Estimating spending
The first step of saving is tracking your spending, one way to do this is a budget where you plan what you’re doing and spending money on ahead of time. I find the best way to estimate how much you will spend or should be spending is to keep track of all that you spend money on for a given month, by doing this once every couple of days it makes tracking it easy and you do not forget about everything. Then once you have this information on yourself you can retroactively go back and determine where you’re spending on these 3 categories
When you divide your savings by total take home pay it should be around 0.20 (or 20%) it is always better to save more if you can until you have at least 6 months worth of costs in savings.
Save early Save now
How to save if you struggle with it in simple steps
Takeaways:
1 Start saving today
2 Commit to save more when you get your next raise
3 Have your savings automatically deposited in your retirement and/or savings account
Prioritizing Savings
If an emergency does come up pay for it out of your security fund then replenish it with your next paycheck (or next few) [or with the money you make back from your investments like the stock market]
The purpose of your security fund is to help you cope with the unexpected without going into crushing credit card debt so do not put it into a Roth IRA or anything stock market related.
Note: If you plan to retire early you will want 3-5 years of living costs in a savings security fund in case the economy crashes and you need to stop living off gains from your investments. Generally speaking economic downturns do not last more than a couple years and the 3-5 is to give yourself a buffer or cushion in case something bad happens.
Wants category; do not buy wants with money you don’t have yet, save for things before buying them or “pay for them in advance” so to speak. This is better than buying something with debt (credit card) and then having to pay for it later with potential added interest.
For example, say you spend $1,000 on something today and plan to pay for it with your next paycheck. But then something happens and you can’t immediately pay (say the paycheck is delayed or a surprise bill comes up) then with the current average APR of 17.73% (source:https://www.msnbc.com/velshi-ruhle/watch/bernie-sanders-on-credit-card-bill-trump-2020-59310661586) you would owe 17.73% divided by 12months times the $1,000 which means you would have to pay back $1,014.78.
Lets assume you do this once every year for 35 years (the average length of a career in the US)
Over your career lifetime you would spend an extra $517.13 but lets say you took that money and invested it in a stock market ETF that gives an average return of 7% per year (less than what you would expect from the stock market over a 35 year window) then you would have missed out on $5,519.79. By simply spending your money once you have it and not before you have it, then investing anything left over in your savings, you could splurge 5 more times over the course of your carrier.
This is assuming you only go out and spend $1,000 on yourself once per year, what if you did it more? These costs could add up quick so save for things before you buy them.
Another thing to consider is what would happen if instead of spending this money you saved it, by the end of your 35 years if you invested in the same stock market index you would have $379,201.53 in savings. So consider this next time you plan on spending money that you don’t have yet, which you could otherwise be saving.
FAQ: Should I save for my young child’s college or my retirement
Answer: Save for your retirement because college students can get loans and scholarships but there are less financial support mechanisms for retirement.
401(k) and IRA Accounts
Lets start with an example, say you just graduate and have a 50k starting salary saving 10% per year (in other words 5K per year in a 7% interest return like S&P 500 account) you’d have nearly 1Million saved by the time you’re 65 and ready to retire.
There are different names for retirement accounts offered through an employer depending on how that employeer is classified, but they all work pretty much the same. In the government there is a TSP, in the private sector it’s called a 401(k) or a 402(b) in the non profit sector.
-You will pay tax when you withdraw from this account but not when you put the money in
-You can take this money with you when you leave and ERISA 1947 states you're entitled to all your employers contributions after 6 years (although some companies let you get this earlier)
There are also retirement accounts that you can open yourself which are called Individual Retirement accounts or IRAs, and can be opened through a brokerage company like vanguard.
There are several types and for a Traditional IRA it works just like a normal 401k plan
- No taxes are charged now but you will pay taxes later when you withdraw
- The downside is a lower maximum amount that you can contribute than the 401k, additionally the employer doesn't match anything, it’s just you so the amount you put in is the amount you have
If you take any money out of these retirement accounts before 59.5 years you have to pay taxes and a 10% penalty but you can sometimes get it out due to hardship reasons.
There are also retirement saving programs call a ROTH 401k and ROTH IRA
You can have a mix of accounts but there is a $5,500 total maximum in combined IRA accounts (for both tradition and ROTH) but that number may be increasing to $6,000 soon.
If you have access to a 401(k) at work you might not get the full tax benefits of the IRA because the 401(k) option is usually easier to utilize since deductions come directly out of your paycheck. Additionally, there is a maximum amount you can put into combined traditional retirement accounts that reduce your tax liability.
