Set it and forget it.– Ron Popeil
Who knew one of the greatest wealth-building terms would be coined by a rotisserie chicken infomercial guy. Ronco pitchman, Ron Popeil, was famous for his late-night infomercials selling rotisserie appliances with the promise that all you had to do was set it up and walk away.
Before we get too far into it, we must first address the financial professionals that take offense to this statement. Yes, setting up long-term savings and investing plans while ignoring them for decades is not the optimal approach. We use this term as a segue into the idea of automating your actions, not ignoring your investments.
Psychology of (Not) Saving
Humans are awful at saving money for long-term goals like retirement.
To understand why, we need to take a brief look at our distant past and the psychological conditions our evolution created, while comparing that to the society we live in today.
Wired for Consumption
Evolution is a slow process, and for almost 300,000 years most of human existence was fairly similar. Resources were scarce, and survival was not guaranteed. There was very little incentive for humans to think long-term (past winter). If a berry bush with edible fruit was found, it was better to consume it now and capture the calories.
Fast forward to today and most of the world looks completely different. Unfortunately, evolution has not had a chance to catch up to the rapid change we see in modern societies. We still operate with similar impulses our ancestors shared, so we are wired to consume now and not think too much about our future needs.
Mad Men to Facebook
If human evolution put us near the consumption cliff, advertising companies walked us to the edge while technology companies shoved us off.
We like to think we are unique individuals that make our own decisions. The truth is our actions and decisions are highly predictable, and there is a lot of money to be made by manipulating them. Advertisers learned early on that humans could be persuaded to take certain actions based on the messaging they received. Decades of research and the introduction of modern technology has turned it into a science.
So what does that mean for you and your budget? It means you are swimming against a current that is designed solely to separate you from your money. It’s estimated that Americans see on average between 6,000 and 10,000 ads each day. That is a lot of “No’s” you need to say in order to stay the course.
Remove the Decision
The single best way to combat the hurdles above comes from our friend, Ron, “Set it and forget it.”
One of the key tenets of wealth-building is saving on a consistent basis. For most of us, that means monthly. A 25 year old has 480 months until they are 65. What are the chances they are able to manually save a predetermined amount of their income 480 times? Every month this person will be faced with wants, needs, desires and emergencies that will go head-to-head with their retirement savings goals. It’s fair to assume the chances are slim that they maintain their streak.
This is where automation comes to the rescue. By taking advantage of an employer 401K plan or setting up an automated transfer to an IRA, you can remove yourself from the decision making. It happens automatically.
The same can hold true for other savings goals. If you want to ensure you have $1,800 for Christmas spending each year, automatically transferring $150 to a separate account each month will ensure the money is there when you need it.
Now that we’ve set the table, let’s dig into the meat and potatoes.
A few generations back, financial experts referred to retirement funding as a “Three-Legged Stool.” Each leg was represented by the following:
- Social Security
The idea was that their retirement years were funded by a combination of tax dollars, their personal savings (investments) and the company (or companies) they worked for. This “three-leg” approach served many retirees well, and diversified their income a bit.
Today the pension is all-but-dead outside many government jobs. In addition, people are living longer and wanting to spend more years in the retirement phase. This shift puts much more pressure on each individual to take control of their own retirement planning and savings.
How Much to Save
There are two ingredients necessary to grow a sizeable retirement nest egg that will provide for your life after work:
If you have a lot of time, you don’t need to add as much money. If your time frame is shorter, you need to save more.
A good rule of thumb for retirement savings is to use a percentage of your income depending on your age. As mentioned above, the younger you are when you start, the less you need to contribute.
20’s – 15%
Getting started earlier is the surefire way to get to your financial goals in retirement. Investing 15% of your salary each year should get you there.
30’s – 20%
Many people don’t find their financial footing until their 30’s, so you’re not alone. Getting serious about retirement savings and investing 20% of your income until retirement will likely get you across the finish line.
40+ – 25+%
If you are in your 40’s and haven’t started saving for retirement, this needs to become one of your top financial priorities right now. You are entering the danger zone. You should be reviewing your budget and finding ways to contribute as much as possible.
It’s no secret that the cost of a college education has soared in the last few decades. Looking just at tuition from 2002 through 2022, the cost has basically tripled. Unlike generations past, it’s practically impossible for most attendees to cover the cost by working their way through a degree. That leaves parents and loans to make up the difference.
