8% isn’t going to happen every year, but historically, it is possible to average that rate of return over time. In the long-run, the returns can take care of themselves when you stick with a sensible, diversified approach. The factor which needs more attention, and which you can control, is your savings rate.