2Q2018 | Ages 18 – 29
Start Saving Now So You Don’t Have to Work Later
Saving early and often is a topic that resonates with me deeply. I started my career a little under two years ago; I know the importance of it and how challenging it can be for those of us just starting out in our careers. When discussing healthy retirement with younger participants, it is important to stress three points. First, that you are creating great habits from day one. Second, is saving with discipline. Third, is understanding volatility in the marketplace.
Let’s dive into what creating great habits from day one means. To some people, this could mean that you take out your pocket change at the end of the day and place it in the large jar located in your kitchen. For others, it may be a strict, detailed, line-item budget with the exact amount that you are comfortable spending each week. The important thing is that you begin saving as early, as often, and as much for your retirement. If you have not yet started, it is better to start today rather than tomorrow.
The first time my first adult job’s paycheck came it was extremely exciting at the thought of what I wanted to purchase. I realized that as a young adult starting my career, any money I was making now was more than I had made in the past. Therefore, instead of jumping from ramen noodles to filet mignon; I reminded myself that if I started contributing to my savings and my 401(k) immediately it wouldn’t be as big of a pinch doing so. I was right! I never felt a pinch because even with some of it going to savings, it was still more money than I had made before. My “new normal” had savings already built into it. Now, let’s look at the reverse of this situation. Had my “new normal” been spending every last cent until I decided to save later on, it would have hurt much more. When you first enter the work force you can create a new normal for yourself by contributing as soon as possible at as high of a rate as possible. Hopefully, the start of your “new normal” was a 5, 6, maybe even 7% contribution! You never used the money for your living expenses to begin with, so how can you miss it? All the while it is growing and building the financial freedom we all desire to have later in life. Starting now we can improve on our saving habits and become more disciplined in how we save.
This brings me to my second point, discipline. Discipline in terms of your finances means diligently sticking to a specific and consistent routine. If you are saving 5% of your paycheck and you receive a raise, do not stay at 5% of your former salary and pocket the raise. This is money you are not accustomed to, so save it! Make an effort to increase your deferral rate to include a portion of that new bonus or raise. If you do not I can almost guarantee that you will find a way to spend it elsewhere. People have this uncanny ability where their life style will always grow to match their cash flow. Without discipline, that extra $100 or $200 a month will be eaten away by an increase in your standard of living. Wouldn’t you prefer that money to be saved and grow for your retirement where it will make an impact later in your life? Or would you prefer to go to Starbucks 15 times in a week?
My favorite example of disciplined saving is the car payment. Let’s imagine that you bought a car and are now making payments on that car. Let’s say you spend $250 a month on your car payment. When that car is paid off, you are used to living each month without that $250. Instead of increasing your monthly expenses, why not direct that back into your 401(k) or your rainy day fund? You have been living just fine without it, so why increase your expenses to match it when you can save that money instead. This alone will add an additional $3,000 a year to your savings. All you need to do is act like you still have a car payment but send that money straight into your 401(k) and watch your savings grow.
The chart below shows the impact of disciplined saving. This applies to each of the situations I laid out above. Starting at age 25 that $200 a month becomes an additional $300k+ for your retirement.
Let’s talk about volatility. When the stock market goes up one day, and then goes down for the next five, then up again, and then down again, that’s what you call stock market volatility. I will focus on how volatility is not something to run from or jump to cash every time it rears its ugly head in the market place. I realize that discussing how volatility can increase your portfolio by 24% like it did in 2017 or remove 31% like it did in 2008 and saying, “we should not be afraid” is no easy task. However, being the young savvy investors you all are, I have faith you will hear me out.
I will focus on our recent history in the market to justify this thinking. When the crash in 2008 hit, investors were also hit with a decision. One option was to pull out of the market and stay in cash where they feel safe and confident they will not lose any more. The other option was to ride the market and wait for it to rebound. The individuals that pulled out and sat in cash, for the most part, never returned to the market. Because of this, they missed out on great returns year after year only to buy back into the market after its peak! The old adage is to buy low and sell high, but most people did the exact opposite! Many of these individuals have yet to recover from 2008. The investors that chose to ride the market and viewed a down turn as a buying opportunity were mostly recovered by the end of 2009 and late 2010. It pays to be aggressive especially as a young investor. This is not easy when you see numbers turn red instead of green your heart beats a little faster and all of the sudden we all feel nauseous. In that moment I encourage you to remember that you are not retiring next year. We have decades to recover from any setback a 2008 can bring. What we do not have, are decades to recover if we pull out of the market only to lose to inflation while we sit in cash.
Most frequently asked question by new participants:
Is there a difference between my pre-tax 401(k) account and my Roth 401(k)?
In most 401(k)’s, participants now have the ability to defer into the Pre-Tax account or the Roth account. Each has their pros and cons. Fortunately for everyone, there is no wrong answer here, only personal preference.
Pre-Tax- When you defer into the pre-tax account 100% of the money goes into the account untaxed. It will also lower your reportable income for tax purposes, you can defer up to $18,500 a year if you are below the age of 50. When you go to take money out of this account in retirement however, it is a fully taxable event. Your withdrawals, principle or growth, will be taxed at your income tax rate.
Roth- When you defer into the Roth account, the money is taxed up front. Because of this less money is going in upfront based on your tax bracket. Once the principle is in the account, it grows tax-free. This means that when you take money in retirement the money will not be taxed. The other benefit to a Roth being available in a 401(k) is that based on your income you may not be able to use one otherwise. An outside Roth IRA has an income limit. If you cross this limit you are no longer allowed to invest fully into a Roth. Also, outside Roth IRA’s have a cap of $5,500 a year if you are below the age of 50. Roth 401(k)’s have no income limit and are capped at $18,500 a year.
Advisory services offered through Prime Capital Investment Advisors, LLC. (“PCIA”), a Registered Investment Adviser. PCIA: 6201 College Blvd., 7th Floor, Overland Park, KS 66211. PCIA doing business as Qualified Plan Advisors (“QPA”).
This commentary is provided for information purposes only and does not pertain to any security product or service and is not an offer or solicitation of an offer to buy or sell any product or service.