OK here it is the Holy Grail of financial planning get this concept down and more importantly practice it no matter what and you will be well on your way to living without the stress of worrying about money.
Ready!!
Save Money !!!!!!!!!!!!!!!!!!!!!
Disappointed, well basic fundamentals aren’t too sexy but they sure do work that’s how they became a fundamental.
Sounds easy enough but OH so difficult in our consumption driven lifestyle these days. If you can’t save at least 10% of what you make then you my friend are living above your means. There probably wasn’t a day in my career as a Investment Adviser that I didn’t get a call from someone who was in a bind and they needed to get there hands on the little money they had put away for retirement and these were the clients who actually tried to save. I shudder to think of what was happening to the other 50% of the population that had practically no savings at all.
When you get that first real job if you haven’t already started a savings program start one now. If you have neglected doing this and your older for your own good start one now. If your in college or in high school with just a part time job start one now. The point is you have to start somewhere so were ever you are in life get to work.
In the beginning start with a savings account or money market. Most of us are going to have situations arise, unexpected emergency’s that catch us off guard. If we have been setting money aside every time we get paid it can be a huge relief not to have to worry about were am I going to get the money for that.
Once you have set aside enough money to cover 3 months worth of expenses start putting some of your savings in a mutual fund something that will get you a little better return than the savings account. Once you have another 3 to 6 months worth of expenses set aside in the savings account and mutual fund combined start putting money in a retirement account like a 401k or IRA. If your employer offers a retirement plan like a 401k you should put retirement money here first because you may get a matching contribution. Even if you don’t get a match the money you save comes out of your pay check and comes out pre tax this is an advantage over the IRA because your tax break is immediate.
A good savings plan would progress something like this for a person making $50,000 per year.
Step 1
Save 10% or $192 per bi weekly pay period towards savings. If you can save more by all means do it. Do this until you have 3 months worth of expenses saved up.
Step 2
Continue to save the 10% but now split half to the savings account and put the other half in a mutual fund. Choose a moderate fund like a balanced fund which is made up of stocks and bonds. The mutual fund will give you a greater growth rate on your money. Do not worry about the ups and downs of the market the money you put in the mutual fund should be your intermediate term savings ie money you can get to but you have no immediate plans to do so. A good balanced mutual fund should average in the 7 to 9% growth rate over time. Some years you will do better than that, some years worse, some years it may actually lose some money. Do not fall in the trap many amateur investors do which is to get all worked up about how your account is doing at the moment whether good or bad. This obsession leads to mistakes like constantly moving your money from one account to another, or stopping your savings because they do not think it is going well. Here is what and average balanced fund might do over a typical 5 year period.
8% 5% -3% 8% 11% 6%
Over that 5 year period you made 35% or 7% average return per year. Your savings account would have probably made you 2 or 3% per year. Now a certain number of people in year 3 would have bailed and stopped saving because the market and the fund were down that year. The fund lost 3% so they think well this fund isn’t any good or I’m going to lose all my money. This is a typical mistake and is very foolish.
All your savings programs should be automatic, DO NOT rely on your own discipline to write a check out to savings or manually move the money. Set up a automatic draft to the savings and mutual fund accounts so it happens without relying on your own discipline to do it every payday.
Continue saving this way until your savings in both accounts equal 6 months worth of expenses.
Step 3
Stop putting money in the savings account. You do not want too much money in an account making 2 or 3%. Put 5% towards your mutual fund put the other 5% in a retirement account. Use your companies 401k or 403b, if you get a match on 6% or some higher amount increase your savings to get this level. Your retirement account depending on your age should be more aggressive in its investment mixture. It should be diversified you will typically want to have money in 4 categories of mutual funds Bonds, Large Cap Stocks, Small Cap Stocks, International Stocks.
Example 30 year old person 15% Bonds Mutual Fund
40% Large Cap Stock Mutual Fund
25% International Stock Mutual Fund
20% Small Cap Stock Mutual Fund
These are in order of risk as you get older decrease the percentages in the aggressive funds and add to the conservative ie 25/40/20/15 (age 40) 30/40/15/15 (age 50), 40/35/15/10 (age 60)
The reason you should be more aggressive with your retirement account is that this money is very long term. It does not matter how your account performs in any one year it is about what it does over 30 years. So stop watching the financial channels and freaking out if the market is having a bad day or a bad year. Consistency and discipline is a far more profitable strategy.
Follow this basic stategy and increasing your savings as you can afford to, especially as your income increases and you will be well on your way to a sound saving and investing program.
