There are four fundamental interconnected financial behaviors that determine one’s ability to achieve their targeted retirement outcome: Earning, Spending, Investing and Insuring. As life events shift and alter our course, individuals must continually reprioritize and balance these behaviors while maintaining a focus on their retirement target. Use this framework to develop financial plans and course-correct as lives inevitably change.
Below we discuss the Spending behavior and how it has a critical impact on retirement success.
Well-disciplined spending continues to be an issue for many people. According to a 2015 Gallup report, American spending has stabilized over the last few years, but it is still higher than it was during the financial crisis. Thirty-nine percent of Americans polled said they are “spending less money,” which is similar to percentages in 2014, 2013 and 2012. However, that is down sharply from the 57% who said they were “spending less money” in 2010 when the country was emerging from the recession.
It is clear that many individuals still struggle with poor spending habits, and the best way to improve this is through a budget. While there are countless apps, programs and tools available to help people manage their money, the basic premise to budgeting is the same: balance monthly income and expenses. If the expenses exceed the income, reducing the expenses or increasing the income, or some of both, is necessary. It is crucial to stick to a budgeting formula to effectively pay down debt and create savings for retirement investment.
The Average American Spends $20 a Week on Coffee*
But if a 30-year-old puts that coffee money into savings, by the time that person retires, the amount deposited would be nearly $40,000; invest at a hypothetical 8% rate of return and the amount becomes more than $200,000.
* According to Oleg Urminsky, marketing professor at the University of Chicago Booth School of Business
The Three Methods that Can Help Individuals Keep Spending on Track
Develop Healthy Habits on Budgeting and Prioritization
Life entails many goals, from short-term to long-term. But they cannot all be achieved at once, nor would that be ideal. Nonetheless, it is important to prioritize them. Obviously food and shelter are fundamental needs and when lacking, become top priority. Wealth transfer is an end-of-life goal. To start, these goals can generally be organized within a hierarchy as illustrated in the pyramid below.
Once the goals are determined, develop a budget that balances earnings against spending and investment contributions.
Prioritizing Life's Expenses and Goals Over Time
For example only. Every individual will have his or her own set and ranking of priorities. Priorities will change over time.
Debt: The Good and the Bad
Savvy consumers understand there is good debt and bad debt. Good debt, also known as investment debt, helps build wealth in the long term. Bad debt simply makes one poorer.
Student loans are considered to be good debt because they can lead to greater future income. Home loans are also good debt because they provide housing for years to come, lock in the cost of housing at today’s cost of living, and allow most homebuyers to deduct mortgage interest, which effectively lowers the cost of payments.
Bad debt is incurred when a purchase is unaffordable today and doesn’t yield long-term benefits. For example, a typical credit card has interest rates around 21%. If an individual buys the latest $1,200 gadget with a credit card, making $100 monthly payments, the total cost will become $1,440. However, if that same person buys the gadget with cash, that $240 in interest that would have gone to the credit card company could be invested in an equity investment with a 7% return, yielding $970 over 20 years.
Generally speaking it is best to get bad debt under control before turning attention toward investing because the cost of bad debt typically is much greater than any returns one could earn through investing.
Spending Guidelines for Every Age
Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. Contact your financial advisor to obtain a prospectus, or a summary prospectus, if available, that contains this and other information about a fund, and read it carefully before investing.
This information is general in nature and not intended to constitute tax or estate planning advice. Please consult your tax or estate planning advisor for more detailed information on these issues and advice on your specific situation.
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