These are some thoughts that I provided to a client couple struggling to live within their means, while also saving and investing for their future:
The most important long-term topic we discussed was how you as a couple can find a way to balance current consumption, which presently exceeds your dual incomes, against the need to save for the future. This will require a significant modification of behaviors and the development of some techniques for you both to reinforce each other’s intentions to save and invest for the future — perhaps in a similar, but opposite manner, to which you have said you tend to reinforce each other’s desires to splurge and to break into the weak locks on the “savings lock boxes” that you currently have.
We discussed the idea of you both having money taken out of your paychecks and invested into your 401k/403b plans, and then living on the net check without allowing yourself to use a credit card except in dire emergencies. We discussed the idea that those in their mid-40s need to save and invest at least 15% to 20% to prepare to maintain their lifestyles in retirement using their Social Security full retirement ages.
There are multiple ways to approach this, but fundamentally it means that, when making decisions about consuming now versus saving and investing for the future, you need to find ways to value your “future needs” above your “current wants that are not really needs.” There are a variety of techniques to do this, but among other things one needs to:
A) find mechanisms to automatically save and invest to remove the temptation to over consume (e.g. 401k, 403b, automatic deposits from paychecks into taxable accounts that you never touch, etc.)
B) understand the potential long-term value of investments (See my free book, “Lifetime and Retirement Financial Planning and Investing” which is available on this website. Focus on the investment chapters. There is a lot of material, but reading some should be helpful.)
C) find a means to identify with your future selves over a long lifetime
D) strive to increase income while holding consumption in check (for example, the idea of committing to invest 100% of a bonus or 75% of a raise rather than thinking about how to spend it)
E) find ways to systematically cut repetitive expenses and convert the expense reduction into savings and investments. (For example your residence refinance to reduce both costs and interest rate risk)
Just for your reference, we talked about the idea of the modest $40 dollar “upscale fast food” dinner” versus the $80 splurge dinner, which is eaten out on a regular and frequent basis — and the idea that the $40 saved could buy multiple future $40 dinners. While it is difficult for any human being to be entirely rational on almost anything, the rational mind needs to wrestle with current desires. The $80 dollar dinner will always win over the $40 dinner without some frame of reference about the $40 saved, if that $40 is truly saved for the long-term.
Here is an example of long-term investment appreciation. Long-term historical investment returns indicate that a 5% constant purchasing power, real dollar, annual compounded return is a reasonable middling expectation. So what happens with $1 saved over the decades with a 5% return? After 10 years, the dollar becomes $1.63. The math is just 1.05 multiplied by itself 10 times, but it implies that $40 saved today buys about 1 and 2/3 equivalent $40 dollar meals ten years from now or $40 saved now buys one $65 meal in 10 years. ($40 x 1.63 =$65.16)
The math of compounding accelerates with time, and since it is reasonably possible/probable for one partner of a middle-aged couple to live into their 90’s, it makes sense to look at the numbers up to 5 decades out. Here they are:
- 10 years is a factor of 1.63 (or that many $40 dinners or whatever is the equivalent dollar amount compared to the amount saved now)
- 20 years is a factor of 2.65 (your mid-60s – “decide when to retire” $40 becomes $106 — all those savings across the many times you chose investing over current consumption allow you to retire with confidence or let you retire comfortably, if your employer forces you into retirement??)
- 30 years is a factor of 4.32 (your mid-70s – “go – go retirement” $40 becomes $173 — spent on travel if you have accumulated enough otherwise??)
- 40 years is a factor of 7.04 (your mid-80s – “go – slow retirement” $40 becomes $282 — spent on medical because you have to??)
- 50 years is a factor of 11.97 (your mid-90s – “no – go retirement” $40 becomes $573 — help pay for your grandchildren in college because you want to??)