There is no wonder why so much of the financial burden has fallen on parents. No one wants to see their freshly-minted graduate start their working career with a debt load that rivals mortgages from a few decades ago. If you plan on helping fund your child’s ongoing education, the time to start saving is right now. As mentioned above, the sooner you start the less you ultimately need to save.
College Savings Vehicles
While a deep dive into the pro’s and con’s of variable college savings vehicles is outside the scope of this guide, here is a list of the primary tools you can use:
- 529 Plan
- Roth IRA
- Taxable Brokerage Account
- CDs and Savings Accounts
- Coverdell Education Savings Accounts
College savings is important for many families, but make sure to keep it in perspective of your overall financial plan. Putting you and your family on the edge of destitution in order to max out college savings probably isn’t the best strategy.
While debt can be a burden, students and parents can usually borrow the extra funds they need for school. You can’t borrow for your retirement. Do not put your long-term well being at risk in order to speed up college savings.
You won’t miss what you never see.
Many Americans struggle to save for long-term goals because they tend to spend what they have available to them. The main constraint on their lifestyle expansion is their income. When their income goes up, their spending usually follows.
While there is nothing wrong with expanding your lifestyle as you move up the income ladder, these increases in creature comforts should be balanced with increases in savings. The single best way to accomplish that is to automate your savings first before inflating your lifestyle.
60% of the working population have access to a 401k through their employer. Work-based 401k plans are so effective because the money comes out of your paycheck before you ever see it. This makes the automation process as easy as possible and prevents you from spending your retirement money before having a chance to set it aside.
Unfortunately, only about half of those eligible are actually contributing.
IRAs and Taxable Accounts
If you do not have access to a 401k plan at work, you can build your own automated retirement savings using scheduled bank transfers. The 2022 maximum contribution for an IRA is $6,000 ($7,000 if you’re over 50). There is no limit to what you can invest in a taxable account.
Let’s say you are paid twice a month (24 pay periods annually) and want to max out your IRA for this year. Here is how you do it:
- Calculate transfer amount ($6,000 divided by 24 pay periods is $250).
- Set an automatic transfer from checking to IRA that lags a few days behind your paycheck deposits.
That’s it! You have just created a roll-your-own automatic retirement savings plan.
Here are a few tips:
- If you are paid once a month or every two weeks, adjust your amount accordingly.
- If married, you can both have your own IRAs.
- If your income allows you to save more than your 401k or IRA limits allow, use the same strategy to automate transfers into a taxable brokerage account.
- Check with your employer and see if you can split your paycheck deposits into multiple accounts. You may be able to have them automatically transfer your retirement allotment directly into your IRA.
While they do exist, most people do not have access to college savings plans that automatically deduct from their paychecks like a 401k. If that is the case, you can use the same strategy mentioned above for IRAs and taxable accounts.
Other Savings Goals
These processes can be used for any savings goals you may have, long or short-term. If you are saving for a downpayment or a wedding, for example, make a separate online savings account and set up automatic transfers to it.
Pay Yourself First
We frequently express the importance of having a sound budget to serve as the foundation of any long-term financial plan. Since the budget serves as the roadmap for where your money travels, it only makes sense that your savings goals should be front and center.
Most personal finance experts recommend saving first and living off what is left, often referred to as Pay Yourself First. It’s a simple concept, but when implemented correctly it can have powerful results.
John is a 28 year old single father that makes $5,000 a month. His daughter, Lilly, is 3 years old and he wants to save for both his retirement and her college expenses. He determines he wants to save 15% of his income for retirement, and 5% for her college. In order to hit his savings goals, he needs to set aside the following each month:
- $750 – Retirement
- $250 – College Savings
Rather than having to constantly think about saving a few dollars here and there to hit his savings goals, John goes back to his budget and puts retirement and college at the top of the list. He then rebuilds his budget categories using the $4,000 remaining from his income.
This simple example shows the basics of Paying Yourself First. Businesses everywhere are trying to take a cut of your resources. Make sure to take your cut first before handing out the rest.
If you have followed all the steps this far, you should:
- Know your income and living costs.
- Have a budget and tracking expenses.
- Have consolidated your high-interest debt into lower-cost loans.
- Have a $5,000 emergency fund.
- Be automatically setting aside money for retirement and other savings goals.
In the final step, you are going to bulk up your emergency fund and kiss your consumer debt goodbye.