Last quarter we started a look at Jocelyn Black Hodes’s article, “10 Things Rich People Know That You Don’t.” This quarter, we will continue that discussion with a couple more topics from her list. Here’s another look at the full list:
- Start early
- Maximize contributions
- Never carry credit card balances
- Live like you’re poor
- Avoid temptation
- Be goal-oriented
- Get educated
- Diversify your portfolio
- Spend money to make money
Automate: Have you noticed that the balance of your savings account is not growing? Even if you have created a budget with enough surplus to allow you to grow your savings, for many of us, it is just too easy to find another use for that surplus. Hodes suggests that “rich people” automate their savings.
Other financial experts refer to this principle as “pay yourself first.” The concept is simple, have your paycheck direct deposit split into two accounts. Deposit your savings target amount directly into your savings account. The remaining amount is deposited into your checking account. What is in your checking account is the amount available for you to spend, and you should not feel guilty for spending it (because your savings is already done).
Another tip: Setup the savings account and checking account at different banks, or do not link the two accounts if they are at the same bank. This will require that there is a definitive step required (and generally a couple days’ time) before you dip into your savings.
Maximize Contributions: Obviously the fastest way to grow your retirement savings is to contribute as much as possible, that’s no secret. But few of us can start with a $17,500 annual contribution (the 2014 maximum contribution) to our 401(k). If a maximum contribution is out of reach for now, start with the full amount of any employer match. Then, use any bonuses and raises as an opportunity to increase your deferral percentage without feeling the impact on your budget.
Consider an employer match equal to 50% of the employee’s contribution, up to 3% of the employee’s salary. If the employee earns $40,000/year and contributes 3% of his salary, that’s $50 per paycheck based on semi-monthly pay periods (or just over $3/day). Every time the employee contributes that $50, the employer is also contributing $25. If the employee continues that deferral for 10 years and earns 7% average (linear) return, his $12,000 of total contributions are worth over $26,000. His employer contributed $6,000 and his investment return generated over $8,000.
This example does not take into account increases in salary or increases in deferral amounts, which would both have a considerable positive impact on the growth of the 401(k) account. If you have a good year at work, and earn a 5% raise, consider increasing your 401(k) deferral by 2.5% and allow yourself to enjoy the other 2.5% as an increase in your take-home pay. You will never miss the money, and your 401(k) will grow at a much faster rate.