You’re Handling Retirement Savings All Wrong!

Saving money for retirement is something that is very near and dear to me. I work 80 hour weeks at my day job, which is probably why you don’t see the proper attention being given to this blog. Then I come home and spend nights and weekends working on my “blogging business”, if you will. I try and make sure to leave enough time open for both my wife and our puppy 🙂 The fact that we are trying to have children makes me think that I’m going to have to invent the 28 hour day if I hope to spend time with him or her as well. Thinking about how fleeting our time is, especially the time we spend on this planet, I’m very driven towards saving for retirement. I watch my parents who worked hard their entire lives and provided well for me, but they didn’t really save much for retirement. They were part of that generation that were promised social security but are now finding it may not always be there for them. They were part of that generation that promised lifetime pensions and benefits, but are now finding that being cut and stripped away, and even taxed at higher rates. Such is life for many of the boomer generation. The post-boomer generation has fewer excuses, however, as we already know that there is no such thing as a guaranteed pension nor will there be any social security funds left over for us in 30 or 40 years. While many people think that puts them at a detriment to earlier generations I tend to disagree. Allow me to explain.

It because we have the knowledge of all the shortcomings of our financial future that we are able to prepare for retirement in a way that generations before us were unable to. Just think about how our parents would have saved differently had they known that their pensions would have been taken away, or their social security checks would one day cease to exist. Or even that their investment accounts would be subjected to such violent swings that it would feel like you literally got punched in the gut every time the DOW dropped a 100+ points. This are tough times we live in, but they are also very self-aware times. We may not like it, but we know what to expect, and the requirements to prepare for our futures.

How much are you saving for retirement right now? I’m not going to give you the same tired speech of how important it is to invest at the same percentage of your company 401k match…just make sure you do it. I will tell you that your investment savings should go above and beyond that amount. This isn’t the advice of a privileged one-percenter’ telling you how to live your life, this is simply the words coming from someone who has learned financial security the hard way. Despite my financial misgivings, I was relatively wise out of college and took advantage of my company sponsored 401k shortly after I started working there. What I didn’t do was max out the savings threshold, which is currently $17,500. I do that now though! I’m not saying that everyone can max out their 401k savings, I’m only saying that should always strive to get as close as possible though. The 401k account is today’s equivalent of your social security + lifetime pension, this is one of the single most important tools you have to create that security blanket for yourself. The financial guru’s often tout the benefit of compounding interest, and for very good reason. What they often don’t explain is that amazing tax benefit you get by deferring your income into these accounts. First, you get used to living on less money, which means spending less money…that is sort of a forced lifestyle change, and usually for the better. Second, you pay less in taxes every year! All of those tax deferred income earns interest, and improves your bottom line each year. I play the tax game every year, and actually find it to be quite fun. For instance, a single person making $75,000 a year is in the 25% income tax bracket. However, that person should never be paying 25% of their income to the government, they should be paying a MUCH lower “effective tax rate”. Effective means this is the actual percentage of your income you pay in taxes. My effective tax rate usually hovers right around 10%. I will explain how as you read on.

I’ve explained the virtues of the 401k account, but these accounts should not be the end all be all of retirement savings. In case you missed my earlier points above, you aren’t going to have a pension or social security available, and you are most likely going to live longer than our parents and grandparents, so you need to save money in as many tax-deferred accounts as possible.  Notice I said tax-deferred??? I always try and provide real life examples whenever I am able to. As I’ve mentioned before I run a blogging business of sorts, meaning I sell ad space on some of my sites. By no means am I retiring and living off this income, but it is additional income none the less. Because the additional income is always taxed at the highest % rate according to my appropriate tax bracket it behooves me to defer as much of the income as possible. This is precisely why I invest in a SEP IRA. This is a special IRA for small business owners, and one that even individuals with a company sponsored 401k account can take advantage of. I am able to defer 25% of my net earnings each year into this account up to a maximum of about $50,000. I come no where near that amount, but obviously you can see the benefits of this account right away. Even if don’t run your own business you most likely have the option of opening a Roth or Traditional IRA. Either or works for me. One account allows you to defer income tax and the other allows you to withdraw tax-free earnings after 59 1/2. Both have their positives. The point is that you need to take advantage of one, or both if possible!

Ok Ok, so let’s say you are already doing all of the above to the best of your ability, what’s next? Plenty! The two most common mistakes I see my friends, family, and random people doing is failing to diversify. The average person simply does not know enough about investing to diversify their own retirement accounts adequately. Nor do they have the expertise on how to make the appropriate changes as they age. Target date funds take away all the guess and wonderment of investing. Fidelity is one such company that offers retirement funds that target your age of retirement. If I think I’m going to retire in 2040 then I pick the 2040 target date fund and the investment allocations change as the years roll on. They employ all the logic and advice that you hear about when it comes to diversification and the best part is that you don’t need to buy, sell, and trade shares every year. The only thing you really need to focus on is the fee’s associated with the account. These tend to be low fee accounts, but with the number of target funds increasing each year it’s best to make sure you are in a low-cost one at any given time. One of the hidden benefits of these accounts is that they prevent over-trading! That’s term I coined myself, and one that I see a couple of my friends doing all too often. They consider themselves investment guru’s and think they can beat the market when it comes to their 401k accounts. While they may have occasional luck, it is just that, luck. They trade themselves into a bunch of transaction fees and buy high sell low moments than they otherwise would if they simply used a target date fund. I also love to be frugal by finding coupons, I like got one for Astro Gaming.

Last, but certainly not least, don’t forget the importance of plain ole brokerage account! Savings accounts are useful for short term emergencies, but they should not be used to save for retirement. Inflation eats away at them, and despite seeing a growing bank balance you are actually losing money in your account. Brokerage accounts allow you to save after-tax money as well as benefit from years of compound interest, much like a 401k. The reason I tout these accounts so much is because I want to retire before 60 years old…it’s a dream of mine! Well, you can’t touch most tax-deferred retirement vehicles until 60 unless you want to pay taxes and penalties. This is precisely why I need enough money to bridge the gap between my retirement age and 60 years old…which I’m hoping is AT LEAST 5 years, if not more. So I have an online brokerage account that costs me $6 a trade and no annual or statement fees. Please stay away from the brick and mortar brokerage houses like Edward Jones. They charge excess fees for something that you can easily do yourself at a much lower cost. Same thing apply to 23andme too. There are times that you can pay a $50 trade fee depending on the fund you are investing in, much more than $6 I pay now

Regardless of your savings methods, make sure you save…that is really the most important part! However, doing it wisely and methodically doesn’t hurt either.