Plan for the Future
Whether you are a recent graduate, new in your career, or looking to begin a family, you have a lifetime of experiences and adventures ahead of you. Now is the time to identify your goals and become financially independent. We’ve identified three steps to get you there: set a budget, determine your retirement savings and set your retirement income.
Set Your Budget
The budget can be scary and because of that, many people put off creating one. They don’t want to know how much they spend on certain items, because they may feel guilty or surprised by purchases they make. The goal is to embrace treating yourself to purchases like this, but keep them within the guidelines of a plan. You may like chocolate ice cream, but know you shouldn’t eat it at every meal.
To begin creating the budget, you first need to figure out how much money you bring home on a monthly basis. If you are paid on the 15th and the 30th, how much money lands in your bank account after taxes or other withholdings are taken out? Use this amount as your starting point.
Now, list all the items you spend money on every single month that are essential. These will include things like groceries, rent or mortgage, and utilities. Next, list all of your discretionary budget items. Examples of these items include gym memberships, coffee shop spending and dining out.
The final step is to take the money you bring home each month and subtract the essential list total and the discretionary list total. Did the number stay positive or are you spending more than you are bringing home? If you spend more than you bring home, we need to change some things. There are two ways to go about this. The quicker way is to remove some discretionary items from your monthly spending, such as the gym membership or the monthly video subscription. The more time consuming way is to get a bigger income shovel — meaning get a job that pays more than you are currently making or find a way to make more money outside of your current income. This could be picking up overtime at your current job or taking on a part time job.
If you take your income, subtract your expenses, and the number was still positive, that is great. Now we get to the fun stuff. Next, we need to budget for those items that may occur once or a few times a year, such as oil changes, season tickets to watch your favorite sports team, buying Christmas presents, or renewing your car’s license plates. We call these irregular budget items or irregulars. Many successful budgeters will account for the irregulars by adding up on the expenses on the list of irregulars and divide it by 12. This way, those items are incorporated into the monthly budget. To make sure those dollars stay segregated from your normal monthly expenses, you can set up a separate savings account. If your total for irregulars is $300 per month for example, then you need to set up a recurring automatic transfer of $300 between your checking account or wherever your paychecks get deposited, and this new savings account.
Determine Your Retirement Savings
It is often said that retirement is not an age, it is a financial number. That phrase means you don’t get to retire at some arbitrary number, because it sounds nice. You get to retire when you have saved enough to replace the income you need to live on. That is why we put creating the budget ahead of setting a goal for retirement.
Hopefully, after you created a budget, there is still some extra money left over between what you are taking home each month and what you are spending each month. The ultimate goal is to contribute 15% of your income going toward retirement. The 15% generally doesn’t include the work match. The main reason behind this is because your work match is not guaranteed to stay. During periods of financial hardship, like 2008 and 2020, one of the first things to get put on pause for employees was the work match. If you can set aside 15% of your income toward retirement, then the extra you get as a work match will either help you retire earlier than you planned or retire with more income to live on than you needed. We call this “the gravy effect.”
Don’t get into the minutia of determining if 15% of your income is going partially into a pre-tax 401k at work and partially into an after-tax Roth IRA, either inside your work 401k or in a Roth IRA set up outside of your work plan. Getting to 15% of your pre-tax income going toward retirement is the goal. The big question then becomes, “How do I fit this into my budget?” Here is an example.
"Always take advantage of your work match; we call this free money."
Let’s say your annual salary is $60,000. Disregard the idea of getting bonuses. If you get a bonus and have part of your paycheck going to retirement, then part of your bonus paycheck will go toward your retirement too and add to “the gravy effect.” 15% of $60,000 is $9,000. This means your goal is to contribute $9,000 into retirement accounts each year. We always want to take advantage of the work match, up to the maximum match, if there is one. We call this free money, or getting your employer to contribute money to the work 401k, just because you are. If your employer contributes 50% of your contribution up to a maximum of 6%, that means you need to contribute 6% to get a 3% match. Remember, we don’t count the 3% match into our 15% goal. You then contribute 6% to the work retirement plan or $3,600 of pre-tax income. You need to account for another 9% of the $60,000 salary or $5,400. This is where we look outside the work retirement plan and open a Roth IRA. If we need $5,400 to go into the Roth IRA for the year, then we need to contribute $450 each month to the Roth IRA.
Set Your Retirement Income
Now that we have our budget, we know how much we spend each month. And we have identified how much we should be saving. The next step is to determine if we have enough time to save, before we want to be done working or retire. Saving 15% for retirement is the ultimate goal, but someone starting that goal at age 35 will have a drastically different outcome than someone starting at age 55. Here is a link to a retirement planner calculator. This calculator will allow you to plug in different retirement ages, along with your income, and retirement savings, along with a few other things to determine if you have enough time to save for retirement. If the calculator shows your money will run out, you have a few choices. You can go back to the budget, trim some of the discretionary items, and save more for retirement. You can increase your current income by working a part-time job, overtime, or looking for another job that pays more to help get more money going into retirement. Or, you need to plan to retire at a later age or look to live off a smaller budget when you retire.
How a Financial Advisor Can Help You Reach Your Goals
It is sometimes said, “If you don’t have the time, the knowledge, or the energy to do something yourself, you should hire a professional.” For instance, if you need a filling in your tooth, you don’t do that yourself — you go to a dentist. That same concept applies to working with a financial advisor. A financial advisor can help set your budget, figure out how much savings should go toward retirement, what to invest those savings in, and plan for your retirement income.