Begin by making sure your income allows you to maintain your spending level. Start by listing your monthly after-tax income at the top of a sheet of paper. Then, list all the monthly expenses you incur, starting with those that you cannot avoid, such as car payments, rent or mortgage payments, utility bills, etc. Subtract your expenses from your income to see what you have available for savings.
The next most important step is to pay yourself first. Employee Benefit Research Institute’s annual Retirement Confidence Survey showed that only 57 percent of workers are saving for their retirement years. You might think your retirement is decades away, but the survey showed that less than 25 percent of those 55 and older have more than $250,000 saved for retirement — and 36 percent have saved less than $10,000! If you plan to spend $30,000 (in today’s dollars) in retirement after taxes, you will need to have saved approximately $580,200 by age 65 to carry you to age 90. Additionally, you’ll need at least a 10 percent return every year on your $580,200 for it to last through 25 years of retirement. While the long-term growth of the market is often 10 percent, achieving a 10 percent return every year is nearly impossible. If you haven’t started saving at age 55 do you want to find yourself having to trim expenses so that you can save more than $36,000 a year after taxes, and invest it aggressively enough to yield a 10 percent annual return to afford your retirement? If these numbers do not scare you, nothing will.
Needless to say, establishing savings habits should be top priority, regardless of age. How much you should save depends on your age, spending habits, how much you earn, your short-term and long-term goals, etc. The Charles Schwab Center for Financial Research suggests 10 to 15 percent of your pre-tax income during your 20s, adding 10 percent for every decade you delay. If you’re not currently saving, 1 percent is better than nothing, and 2 percent is better than 1 percent. By making the commitment to paying yourself first, you should be less likely to see “saving” as a budget item that can be skipped one month when money is tight.
As part of your savings, you should establish your emergency savings of three to six months of expenses. The actual amount, however, should be based on your particular circumstances and financial obligations. Without an emergency fund, a period of crisis, such as, unemployment, illness or disability, could be financially devastating, regardless of how well you have budgeted.
One final pre-budget step should be to define your short term and long term goals. Write down next summer’s vacation in Italy. List the anniversary dinner and theater tickets next month. Make note of the laptop your daughter wants for her birthday. Why go through the trouble if you don’t know what you are working for? Next week we’ll delve into accounting for your household costs and determining what is mandatory versus discretionary.
William G. Lako, Jr., CFP®, is an executive in residence at Kennesaw State University’s Coles College of Business and a principal at Henssler Financial. Mr. Lako is a CERTIFIED FINANCIAL PLANNER™ professional.