by F. Thomas “Tom” Winters III
… or is there more month than money?
- F. Thomas Winters III
Effectively running out of money before running out of month is a common problem not restricted to working class people. Our national savings rate reveals that, on the whole, Americans are pretty dismal savers as well as retirement planners. Having a hefty income more often than not appears to mean hefty expenses as well.
For quite some time now, we as a nation have been spending as much or more than we earn, and consumer debt levels are at or near all-time highs, according to the US Department of Commerce. Our political leaders seem to want us to both spend more to stimulate the economy and save more to fund the deficit. A neat trick, if our incomes don’t go up and we’re already up to our necks in debt.
I, for one, am a strong advocate of increased savings. Our personal balance sheets need the strong dose of equity corporate America is currently giving itself. Since we as individuals cannot sell shares in ourselves, and Social Security is not a sufficiently sure thing, we all need to resolve to save more. Remember, the US Department of Commerce says that anyone who was born after 1965 has a work span of at least 30 years before they turn 65.
A Simple Plan
How can you help yourself to increase your rate of savings toward retirement? First, even though it might sound simple, establish a long-term goal. A well-established, written goal is the foundation of all financial/retirement planning. Increased savings may appear to some to come at the expense of your current lifestyle, so a goal that’s worth working for is essential if you want to have any hope of success.
The second key to successful saving and retirement planning is to follow the concept of paying yourself first. When you plan the payment of the monthly bills, you should write the first check in the form of an investment toward your long-term goal. Automatic debits to your checking account and/or payroll deductions put in a IRA or 401(k) plan are marvelous ways to begin.
Third, avoid overusing consumer debt, even if it means cutting up credit cards or putting them in a desk drawer. Go ahead, you’ll probably feel better, and your wallet will close easier. Almost anyone with a credit card can get a 6% to 20% guaranteed return on his or her investment just by paying off credit card debt. As a society, we need to learn that the offer of a preapproved credit card with a $5,000 limit does not translate into a $5,000 increase in lifestyle.
You’ll notice an absence of budgeting in the aforementioned suggestion. It’s not that budgeting is a bad idea-in fact, it’s a pretty good one for some people. However, most seem to lack the discipline it takes to really make a budget work. It’s far too easy to rationalize a budget-busting expenditure, as the politicians in Washington are constantly proving.
Most people spend to the level of their incomes. Their lifestyles automatically adjust upward with every increase in salary. If you pay yourself first and avoid credit temptation, your lifestyle will seem to miraculously adjust to your new level of income. After a few months, you won’t even miss the money you’ve begun to save.
Implement the Plan
Now, close your eyes and visualize your dream vacation or the shiny new car that you’ve always dreamed of having. Sure, looks great! Unfortunately, for many of us the planning stops right there.
Actually, most people put more planning into their vacations and car purchases than they do into their retirement programs. However, with a little discipline, the likelihood of achieving goals can be dramatically improved. Consider, after learning to pay yourself first, implementing one, if not all, of the strategies listed below to improve your financial picture.
- Remember to write down your financial goals and objectives, and include deadlines. This will help you stayed focused.
- Use credit cards as little as possible. Financing your lifestyle with credit cards is a trap. Reach for your checkbook instead.
- Pay off your credit cards each month.
- Spend a little, but save a little more. As your student loans and practice-establishment expenses are paid off, save the “extra” each month. Many people are tempted to overspend with the “extra.”
- Establish a savings balance of at least 6 months of expenses. This cushion can be used when emergencies do arise—instead of reaching for the credit cards.
- Map out a college saving plan, if applicable, and begin to fund it early.
- Manage taxes early in the year and look for deductions, credits, and deferral of income to reduce your tax bill. The savings on taxes can be used for other goals.
- Go for steady, consistent, long-term growth in your investments. By the time you read about a “hot tip,” it’s usually cold.
- Protect your valuables and income-earning potential with appropriate insurance policies, including mortgage, life, and disability.
- Create an estate plan. Many people think you must be superwealthy and old to do estate planning, which is not true. Avoiding probate and passing assets to heirs estate-tax-free are the main goals.
