When we’re young, we tend to view life as an endless stretch of highway, with no end in sight. The problem is that for many young people, the concept of retirement is so far off they don’t bother thinking about it much. But the truth is, that endless highway has a destination point, and it’s not as far in the future as one may think.
Retirement planning is an easily defined concept, but often is brushed over as people in their 20s or 30s are focused on paying down debt, buying a home and starting a family. Many in this age group are parents of young children. They may be making ends meet, but life is crazy and expenses are high, so they are focused on the here and now. What they may not realize is the impact today’s spending and saving habits will have on their golden years. Said more bluntly, I don’t think they’re anticipating the financial stress of being 55 and realizing they will not be able to retire at 65, or the regret of having to live more frugally at age 70 than they did at age 25 because their poor financial decisions have finally caught up with them.
Yes, houses are expensive; it takes time to save enough money for a down payment. If your family is also dealing with paying off student loans at the same time, retirement planning is likely to go to the back burner. The problem is, long-term investing for retirement is far more effective when you start young than trying to play catch up the closer you are to retirement.
Extra Income? What Extra Income?
What I recommend my friends do is to prioritize their extra income. Don’t feel like you have any extra income? Ok, let’s start there. In financial planning coursework, I’ve been taught that if someone is not on track to reach their financial goals, their options are as follows: reduce spending now to save more for the goal; delay the goal; reconsider the goal. So, do you want to retire? And do you want to retire before your health is failing you and you’ve lost interest in travel? Then find some extra income in your budget today! This is the income on hand after the critical monthly expenses of food, shelter and transportation are taken care of. For example, first make the pre-tax contribution toward your 401(k) at work to get the employer match – if that option is available. This is a win, win, win situation. You’re reducing your taxable income today, you’re getting free money from your employer, and you’re getting started on your retirement savings.
Get Rid of PMI to Build Equity Faster
Second, if you’re looking to buy a house, consider contributing toward an account earmarked for your down payment. Saving enough to avoid paying the private mortgage insurance (PMI) will help your overall finances in the long run. If you already have a mortgage with PMI attached to it, review your options for paying down your mortgage ASAP to qualify to have that removed. We did have PMI with our first house, and it drove me nuts. I found prioritizing this goal to be an excellent use of every $20 we could spare until the goal was achieved.
Stay on Track by Preparing for the Unexpected
Third, I recommend everyone (especially single income households, families and homeowners) prioritize their extra income into developing an emergency fund that has at least 6 months of living expenses in it. If you’re a DINC (dual income no children) couple, you can probably make ends meet with slightly less than 6 months’ expenses if one of you loses a job or has a health issue. But those with larger fixed expenses or more family members relying on one solo income should really have this emergency fund in place for peace of mind. If you’ve used up your emergency savings for the home purchase (been there), be sure you backfill that savings account. As a homeowner, you have many more potential financial emergencies than renters do, so be sure you are prepared.
Keep the Momentum Going
Once you’ve addressed the critical emergency fund savings goal and reached other near-term financial priorities, consider reallocating any extra money into your retirement savings. What I suggest people do is start with the minimum contribution needed to meet the company match. Then on a yearly basis, increase your contribution by 1 percent. If you received a raise, there’s a good chance you won’t miss that 1 percent increase. Keep that small increase continuing on an annual basis until you’ve met the maximum contribution you can make. And if you’ve already maxed out what you can contribute toward your 401(k), work with your financial advisor to find another savings vehicle that will work best for your family, such as an IRA or a brokerage account.
Many people forget that their retirement accounts are quietly working for them, out of sight, out of mind. One of my favorite finance geek activities to do is to review my retirement accounts and compare the value of the money I contributed, the value of the free money my company contributed, and the value of what has been earned (without any effort on my part) through the compounding of investments over time. I’m so glad for every dollar that I put in five or 10 years ago. That money is working hard for me. That account is hitting milestones faster than I expected it to. Not every month is positive, but some months, the account balance grows more than twice what I’ve contributed for the month. Compounding is a beautiful thing, but it takes time to work. Start early.
You Can Both Win
One last thought is that when financial decisions are a family decision, sometimes it’s hard for both sides to agree on where to direct the funds. In situations where there’s disagreement, I recommend going 50/50. For example, if the wife wants to put $1,000 of additional income toward paying off student loans, and the husband wants to use it for 401(k) contributions, I suggest they do both. Put $500 toward the loans and $500 toward the 401(k). There’s no wrong answer, and marriage is all about compromise. Identify your list of financial goals together, prioritize them, and try to make slight progress on each one as early as possible. By doing the 50/50 approach, you’re hedging your bets on all of the “what if’s” and also reducing the risk of “I told you so” down the road.
If you want to retire someday, take the time when you’re young to redefine that scene of life as an endless highway stretching beyond the horizon. Instead, it’s a highway with a focused goal in sight - retirement.