Section takeaways and Conclusion
The first step of saving is tracking your spending, one way to do this is a budget where you plan what you’re doing and spending money on ahead of time. I find the best way to estimate how much you will spend or should be spending is to keep track of all that you spend money on for a given month, by doing this once every couple of days it makes tracking it easy and you do not forget about everything. Then once you have this information on yourself you can retroactively go back and determine where you’re spending on these 3 categories
- Needs: The things you need, and things you can’t do without such as the bills you must pay even if you lost your job. Examples of this includes Housing, food, etc.
- Savings: Money you put away for later or invest into your future. Examples include paying off debt (student loan, credit cards, etc.), retirement accounts, and a rainy day/ emergency expenses fund
- Wants: Anything not in the other two categories such as vacation costs, gifts for others, recreational eating out or entertainment, etc.
- Estimate your monthly take home pay (this is after taxes and deductions)
- Write down average monthly needs and expenses; remember needs are mortgage or rent, utilities, insurance, car and student loan payments, alimony or child care support, credit card payments, gas or uber or public bus fairs for transport to get to and from work, basic groceries. Also note to include yearly fees or things that don’t come up often but must be paid like car maintenance or health bills, vacation or others, these can be estimated by how much and how often its needed (for yearly divide total cost by 1/12)
- Write down how much money you save each month, (401k, credit card debt payments?, rainy day expenses, more?)
When you divide your savings by total take home pay it should be around 0.20 (or 20%) it is always better to save more if you can until you have at least 6 months worth of costs in savings.
Save early Save now
How to save if you struggle with it in simple steps
- Automate savings, so whenever you get your paycheck take out some for savings before you even get it
- Maximize company matching if there is a company match for your 401(k) automatically setup deductions from your paycheck that match the max for your company program otherwise its like you’re leaving money on the table.
- Set up your own person savings account with an IRA or Roth IRA
- Pay yourself first, don’t spend money on stuff you don’t need and always first thing to do with your paycheck should be to put money into savings or into retirement
- Save more tomorrow, if you can’t save right now then just keep living the same way and once you get a pay raise put that money towards your savings and keep living the same way, don’t get more expensive of a lifestyle with the extra money.
- Start saving today; it’s not an all or nothing game, it’s a spectrum and you can start right now event if you missed out on savings opportunities beforehand.
Takeaways:
1 Start saving today
2 Commit to save more when you get your next raise
3 Have your savings automatically deposited in your retirement and/or savings account
Prioritizing Savings
- If your employer makes matching contributions to your 401(k) retirement plan, always contribute enough to the plan to get the entire match. (not doing so is literally like not getting free money or money you already earned, some even liken it to not cashing your paycheck) (this can count as part of your goal for saving 20% of after tax income)
- Your goal should be to put 20% of your income into some form of savings
- 10% should be in an IRA, 401(k), or other retirement account (if you’re over 35 and haven’t saved for retirement consider investing more in savings because you need to catch up so to speak)
- 5% should be to build up a security fund or save for a downpayment on a home or payoff principle on a mortgage of a home you already own. If you do not have a home or are renting put more into savings
- Final 5% should be used to save for something important to you (child's education, vacation you always wanted)
- 10% should be in an IRA, 401(k), or other retirement account (if you’re over 35 and haven’t saved for retirement consider investing more in savings because you need to catch up so to speak)
- Security fund, keep at minimum up to 6 months of must have expenses available in case you have an emergency. This can vary from case to case for instance;
- If you have a high income, secure job, and other savings you may not need a six-month cushion
- But if your income is unstable or you have a greater than average risk of losing your job you may need a larger security fund, or if you health is bad and/or your job has a high risk of injury
- If you have a high income, secure job, and other savings you may not need a six-month cushion
- Do not put this money in a checking account (too easy to spend)
- Do not put it in a Certificate of Deposit (illiquid and you might not be able to access it when you need)
- Do not put it in the stock market (too many ups and downs and if you need money like when the market crashes you’ll lose a lot)
- Do put the money in standard savings or money market account
If an emergency does come up pay for it out of your security fund then replenish it with your next paycheck (or next few) [or with the money you make back from your investments like the stock market]
The purpose of your security fund is to help you cope with the unexpected without going into crushing credit card debt so do not put it into a Roth IRA or anything stock market related.
Note: If you plan to retire early you will want 3-5 years of living costs in a savings security fund in case the economy crashes and you need to stop living off gains from your investments. Generally speaking economic downturns do not last more than a couple years and the 3-5 is to give yourself a buffer or cushion in case something bad happens.
Wants category; do not buy wants with money you don’t have yet, save for things before buying them or “pay for them in advance” so to speak. This is better than buying something with debt (credit card) and then having to pay for it later with potential added interest.
