Financial Briefs – Pay Yourself First.

Finance Briefs are a new section here at retirement is possible. They are short posts, generally only 500-600 words, covering a very specific topic. The idea is that you can quickly see a bit of news, find out how to solve a problem, or get a new insight. Let me know what you’d like to see in future Finance Brief posts. To see more Finance Brief posts check out the Finance Briefs Index.

 

The single biggest reason that people don’t save is that once they spend their money there is nothing left over to save. You get your paycheck. You pay rent. You pay the utilities. You buy your groceries. By the end of the month there is nothing left in your account to save or invest. This is a very common problem with a surprisingly simple yet sometimes scary solution. Pay yourself first.

 

This may sounds scary since you know that at the end of the month you are out of money. So in theory this sounds like an impossible task. But it’s not. Look at it this way. Before you even get your paycheck taxes are taken out. Social Security, income tax, yadda, yadda, yadda. They’re all taken out before you even see your money. That’s because the government and your employer learned long before you were born that if the money comes out of your paycheck before you get it then you won’t have much of a problem paying your taxes each year. That’s because we get used to living off of the money we receive. For the most part we figure it out.

 

This is also why you hear about people making millions of dollars then going broke. They got used to spending all of their money when they saw it so they didn’t have any left to pay taxes or loans. This concept works both ways. We as consumers figure out how to spend all the money we make, but we also figure out how to only spend the money we make. Assuming of course you don’t take out debt. If you’ve been reading this site for any length of time you know that I consider debt a bad thing for most people most of the time.

 

So what do we do? First, pay yourself first. When you get your paycheck put some of it into a savings account. Start off with just a little bit so that you can get used to having less to spend. You’ll notice that after a few months you don’t even really notice those few dollars missing. After you do that put a little more in savings. Keep raising the amount you put into savings each paycheck until you are saving enough to reach your goals.

 

Sometimes it’s tough to put the money into savings ourselves. Especially when you already have bills that need to be paid. In this case you can do one of two things. You can have your bank automatically pull money out to go to savings whenever you get your paycheck. Talk to your bank about setting up the automatic draft. The other option is to have your employer deposit a part of your paycheck into a separate savings account. Many companies can set this up for you. Just ask your HR department.

 

The point is that if you pay yourself first then you will be able to save money. You also will get used to living on slightly less money. Start off with a small amount at first. The first time I did this I only put 5 dollars away. That’s all I felt I could afford. But it was a starting point to saving even more.

 

What kinds of things do you do to help you save more or to make it easier to save?

Five Ways Retirement Accounts Fund Your Retirement, and How To Maximize Them.

There’s always this goal of having enough money to not have to work again. Some people call it retirement. Some call it financial independence. Some people just call it freedom. But how exactly does that saved up money actually fund your life?

 

The common misconception is that you have this pile of cash, and you just spend it as you go. Hopefully you won’t spend it all before you die. But that is a misconception. That would require a huge amount of cash sitting in a savings account to fund the rest of your life. Especially if you wanted to retire early, or if you wanted to leave some for your kids. That also means that it can’t last forever. True financial freedom should be able to last forever. Theoretically anyway.

 

So how does your retirement account actually fund your life style? And how can it last forever? Well, there are five basic ways that your retirement accounts fund your life.

 

Dividends and Income

What it is

Dividends and Income are my favorite way to fund retirement. This is when you own a business and you get paid a bit of the profits regularly as an owner. For example, some stocks will pay a regular dividend every quarter. Coca-Cola has been paying a regular dividend for over 50 years. If you own shares of Coca-Cola then every three months you’ll receive a check from them. If you own enough shares of Coca-Cola then you could live off of the dividend checks that you receive. You can also pass those shares on to your kids and so on.

How to maximize it

The most common way to maximize this is to buy stocks in solid companies that are paying a higher dividend. REITs tend to pay higher dividends and sometimes utility companies do as well. Don’t be too swayed by really high dividends though since they can indicate that the company may be having problems. Do your due diligence and investigate the company.

