By Matthew Gaude & Shawn McGuire
After almost two decades in the financial services industry, we’ve come across many pieces of sound financial advice. You’ve probably heard some of them as well, such as the importance of living within your means, managing risk, and creating an emergency fund. You would do well to follow any of those lessons, but if we could give just one piece of financial advice, it would be to pay yourself first by saving and investing early and often.
Pay Yourself First
In practice, paying yourself first means depositing into your own savings and investment accounts before you divvy up your paychecks amongst your living expenses and wants. The reason this is so important has to do with two of the most powerful words in the financial world: compound interest.
The Power Of Compound Interest
One of the most significant benefits of saving early and often is the power of compound interest. Compound interest helps the money you put away grow faster due to interest building upon itself. It means that not only do you earn interest on your principal, but on the interest you’ve already earned as well, so you are earning interest on interest. You can make your money work smarter rather than harder to pursue your goals.
If you procrastinate and don’t prioritize saving, you not only lose out on your money working for you, but you’ll also have less time on your side. For every year you delay in saving, you’ll have to contribute exponentially more to reach your savings goals because of compound interest. If you start saving $400 per month at age 25, you would have $1 million saved by age 65 (assuming a hypothetical 7% annual investment return). If you don’t start until age 35, you’ll have to save around twice as much to reach $1 million by age 65.
Make Saving A Priority
If compound interest is so powerful, why don’t more people take advantage of it? Over 46% of Americans are putting less than 5% of their income into long-term savings. Even those who are saving 5% are still not saving enough. (1) How can you, amidst the responsibility of taking care of today’s needs, take care of your future self? Here are some practical ideas that can pay off in big ways.
Be Intentional With Your Money
Cut back on expenses, channel a healthy percentage of any raises and bonuses directly to savings, and automate savings increases of 1% of your paycheck every few months. It may not seem like you are making much of an impact, but every dollar helps. If you want to get a big-picture view of the benefits of saving early, use this calculator to see how your little-by-little investments add up over time. Play with the numbers to see how various amounts of savings, number of years left before retiring, employer match, and rates of return impact your savings picture.
Your increased savings can be invested into your company 401(k) or 403(b) plan or your personal IRA. For 2019, you can contribute as much as $19,000 to a 401(k) plan and $6,000 to an IRA. If you are over 50, you can invest an extra $1,000 per year into an IRA for a total of $7,000 for 2019. At $6,000, the catch-up contribution for those over 50 is even greater for 401(k) and 403(b) plans, for a total contribution limit of $25,000.
Leverage Your 401(K)
If your employer offers a 401(k), take advantage of it. If you aren’t able to contribute the full allowable amount to your employer-sponsored account, save enough to max out your employer’s 401(k) match. One in four Americans leaves money on the table by not maxing out their employer’s 401(k) match. (2)
Here’s an example of how this strategy can boost your retirement savings: If your employer offers $0.50 per $1 up to 6% of pay and your annual salary is $100,000, that’s $3,000 in free money for a total of $9,000 saved for the year. That amount adds up over time and can help you maximize your savings in a big way.
Automate Your Savings
When you enrolled in your retirement plan you might have opted for the default contribution amount, which is often not enough to give you a comfortable nest egg. Research shows that most plan participants do not change their default contribution amount and that most workers need to increase their annual contributions by 5 to 10 percent above their current savings rate to meet their retirement goals. (3) While it might seem daunting, we suggest you try to work up to investing between 10% and 20% of your income to your retirement account. So if you earn $50,000 per year, saving 10% equals $5,000 in savings every year in addition to company matching and compound interest. That will add up to a significant and rewarding investment into your future.
If you are self-employed, you have access to various retirement accounts that allow you to potentially save more. Even though you may not have a traditional employer-sponsored retirement account in your savings arsenal, you can still set up systematic contributions to a retirement plan such as a solo 401(k) or a SEP IRA.
Pay Attention To Taxation
When it comes to saving for retirement, there are two key terms you need to be aware of: pre-tax and after-tax. When you contribute to a traditional IRA or 401(k), your contributions have not yet been taxed. You get a tax break today but will pay tax on the distributions at whatever tax rate is in place when you retire. Roth IRAs or Roth 401(k)s work the opposite way. You pay tax on your contributions now, at today’s rates, and receive the distributions tax-free in retirement. Everyone’s situation is unique and there is no one right answer or product for everyone. What’s important is to be aware of how your money will be taxed both now and in retirement and work with a professional to find the best solution for you to maximize your money.
Creating strong money habits early on is going to put you in your best financial position in the long run. If you wait until you have “extra” money, you will never save. The cost of living keeps rising and there will always be things to spend your money on. But if you create the habit of paying yourself first, you won’t even think about spending that money. Do your future self a favor: save your money from a young age and you will give yourself financial peace of mind for the rest of your life.
Whether you have been saving for years or are just starting now, our team at Live Oak Wealth Management would love to help make your money grow faster, keep you on track toward your goals, and come up with creative ways to save more. Contact us at 770-552-5968 or [email protected] or schedule an appointment online today!
Matthew Gaude is an *investment advisor representative and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. Working first as a commodity broker and then as a Business Development Manager for a national broker-dealer in previous jobs, he has the insights and experience to help clients understand the complexities of the market and implement strategies to minimize risk. To learn more about Matthew, connect with him on LinkedIn or visit www.liveoakwm.com.
Shawn McGuire is a financial advisor and the co-founder of Live Oak Wealth Management, a financial services firm in Roswell, Georgia. He serves the planning and investment needs of corporate employees, those approaching or in retirement, and 401(k) plan sponsors. He has worked in financial services since 2002 in positions ranging from financial advisor to stock broker and portfolio manager. As a CERTIFIED FINANCIAL PLANNER™ professional, he is trained to help clients with virtually all their financial needs. To learn more about Shawn, connect with him on LinkedIn or visit www.liveoakwm.com.
Securities offered through American Portfolios Financial Services, Inc., member FINRA/SIPC. Investment advisory services offered through *American Portfolio Advisors, Inc., a SEC Registered Investment Advisor. Live Oak Wealth Management, LLC is independently owned and not affiliated with APFS or APA.
Any opinions expressed in this forum are not the opinion or view of American Portfolios Financial Services, Inc. (APFS) or American Portfolios Advisors, Inc. (APA) and have not been reviewed by the firm for completeness or accuracy. These opinions are subject to change at any time without notice. Any comments or postings are provided for informational purposes only and do not constitute an offer or a recommendation to buy or sell securities or other financial instruments. Readers should conduct their own review and exercise judgment prior to investing. Investments are not guaranteed, involve risk, and may result in a loss of principal. Past performance does not guarantee future results. Investments are not suitable for all types of investors.
(3) “Overcoming participant inertia.” Prudential. http://[Accessed 15 April 2014]research.prudential.com/documents/rp/Automated_Solutions_Paper-RSWP008.pdf