Saturday, October 28, 2017

How to increase your saving and investing rate


I first started working when I was around 16 years old.  My parents told me that if I wanted money, I would have to go work for it.  I’ve done many odd jobs and side hustles such as building computers, selling jewelry, product reselling, tutoring, being an information desk attendant, paid chauffer (before Uber!), and more.  What my parents never taught me was that I should try to save some of the money that I make.  I kept telling myself that I would start saving money “once I started my career.”  The thought of investing my money for greater returns never even crossed my mind.

From high school to college to graduate school and even after first starting my career – I was terrible with my finances.  Whatever money I made, I somehow ended up spending.  It didn’t matter whether I was making a little bit of money or a lot of money.  I never tracked my spending.  Sometimes I would even make purchases on my credit card, and then wait to get paid so that I could use my paycheck to pay off my credit card bill.  I was always one month behind – and it felt awful. 

While I was always good at making money, it took me decades to get good at saving money.  Once saving more became second nature, investing more was simply the next step.  It took a long time, but we have finally reached the point where we are comfortable with our finances.  Today I am going to talk about how you can start saving and investing more.    

Hide your money (from yourself)
Back when I had poor spending habits, whether I had a small paycheck or a large paycheck, I always ended up spending most of it.  I would always find myself just barely getting by.  My rent, bills, food, and entertainment expenses would all somehow get paid, but I was never thriving financially. 

Most of us will find a way to make our finances work and live on the amount of money that ends up in our checking account.  This is where hiding your money from yourself can work extremely well.  You are your own worst enemy when it comes to saving more.  If you hide money from yourself in your savings and investments accounts, you can spend everything in your checking account and still manage to hit your saving and investment goals.

There are several easy ways that you can hide extra money from yourself including: splitting paycheck direct deposits, increasing retirement contributions, and automatic investments.   

Split your direct deposit paycheck into separate accounts
Many companies that offer paycheck direct deposit can also split your paycheck into more than one bank account.  Instead of your entire paycheck going straight into your checking account, you can split your paycheck into one deposit into your checking account and another deposit into a savings account.  This is one of the easiest ways to effortlessly save more. 

To split your direct deposit paycheck, you can contact your HR department to have them set aside either a percentage of your total paycheck or a set amount into a separate bank account.  I recommend having your employer deposit enough money to cover your regular expenses into your main checking account, and then putting the rest into an online savings account.  Online savings accounts tend to have better interest rates.  I recommend and use CIT Bank, which offers 1.35% APY on balances up to $100K.  Since your money is held in an online bank, this provides a barrier to hopefully discourage you from raiding that account and spending down the funds.  

Just like with retirement contributions, if you automatically save a portion of your income in a separate savings account, you will be less likely to spend it.  Every time you get a raise or bonus, you can increase the amount that goes towards your separate savings account.  Even just increasing your savings rate by 1% each month can add up to a huge difference over time.  Since the amount of money that goes into your checking account will tend to be stable over time (while the amount of money that goes into your savings increases), you can easily avoid lifestyle inflation.  If you don’t see all this extra money in your bank account, you won’t be tempted to spend more over time. 

Splitting your paycheck allows you to save more without exerting any discipline.  

Increasing your retirement contributions
If you have access to them through your employer, 401K and 403B retirement accounts are the easiest way to automate your investments and accumulate wealth.  Retirement account contributions come directly out of your paycheck and are immediately invested pre-tax.  You simply select a percent of your gross income or a set dollar amount to contribute with each paycheck.  Investment contributions happen automatically so you don’t have to do anything when you receive your paycheck.  This allows you to put more money right away into your investments to let them compound and grow over time.  Retirement contributions decrease your gross income and may lower your tax liability.  Investing in your 401K is a win-win.      
Who wants to pay more taxes?!

Many companies offer an employer match up to a certain percentage of your contributions.  This is free money and you should never say no to the company match.  For example, if your company offers a 4% match on your contributions, you should be contributing at minimum 4% of your paycheck into your 401K.  Saying no to an employer match is like turning down a pay raise.  When starting off, I recommend slowly increasing your 401K contributions by 1% at a time.  If you increase your contributions by 1% every month, you will hardly notice the difference in your paycheck – and by the end of the year, you will now have a 12% contribution rate.  If you find yourself struggling to manage on that 1% increased paycheck deduction, then you can dial it back for your next paycheck.

Generally, 401Ks should not be accessed until you are 59.5 years old or you may be subject to a 10% withdrawal penalty as well as income taxes.  There are several ways to access the money sooner without penalty (and less taxes) such as through a Roth Conversion Ladder or with Substantially Equal Periodic Payments (SEPP).  See this Mad Fientist post for much more detail explaining how to access your retirement funds early.       

Automate your investment contributions
Vanguard makes it easy to set automatic contributions into your IRA, taxable or 529 accounts, with minimum purchase amounts as low as $50.  You can set your contribution rate to coincide with payday, that way a portion of your paycheck automatically gets invested.  You can also set your investment contributions to take place at the beginning of the month, every 2 weeks, or any other schedule that suits you.  This removes the discipline it takes to regularly invest in all market conditions. 

Why automatic investment contributions are so important
The market is volatile, and no one can consistently predict which direction the market will go on any given day.  If the market is going up, you may be tempted to avoid investing.  If the market is going down, you may be tempted to over invest.  Automatic investing simplifies your investing so you don’t over-think your investment timing.  Studies consistently find that those who dance in and out of the market end up performing far worse than those that just stay the course.  Fidelity investments did a study of the portfolios that performed the best from 2003 to 2013.  They found that the best performing accounts were from investors who were dead! 

Saving more doesn’t just mean spending less on something
When many people brag about saving, they like to say things like “I saved 20% off this new outfit,” or “I used this coupon to save $20 off this pair of headphones.”  Don’t forget that when you save money on purchases, it’s just spending less money and still decreasing your account balance.  If you spend all your time trying to chase the best deals out there, you will spend more time exposed to marketers trying to get you to buy more stuff.  Don’t let getting 50% off of something turn into paying 50% more for something you may not have needed.  Browsing deal sites regularly exposes you to so many other deals on things you didn’t even know you wanted.  Instead of trying to resist the pressure of advertisements and sales trying to get you to consume, avoid being exposed to marketing in the first place. 

Instead of thinking “how can I buy this item on sale?” consider “do I need this item at all?”  Buy what you need, when you need it and don’t obsess about the costs.  You’ll save much more this way in the long run.

Bottom line
The formula for financial success is an easy one: earn more, spend less, and invest the difference.  Hiding money from yourself can work wonders to increasing your saving and investing rate.  I track all of my spending with Mint and ClearCheckbook.  I track all of our investments with Personal Capital.  We are currently saving 50% of our income and investing much of that savings.  Our goal is to save 75% of our income.  Start now and work on slowly increasing the amount you save and invest.  Your future self will thank you. 

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