A less common, but potentially more profitable way to do this is to start your own company and hire others to run it for you. Or buy into an existing one. This can give you a share of the profits without having to do the work. This can require a larger initial investment in money or time, but it can pay off well.

 

Interest

What it is

Most people, even without investment accounts, make a little money this way. This is the money you get from having a savings account or a CD. This usually isn’t a lot of money, but with a savings account the principal is safe. You can also make interest money by making loans with companies like Lending Club, carrying mortgage notes, or holding tax liens.

How to maximize it

For retirement account purposes it is usually good to hold some money in a safe place for those years when the market goes down. A savings account or CDs are safe even though they don’t provide a lot of return. You can increase the return by using online savings accounts and watching for special deals. If you’re willing to take on a little more risk you can lend money using peer to peer lending, lend money independently, or buy notes issued by companies. These have the potential to make more money, but your principal money isn’t guaranteed.

 

Capital Appreciation

What it is

This is when stock that you buy goes up in value and you use the extra money to pay your bills. For example, you buy $5000 in stock, it goes up to $6000, and you sell $1000 worth to pay for living expenses. This same concept can work for real estate, stocks, and many other investments. It works best though for investments that you can sell any part of, like mutual funds. When it comes to things like real estate and stocks you generally can sell only whole parts at a time instead of just the appreciated value.

How to maximize it

To maximize this you need to maximize your capital appreciation. That means investments that are going up faster. This can be small, new companies, hot companies at the time, or starting something from scratch. Do balance this with risk though. The more potential to go up usually means the riskier it is. That’s why mutual funds can be a great way to grow and fund your retirement. It provides protection because your money is spread out between a lot of companies. You can also sell parts instead of individual shares of stock so it is easier to continue to grow. You won’t have to worry about selling your last share as much.

 

Annuity/Pension

What it is

Annuities are where you pay an insurance company a large block of money and then they pay you a set amount for the rest of your life. A pension is similar except that it is usually funded by an employer over the course of your employment. A pension used to be an important way that people funded a retirement after working for 40 years. Ideally you’d work at a company for your career and then you’d get a pension from the company when you retired. Today there are very few companies that still pay a guaranteed pension. The federal government still does. As do several local governments. Only a handful of large companies still have the option for new employees. Most have transitioned to 401k type investments.

Social Security falls into this category as well. You pay into it over the course of your working life. When you reach retirement age the government pays you for the rest of your life. In this case it is based on how long you worked, the age you retire and the amount you put in.

How to maximize it

If your employer doesn’t have a pension option then your options are to either switch to an employer that does, make more money so that you pay more in Social Security taxes, or save money to buy an annuity. Your best options to maximize it though are to double dip. By that I mean pay into Social Security and get an employer that pays a pension. That way you can collect both. You can also save money to buy an annuity as well. Just make sure the employer is large enough that they will be around when you retire. If you buy an annuity make sure that you buy with a company that will likely be around for a long time.

There isn’t much protection for either of these if the supporting organization goes out of business. Annuities typically pay in the 2% range so you may be better off with dividends or other investments.

 

Principal

What it is

This is the money I talked about at first. This is the actual money that you put into your retirement account. I don’t recommend using this if possible. This is usually the money that is working to make you more money. However, this is your money. And you won’t have any use for it when you die.

How to maximize it

Since this is the money that you put into your savings and retirement accounts you can maximize this by saving more. To do that you may need to make more. You can check out my post Way Too Many Ways to Make More Money for ideas.

 

These are the key ways that retirement accounts fund your life. Dividends and interest are usually the ones that can make you more money in the long run and help you create a legacy for your descendants. An annuity or a pension can provide you with lifetime income, however you are dependent on the company that controls them staying in business and well-funded. They can also be less stressful during market down turns.

 

How do you plan to use your retirement accounts to fund your retirement? Do you plan to use your money other ways?