For example, say you spend $1,000 on something today and plan to pay for it with your next paycheck. But then something happens and you can’t immediately pay (say the paycheck is delayed or a surprise bill comes up) then with the current average APR of 17.73% (source:https://www.msnbc.com/velshi-ruhle/watch/bernie-sanders-on-credit-card-bill-trump-2020-59310661586) you would owe 17.73% divided by 12months times the $1,000 which means you would have to pay back $1,014.78.
Lets assume you do this once every year for 35 years (the average length of a career in the US)
Over your career lifetime you would spend an extra $517.13 but lets say you took that money and invested it in a stock market ETF that gives an average return of 7% per year (less than what you would expect from the stock market over a 35 year window) then you would have missed out on $5,519.79. By simply spending your money once you have it and not before you have it, then investing anything left over in your savings, you could splurge 5 more times over the course of your carrier.
This is assuming you only go out and spend $1,000 on yourself once per year, what if you did it more? These costs could add up quick so save for things before you buy them.
Another thing to consider is what would happen if instead of spending this money you saved it, by the end of your 35 years if you invested in the same stock market index you would have $379,201.53 in savings. So consider this next time you plan on spending money that you don’t have yet, which you could otherwise be saving.
FAQ: Should I save for my young child’s college or my retirement
Answer: Save for your retirement because college students can get loans and scholarships but there are less financial support mechanisms for retirement.
401(k) and IRA Accounts
Lets start with an example, say you just graduate and have a 50k starting salary saving 10% per year (in other words 5K per year in a 7% interest return like S&P 500 account) you’d have nearly 1Million saved by the time you’re 65 and ready to retire.
There are different names for retirement accounts offered through an employer depending on how that employeer is classified, but they all work pretty much the same. In the government there is a TSP, in the private sector it’s called a 401(k) or a 402(b) in the non profit sector.
-You will pay tax when you withdraw from this account but not when you put the money in
-You can take this money with you when you leave and ERISA 1947 states you're entitled to all your employers contributions after 6 years (although some companies let you get this earlier)
There are also retirement accounts that you can open yourself which are called Individual Retirement accounts or IRAs, and can be opened through a brokerage company like vanguard.
There are several types and for a Traditional IRA it works just like a normal 401k plan
- No taxes are charged now but you will pay taxes later when you withdraw
- The downside is a lower maximum amount that you can contribute than the 401k, additionally the employer doesn't match anything, it’s just you so the amount you put in is the amount you have
If you take any money out of these retirement accounts before 59.5 years you have to pay taxes and a 10% penalty but you can sometimes get it out due to hardship reasons.
There are also retirement saving programs call a ROTH 401k and ROTH IRA
- These are funded with post tax dollars meaning you pay income tax now when you put the money in (this year) but pay no tax on the money later or the money that’s gained from returns later when you withdraw.
- The ROTH 401k is relatively new and most companies don’t have one
- ROTH IRA has an income limit (about 140K/year at the time I am writing this) so if you make that or over you don’t qualify and can’t make an account (There is however a work around for this that I cover in the section on what I learned while at Morgan Stanley)
- The ROTH 401K does not have the income limit
- The principle money in these accounts can be taken out whenever you want or need with no penalty (because you already paid the taxes on them) but the gains cannot (from stock options that increased in value since you bought them) unless its for specific things like buying a first house, for some education expenses, or hardship cases
- Also note that the 401K is more strict concerning withdrawal limits than the IRA
You can have a mix of accounts but there is a $5,500 total maximum in combined IRA accounts (for both tradition and ROTH) but that number may be increasing to $6,000 soon.
If you have access to a 401(k) at work you might not get the full tax benefits of the IRA because the 401(k) option is usually easier to utilize since deductions come directly out of your paycheck. Additionally, there is a maximum amount you can put into combined traditional retirement accounts that reduce your tax liability.
Section takeaways and Conclusion
- Invest enough in your 401(k) plan to get the maximum match from your employer
- Plan for your tax brackets in the future vs. income tax brackets now to determine which retirement account is best for you (when you are making less money thats the time you want to be taxed because you will owe less)
- At the end of the day when you’re looking at your budget, if you have any left over money add it to a retirement account (either an IRA or 401K)
- For retirement plans consider the following
- For early retirement Max ROTH IRA because you can pull that money before reaching 59.5 without penalties or taxes, this is not the case for traditional IRAs or 401(k) plans.
- If you’re looking at a long career and don’t plan to retire early consider that the Traditional IRA is better than the ROTH because it lowers taxable income now so you can take advantage of income contingent tax breaks.
- For early retirement Max ROTH IRA because you can pull that money before reaching 59.5 without penalties or taxes, this is not the case for traditional IRAs or 401(k) plans.