- Invest for retirement. At best, Social Security will cover only a fraction of the money you will need for retirement. Establish a tax-deferred IRA, Roth, 401(k), or similar program, and do it early—this is where paying yourself first should be focused.
Time Can Be on Your Side
Consider the saving habits of this 20-year-old couple. The wife starts putting $4,000 per year into a tax-deferred investment program when she is 20. After 10 years, she decides to stop investing and just let the money grow until she retires. The husband decides to start investing only after his wife stops. He invests $4,000 per year in a tax-deferred investment program from the time he is 30 until he retires at age 65 (that’s 30 years). If they both earn 8% per year on their investments programs, who will have more money at age 65?
Time and compound interest favor the wife. She will have $925,296 at age 65, while her husband will have only $744,408.
Use time to your advantage. The earlier you start the better.
Time Can Also Not Be on Your Side
Retirement statistics show that today’s Americans are enjoying longer lives. Based on information from the AMA, we have seen the average life expectancy grow in the United States from 48 years in 1900 to what is now projected to be approaching 85 years. The same studies cite inflation risk and longevity risk as retirees’ greatest economic worries. For that reason, a fixed monthly income stream may no longer be sufficient to fund a satisfactory lifestyle during your retirement years.
To protect against the increased retirement longevity period as well as inflation, the ability to grow assets and retain the purchasing power of money is essential. Based upon historical performance, that is where stocks may offer an advantage. By offering a combination of long-term capital growth and dividend income, stocks can potentially offset the eroding effect of inflation. However, past performance is no guarantee of future results.
Few investment vehicles are of a longer-term nature than an IRA, Roth, or 401(k) plan, and no other financial asset has historically offered a higher return over the long term than common stocks. Ibbotson Associated, an oft-cited research firm, reports that for the 10-year period from 1995 through 2005 (a period that included one of the market’s greatest corrections), stocks offered an annual total return of 9.1% as compared to 7.6% for long-term government bonds and 3.6% for Treasury bills.
If you reinvested dividends within your tax-deferred retirement plan, returns could have been considerably greater. Using Ibbotson’s figures, $1 invested in a broad index of US common stock on January 1, 1995, and left alone until December 31, 2005, with all dividends reinvested, would have grown to more than $3.59. Remember, dividends and capital gains accumulate in your plan on a tax-deferred basis. If you sell stock in your plan for a gain, no tax is due on that gain until you retire and begin distributions, provided the gain is reinvested back into your IRA, Roth, or 401(k) plan.
Diversification—widely accepted as the best way to minimize the risk of investing and achieving reasonable return—is easy with the vast array of stocks available among hundreds of industries. Moreover, stock can easily be liquidated to take profits or reduce losses, unlike many other investments that may lock investors in for a particular period of time.
A professionally managed, diversified, high-quality portfolio of stocks and mutual funds can offer the retirement plan investor both capital appreciation and dividend income. Of course, investment decisions should be made only upon full consideration of your particular financial situation. To help mitigate the “inflation and longevity risks,” investors need to understand the dynamics of such an undertaking and identify all of their future income sources.
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There is a multitude of projection platforms that illustrate retirement programs; however, a generally accepted, simplistic format uses an 8% annual growth factor, a 3% annual inflation factor, and a future annual withdrawal rate of 5%.
What does this all mean? Based upon the aforementioned format, a 40-year-old person who would like to retire at age 65 with a future current-dollar value of $120,000 per year would need to fund his retirement plan in the sum of approximately $4,000 per month, whereas the person who commences her program at age 45 would need to plan on a sum of approximately $6,100 per month to meet the same objective. Time can be you enemy or your friend.
While many offer the opinion that there is no “magic bullet” to the items that I have touched on, I believe that one does exist. It is called “realistic financial planning.” Remember, wishing is not enough.
F. Thomas “Tom” Winters III is vice president of the Dewane Winters Group and director of AAO Programs for Raymond James Financial Services Inc. Tom’s multidisciplinary background within the investment and asset-management sectors spans more than 30 years and assets exceeding $1 billion under management. He can be reached at