Change the Way You Contribute

Step One: Open a retirement account to start your savings pilgrimage.

Step Two: Fund your retirement account systematically every month with an automatic contribution.

You’ve heard me say this over and over again, make contributions automatic every month. But why? Why is it so smart to contribute systematically? 

The long and short of it is Dollar Cost Averaging. I don’t want to scare any of you off with high finance lingo but trust me, dollar cost averaging is neither complicated nor high finance so bear with me.

Let’s say that your rich uncle died and gave you $100,000 - nice! The very next day you take the whole lump sum of money and dump it into the stock market and the day after that, the market falls 40%. Your $100k is now only worth $60k, so you freak out and pull all of your money out of the market because you don't want to suffer any more losses.

Then lets say, one week later the market is up 60% and you missed the up-swing because you were out of the game.

How would you feel? Horrible, You missed your chance!

Guys, this is exactly what could have happened to you last spring if you did not take advantage of dollar cost averaging with your contributions.

Here’s how it works: 

Let’s say you get the same $100,000 from your dead rich uncle. Only this time you divide it into 20 pieces of $5,000 each and invest each piece on the first Monday of the week for the next 20 weeks. If the stock market declines as soon as you invest the first $5k you can take comfort in the other $95k you still have in cash. When the market increases you will be poised to take advantage of the swing because you are systematically investing, no matter what the market is doing.

The other benefit to systematically contributing  to the market is lowering your average costs of shares purchased. For example, your first week you might buy shares of a specific investment at $5 per share, then next week you might buy at $4 per share and the week after you may buy at $4.50 per share. So the average cost of the shares is $4.50. Now you are really taking advantage of fluctuations in  market because you are buying at lower cost than you would have had you put all your money in on the first day.

Buy Low, Sell High

Everyone knows that the ultimate goal of investing is to buy low and sell high but because of emotion and human nature many people do just the opposite. Use dollar cost averaging to help you avoid falling into the trap. Make it automatic and you can create the discipline that you need.

Who would have guessed that after the miserable winter of 2008 to 2009 in the stock market, March was the month to have your money in! I certainly would not have made that prediction, but I took advantage of it because while the market was falling I was buying every month at lower and lower prices. It’s not rocket science but there is an element of discipline that is required. The good news is that you can create the discipline for yourself.

Your Children Want You to Save for Yourself

You want to give your children a hand up in life, absolutely. You want to provide them with all the opportunities and luxuries that you never had, sure. What if you do all these things but never save for your own retirement? Will that help your children in the long term? Probably not.

Sometimes parents get so caught up in “providing” for their children that they never take the time or resources to ensure that they are providing for themselves in the future. I want this article to ask the question: if you stretch yourself financially to give to your children without saving for your own future are you really helping them?

This is a difficult topic, no one wants to hear that they should hold back on college savings to contribute more for their own retirement. There is a basic human element that floods our emotions with a desire to provide for children. I am sure there are many underlying reasons why giving everything to your children is detrimental to their development of character and work ethic but I am not a psychologist, so let’s leave those arguments out of it.

Let’s just focus on the dollars and cents of it.

I have to argue that your kids have a longer time horizon to save and more opportunities for low cost student loan debt than you do. Saving for college in a 529 plan or through some other savings method is a great goal to have – but you have to remember when you start saving for a college goal you are embarking on a savings pilgrimage for someone else!

Why would you start a new pilgrimage if you have not yet made it even half way up the mountain of financial freedom? Let me put it to you this way, if you focus all your efforts on saving for your children’s future then your future will involve living with your children. Maybe your family culture is different than where I come from but when I close my eyes and dream about retirement it does not involve asking my kids for a few bucks to pay my greens fees for the day.

Friends, if you do not save for your retirement thinking that you are doing your kids a favor, your wrong. The only thing you are doing is ensuring that you will be a financial burden to them in the future.

Your kids will have the opportunity for scholarships, low cost student loans and part time jobs to get through college. And guess what, speaking from experience, they will value the education that they earned and paid for far more than if it were free. The other good news is that your children are quite a bit younger than you are. They have a good twenty years to create their own financial freedom.

If you can afford to put some money away for your children’s education it might be a good idea. I would strongly encourage you to talk with a professional to determine if you can truly afford it.

How about this idea, instead of giving your kids a free education and housemates in their 50’s. Why not give them the opportunity to earn their education and a big fat inheritance when you no longer need it.

Why Worry About Return?

Usually the answer I get when I ask the question above is, “so I can grow my retirement account”. Although this is a good answer, it’s not the real reason why it is so important is to make sure that you are achieving adequate return. The true answer is one word:

Inflation

There truly is no better time than now to talk about inflation and the impact it can have on your goals. With all the “stimulus” and government spending we can only assume that in the future our economy will experience significant inflation. 

