Pay yourself first. What an interesting concept in a world where demands are constantly competing for your income! As you organize for the year ahead, try to reframe your thinking in order to set realistic goals for yourself. And above all, recognize that it is okay to put yourself first when it comes to your financial well-being.
‘Pay yourself first’ is a well-known personal finance term that means when budgeting, a higher priority is given to saving for your future, rather than only being considered if there is money left at the end of the month. In practice, a predetermined amount of your paycheck is automatically set aside at the beginning of each pay period before your paycheck hits your checking account (the idea of “out of sight, out of mind”). For some this translates to deferring a percentage of your income to a retirement plan at work (and that’s it). For others, this means deferring a set amount of your income to your retirement plan at work and saving an additional amount to a separate account (or accounts) each pay period. For many, questions still remain – am I saving enough? How do I stack up against my peers? What can I do to improve my financial future?
What you save while working will need to support you in retirement for 20-35 years. What once was known as the “three-legged stool,” where retirement was supported by a combination of employee-employer-and government, has started evolving into something completely different.Retirement is becoming a responsibility that falls squarely on the employee’s shoulders, where you can no longer rely on the government and your employer to fund your retirement. As the retirement picture changes, employees’ savings habits will be forced to follow suit.
In case you aren’t picking up my subtle hints here…
JUST SAVING TO YOUR 401K ≠ A SUCCESSFUL RETIREMENT.
So, how do you fix this problem?
Surround yourself with good council.
- Partner with a financial advisor early – find a competent financial professional you trust and who wants to educate you along the way. Making smart decisions from the beginning will ensure a more successful financial future for you and your family down the road.
- Fully read and understand your employee benefits. Know what retirement plans are available to you, and make sure you are taking advantage of your employer match. If you don’t, you could be walking away from “free money.”
- Think about the implication of where this money is living. You may be thinking, what does this mean? Certain account types act differently in regards to taxation. Money in a 401(k) plan is “tax-deferred,” meaning you do not pay tax today, but tax is paid in the future when money is withdrawn from the account. How and where you save money today will affect what your retirement looks like in the future. By only saving to a 401(k) plan, you run the risk of depleting your retirement portfolio faster as all of your retirement income will be subject to ordinary income tax in retirement. This risk can be reduced by being mindful of “asset location” – saving strategically to differently taxed “buckets.” If this concept is foreign to you, work with a credentialed financial professional.
- Save as much as possible by paying yourself first. As much as we don’t want to face reality – our cash flow drives our finances. If we don’t have a handle on what is coming in and what is going out, it is impossible to save successfully towards a healthy future. The earlier you can take control of your finances, the better your long term picture will be. The graph below illustrates the benefits of starting a savings habit early, due to compounding effects of investment returns over time.
The above example is for illustrative purposes only and not indicative of any investment. Account value in this example assumes a 7% annual return. Source: J.P. Morgan Asset Management
Is your New Year’s Resolution to take control of your finances? Studies show that only 8% of people who set New Year’s Resolutions actually stick to them for 6 months or more. This year, set yourself up for success by setting goals and forming new habits instead of making resolutions. You need to know where you want to be in the long term to determine what your actions should be today. Start taking control today by seeking good council, educating yourself and being proactive with your finances. The sooner you begin to plan for tomorrow, the higher the likelihood your goals will be achieved.