Most people realize that the more money they put away which in turn makes them money, the more money they’re going to have for retirement. Building wealth is REALLY a pretty simple thing when we get right down to it. It’s just…well…we don’t always ‘get right down to it’!
In fact, the Motley Fool back in 2017 using US Census data concluded that only 32% of Americans were participating in tax benefited retirement accounts. Ouch. Think about it. This even includes all the companies that provide a match for employees to save and people still aren’t taking advantage of getting that free money from their employers.
‘Later On’ is not a viable financial plan
Unfortunately, the reality of the situation is that the majority of individuals are of the mindset that there’ll be enough time to invest in their future ‘later on’. But that’s the disconnect.
‘Later on’ IS the future and when you’re not investing for it NOW, investing when you get there will be too late. In fact, you will be arriving in your future with nothing to show for it.
The other thing that people don’t take into consideration is that if they start too late the truth of the matter is that they’ll never make enough money later on so as to invest in order to ‘catch up’ to where they otherwise would have been if they started investing earlier on.
It’s quite simply just a mathematical truth. The less time you have, the more money you’d need to invest at a later date. The problem with this is the amount you’d otherwise need to invest then FAR exceeds the amount of money that you probably would have available.
Who retires with more money sooner, Sue or Bob?
You remember the old example, don’t you? If Sue invests just $200 a month starting when she’s 25 years old and she continues to invest this same amount every month for 10 years but then completely stops investing, she’ll have roughly $265,000 when she retires at 65 years old if her investment averages 7% annually for all 40 years. Now if Bob doesn’t start investing until he’s 55 and he wants to have $265,000 available when he retires in 10 years at 65 years old, at 7% annually he’ll need to invest $1,525 dollars a month.
You obviously see the problem with this mathematically. In order for Bob to catch up with Sue, Bob would need to invest over 7 and a half times more per month than Sue did in order to end up with the same amount as she has.
The only way that would even be possible is if Bob had the financial ability when he is 55 years old to invest this much money. The harsh reality is that Bob would need to be in a financial position that would allow him to invest $18,300 annually.
This is $18,300 directly out of his overall salary. As an example, if Bob had an annual household income of $75,000, $18,300 represents 24% of this amount on a gross basis.
Remember, gross is BEFORE everyone gets their hands on your money including dear Old Uncle Sam. (That’s why we need to Pay Ourselves First https://thefinancialstoic.com/?p=230
When you start later on you’ll need to invest more
The harsh reality is that Bob really doesn’t have $75,000 from which to choose where his money comes out of. It’s actually more like around $50,000 net when we subtract all of the tax adjustments and withholdings that are applied against Bob’s available income.
So now, what are we looking at? Based on Bob’s need to invest $18,300 a year to meet his goal, he’ll need to invest roughly 37% ($18.300/$50,000) of his salary (the good news is that if Bob invests inside his 401(k) he might get a company match and he’ll lower his overall taxable income but for purposes of simple math, let’s continue on the original approach we have taken).
Thirty seven percent is a pretty high percentage of someone’s annual income to save and invest. Wait, wait, wait!! Yes I know our FI (Financial Independence) readers will be jumping out of their seats because for them this might not be a high enough percentage. However, hear me out…this is 37% of someone’s annual income who clearly has never built up the saving and investment behavior and habit and would need to start at 37% cold turkey.
Starting late and having to invest a large part of our income is tough…REAL tough
Don’t get me wrong, there’s always an opportunity for an individual to do anything that they put their mind to it but I tend to more pragmatic when it comes to financial behavior.
The chances of someone who’s never saved and invested a penny to start cold turkey out of the blue and be committed to set aside 37% of their annual income for this purpose has a strikingly low probability of success. Sad but true.
What is interesting, however, is Sue’s situation. Remember, she was only saving and investing $200 a month to get to the goal. That only totals $2,400 annually. Let’s make an assumption that Sue doesn’t make much money annually, say $25,000 ‘net’.
Now here’s where this point gets made…Sue would only need to save and invest roughly 10% of her annual available income in order to hit the goal. Clearly having to change financial behavior and habits to get to 10% is a whole lot easier than a percentage more than 3 and a half times that amount!
The point being in this post is that it is much easier to save and invest when you have a longer time horizon to do it in and when you only have to invest a smaller percentage of your available income.
Conclusion
So ‘how’ do we make the changes that we would need to make so as to make this happen? The first thing, as in most of these types of activities, is that we have to take out the emotional aspect and the ability to change behavior suddenly. More specifically, we need to make the decision to save and invest ONCE and then put a system in place where that decision is consistently being made every time.
What might this look like? Well when it comes to saving and investing we need to make this automatic. As such, we would first want to work with our HR department if we work for someone else and see what mechanism, if any at all, they have in place for tax deferred investing.
The optimal situation would be that they have either a 401(k) or 403(b) program that they also provide a match to. If that is the case, all we’d need to do is enroll into the program and make our investment decisions that best suit our needs.
This would effectively look like us having to complete and sign a form that would then automatically take out a specified percentage of our income on a payroll basis and enter that amount into an investment or investments within the program that we identify. It TRULY is this simple!
Now, in the event that our employer doesn’t have a program established it is a bit more difficult but also very easy to create an automatic investment. This would entail us having to set up an automatic withdrawal on a monthly basis from our checking account with one of the investment companies such as Vanguard.
Once this is created, we would then have an automatic withdrawal made, similar to paying a bill automatically out of our account, and having those proceeds invested in whatever investment option we specified with out investment company. Simple.
In order to put this process into place as soon as possible, I would recommend it highly that you also put into place the No Budget Budget. This will ensure that you have identified and put to work the maximum amount of funds that you have available to start to build wealth automatically.
Automatic investing is like planting a tree. The best time to plant a tree was 20 years ago but if you didn’t plant one then, the next best time to plant one is today!