So what is Inflation? Well the simple answer is this: The standard assumed average annual inflation rate is 3%, so if I were to go out and buy a box of pencils for $1.00 today, in one year that same box of pencils will cost $1.03. As you can see, the purchasing power of my dollar has been reduced! I can no longer go out and buy a box of pencils for just a buck.

Inflation is caused by many things but the looming cause for our future inflation is monetary policy. When the government passes out “stimulus” essentially they are adding additional dollars to the market which eventually dilutes the value of the dollars already out there.

Let’s use an example, say you are washing your white clothes at home. Every once in a while you will probably use bleach to help restore the whiteness to your clothes, but to keep from burning holes through the fabric you add water to the bleach to dilute it, the more water you add to the bleach the less potent the bleach is.

If bleach is like buying power then adding water is  like adding dollars to the market.

The more dollars you add the less buying power there is! Eventually retailers will have to raise their prices to compensate for the fact that each dollar is now worth less, or the bleach is not as strong as it use to be. And that my friends is inflation.

So why do you have to worry about return… because if you only generate a return that is equal to inflation, your money will only be able to buy you the same amount of stuff that it did last year! If you want to be successful on your savings pilgrimage you have to earn a return that beats inflation.

Let me insert a little disclaimer here, chasing return is a very dangerous thing. This topic is an entire blog post in of itself, but suffice to say that I am a proponent of buy and hold strategy unless you are a professional investor. I’ll write more on this topic at a later date.  As a savings pilgrim I want to always be conscious of the return I am earning on my path to financial freedom. I want to be sure that the investments I am using are falling in line with my risk tolerance and my mountain top goals. The only way to tell if the investments are working the way I want them to is through careful measurement and giving adequate time to let them work. Occasionally, I might have to adjust my path to success.

Inflation is a bear and no one knows when it will kick in from the great recession, but it will. Be aware and prepare yourself for the need to generate increased returns.

Two Things You Have To Do

Several months ago, back when the Dow Jones Industrial Average was at a decade low 6500, a friend of mine who is not a professional stock analyst or broker predicted the bottom of this recession in front of a group of 25 or so clients (bold move!). Turns out he might have been right, although I think it is still too soon to confirm or deny his prediction. But if you had dumped $10,000 into the Dow Jones Index that same day it would now be worth roughly $14250 or about a 42% increase in just 4 months. That’s something you can’t ignore.

Sure, I have been burned just as much as the rest of you in my retirement accounts over the last year and a half, so I understand the sick feeling that comes over you when you have to open your quarterly earnings/loss statement every 3 months.

I also completely understand bulking up the old emergency fund and paying down your unsecured debt – do it! But if you are young (younger than 45 or so) you have got to be taking advantage of the giant rebound in the market that we will inevitably experience over the next several months.  You cannot afford not to!

Friends, the current economic situation we are in is once in a lifetime.

Fortunes are made, missed and lost in environments just like this. If you are disciplined, use the right products and understand your personal risk tolerance, the choices and investments you make could be game changers for your financial future. Your savings pilgrimage will be a lot easier with the initial boost of a 50% return right out of the gate. Talk about a motivation energizer!

There are 2 things you must be doing no matter what your situation is.

First things first, if your company offers a 401(k) with any sort of match, you have to do whatever it takes to get the full match. Scrape every penny together and tighten your belt to take advantage of the guaranteed return. You will not find a guarantee like this anywhere in the market!

Second, the Roth IRA is the greatest gift the government has ever given to savers! There are some income limitations to take advantage of this program. A single individual with an adjusted gross income (AGI) of more than $95,000 is prohibited to contribute funds into a Roth IRA account. For a couple, the AGI is $150,000, and these limitations change on a annual basis.

If you qualify for a Roth IRA you have to have one! No Excuses!

When you reach retirement the distributions from a Roth IRA are tax free because you contribute with after tax dollars. I don’t know about you, but I am pretty sure than in 30 years taxes are going to be higher than they are today. If you do not understand why this is an amazing deal PLEASE CALL ME RIGHT NOW!

The reason I am so adamant and enthusiastic about these two things is because of this…

In a recent survey, 40%…. 40% of respondents said that their best chance to gain $500,000 in their lifetime is via a sweepstakes or lottery win.

WHAT!!

Apparently 40% of people have never heard the good news about the power of compound interest. I have got a lot of work to do.

Please do not be one of these people. $500,000 is easily attainable if you simply do two things, get the match in your 401(k) and contribute systematically to a Roth IRA.