Monday, February 10, 2014
Starting to Save
So, when do I start to save? Generally speaking, if you are alive you should be saving for something. In retirement that might take the form of not spending for some greater good, but if you are planning to be alive tomorrow or if you are thinking about those who will be alive tomorrow after you’re gone, think about savings. As I thought about this question, I concluded the savings habit should begin as soon as a child has the maturity and understanding to connect money to desirable outcomes. For most of us I would guess that happens sometime around 4 years old but certainly before 6 years have passed. I can remember quite distinctly the first time I discovered I could buy what I wanted if I had money in my little plastic cowboy wallet. We were on a family vacation on the Outer Banks of North Carolina. There was a little snack stand near our motel. I discovered that I could exchange nickels and dimes for Cokes and candy bars. That would have been the moment to begin teaching me how to save. My parents did not believe in giving me an allowance. I believe that was a mistake. I think parents should use an age appropriate allowance as a teaching tool. Teach your children to give and save. I expect they will not have any trouble learning how to spend. If you want more of a particular kind of behavior in your children, reward it. As your children learn to save for larger purchases that can not be bought with a week’s allowance, encourage them. I would suggest adding a bonus to any “long term” money, first in a jar or a piggybank, later some time during the grade school years, in a simple savings account at the local bank. How much? Well they’re your children, you decide. I think 10% is too little. Maybe 100% is too much? How about matching 50 cents on the dollar for any long term savings your children manage to put aside for a major goal, like a really cool videogame? While I do not believe in buying a child a car or paying for their insurance, I do believe in subsidizing and encouraging thrift and part time jobs as they move towards buying a used car, likely their first major purchase. Generally, when people ask me this question, they are not thinking about their children. They are more likely concerned about some particular issue that is bugging them. While I have discussed these issues individually and at considerable length in previous posts, let’s consider a general order of priority for a typical family as well as a general approach to starting any saving program. First, consider any exception to the rules that might make sense in your particular case. Some companies offer matching money for the first 3% or so that you contribute to your 401(k) account. For heaven’s sake take the free money. 3% of your before tax income is not going to significantly effect your ability to pay bills. There is simply no way you can beat a 100% guaranteed instantaneous tax preferred return on your investment. Generally speaking this money is even protected in bankruptcy as long as it remains in your 401(k) account and it has not been pledged as collateral in any kind of a loan. Of course there are exceptions to this general rule. The Internal Revenue Service can go after your 401(k) for back taxes. Certain states have certain rules that might allow creditors to go after your retirement under unusual conditions. If you are in that kind of trouble you need to be talking with an attorney. Especially, if you are fighting credit cards or some other form of ugly debt, if you don’t have an emergency fund start one today. I can’t say this often enough, “If you don’t have at least $1,000 in an emergency fund, consider that an emergency.” Do whatever it takes to get an emergency fund started. That includes selling your motorcycle or taking a temporary part time job. The final goal is six months take home pay in an insured money market or savings account at a bank or a credit union. It will take a long time to reach this goal, but as long as you are headed in the right direction, you’re OK. There is another question that is just as important as, “When?” That would be, “Why?” If you have a really important why in your life that will give you the answer the other question, “When?” A powerful why will also provide you with the motivation that is necessary to lead to a successful outcome. Of course, pay off your ugly debt before starting any savings program beyond the emergency fund and the free money exception. Once families are left with only an affordable car payment and some student loans they tend to start thinking about a home of their own. Maybe they should work on those student loans before they think about a mortgage? However, a home of our own is in the genes. It is harder today because young families need 20% down to avoid the dreaded Private Mortgage Insurance (PMI). That is a tall order. As always there is more than one way to skin a cat. Many states offer very generous plans to help first time home buyers. These mortgages can with down payments as low as 3%. They also can offer a break on mortgage rates. Owner financing, typically a five year note with a balloon payment at a higher interest rate, can give the young buyer five years to worry about building a down payment for a conventional loan. In an ideal world, you should be constantly saving for known but infrequent expenses such as family vacations and new cars. You know you want to go to Disney World in six months. You estimate this trip will cost somewhere in the neighborhood of $3,500. Divide the total cost by six months. You need to save $580 a month to make it to Disney World on time. If you can’t pay cash, you can’t go to Disney World. End of story. Please, pay cash for cars. You won’t regret it. The day you buy a different car, pay yourself a car payment. When you have the money saved for a better car, buy yourself a better car. You may find this hard to believe, but it will not take many iterations of used cars before you are driving a late model low mileage cream puff or paying cash for new cars, if that is what you really want. Here is something I want you to think about before you buy into the notion that you have to be a debt slave. It takes more sacrifice and discipline to pay off a loan that it takes to pay cash. Consider a $15,000 car. If you make car payments to yourself in 48 months you can pay cash if you $312.50 a month. That assumes no interest. If you can find 2.5% (not an impossible feat) $300 a month for 48 months will give you $15,459.58. If you borrow $15,000 for 48 months at 10% for that car, you will pay $380.44 a month for 48 months. That totals out to $18,261.12. If you don’t submit to this discipline, the repo man will come in the night and haul your car away. Which path is harder? Do I pay myself $300 a month or do I pay a bank $380 a month? The choice is yours. Let me share three secrets to successfully start and continue any savings program. 1) Start small. Whenever you begin a new savings program, start with a small amount that you are certain you can continue even if something goes wrong. While 15% of your pretax income into tax preferred retirement plans is your ultimate goal that is not a good starting point. It is almost certain that if a young married couple starts at that level something will happen that cause them to fail. If they start at 3% to capture what is offered by the company’s matching program, it is unlikely they will ever miss any of that money. 2) Make slow incremental increases. The next time you get a raise, bump that contribution to the 401(k) by 1%. After 10 more raises that you might get over the next ten years, you will be at 14% of your pretax income into tax preferred retirement plans. 3) Automate. Make your savings automatic. This is particularly important for retirement, the longest goal of all. If you never see that money, you aren’t going to miss it. This extends to any savings program. If you only need to make the decision to save one time you are more likely to succeed than if you have to decide to save every single month. Also the less you have to remember on a monthly basis the more likely it is that you will succeed.