A Time to Save - Part 4
All debts are gone now. You’re living with your parents, contributing $200/mo, and keeping spending down to $100/mo. Emergency fund is full... Now what? Where should that $700 go? Is it party time?
Maybe a little bit. You’ve made a lot of thrifty choices, and the EF is there to help you navigate sudden change, so it wouldn’t be wrong to allow yourself another $50 to $100 a month for spending. Particularly if that spending helps you enjoy life more and achieve your personal goals.
Priority 5: Big Dreams and Entertainment
How this should breakdown depends on a lot of factors like your age, health, and life goals. Do you want your own house? Do you want to travel? Go back to school? Are you likely to retire at some point?
This priority divides into three main categories:
Long-term
Short-term
Entertainment
Long-Term savings is anything that will take more than 5 years or is over $1000. Short-Term savings is savings for anything that will take less than that. And Entertainment is what it sounds like. However, entertainment can be an enriching experience.
Let’s start with retirement, which for most of you should be a long-term goal. Having a well-funded retirement does not mean you have to stop working. For health reasons, I’d suggest at least keeping a part time job in your old age. But having a safety net for your later years is wise (particularly if you’re my age and social security is looking iffy).
Investing can get complex, and I recommend you read some books on the subject to arm yourselves. But let’s start with two common types of retirement accounts.
401Ks are retirement accounts established by your employer.
IRAs are Individual Retirement Accounts.
If your 401k offers matching, this means your employer will put in money based on what you put in up to a certain amount. This is an instant and guaranteed return on your investment, so definitely worth taking advantage of.
IRAs and 401Ks both come in pre-tax (traditional) or post-tax (Roth) varieties. Which is better is a bit of a guessing game as to whether you would pay more tax now or in the future. My current recommendation for minimum wage earners is to go with a Roth or post-tax option.
(A couple articles that go more in depth: Can You Have a 401(k) and an IRA? and 401(k) vs. IRA? Use both if you can )
Let’s say your employer offers 50% matching on up to 3% of your income. In our example, that’s $34.80 ($7.25x40x4x.03) from you and $17.40 ($34.80x.5) from your employer, which means $52.20 is going into your 401K each month if you invest 3%.
You could invest more in the 401K, but the downside of a 401K is you have less control over how the money is invested. So let’s put that in an IRA instead. Most retirement experts recommend 10-15% of your income towards retirement as a starting point, which would mean an additional $81.20 to $139.20 (116-34.80, 174-34.80). However, you can invest up to $458.33 per month ($5,500 annual) into an IRA.
If you don’t have any definite plans or need to urgently prepare to move out, I would recommend maxing out your IRA for the time being. Chances are you will eventually need to redirect your savings elsewhere and this will give you a good head start for those times when you can’t contribute as much.
That would still leave you $206.87 to play with ($700-34.80-458.33).
Urgency of retirement saving depends a lot on your age. If you are 18, it would be good to start, but education (college, trade school, night classes, etc.) might be a better place to put most of that income. However, if you’re 52, you might want to take advantage of catch-up contribution (https://www.tdameritrade.com/retirement-planning/ira-guide/ira-contribution-rules.page) limits to put as much as you can into retirement.
If you dial your retirement contributions down to 15% of your income (which is still responsible), then you will have $526 (700-174) to invest elsewhere.
There’s not a one-size fits all answer to where that money should go, but let’s say you don’t have a definite plan but you’re restless. While you’re figuring things out, you might split the $526 between a housing and transportation fund. To make your numbers round, you leave the $26/mo in your checking as padding/whatever money and put $250 into a transportation account and the other $250 into a housing fund.
Your Savings Plan would look like
Retirement: $174
$34.80 401K (with $17.40 matching)
$139.20 IRA
Transportation: $250
Housing: $250
After 1 year, you’d have $2298 [(34.80+17.50+139.20)x12] + interest in your retirement fund, $3000 in your transportation fund, and $3000 in your housing fund.
Stick it out for 5, and you’ll have $11,490 (plus interest) in your retirement account, $15,000 in your transportation and $15,000 in your housing fund.
While that might not be riches beyond your wildest dreams, it is a good nest egg.
Part 5