There are four fundamental interconnected financial behaviors that can determine your ability to achieve your targeted retirement outcome: Earning, Spending, Investing and Insuring (ESII).TM As life events shift and alter your course, you must continually reprioritize and balance these behaviors while maintaining a focus on your retirement target. Use this framework to develop financial plans and course-correct as your life inevitably changes.
In this paper, 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 you manage your money, the basic premise to budgeting is the same: balance your monthly income and expenses. If expenses exceed your income, reducing your expenses or increasing your 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 7% rate of return and the amount becomes approximately $200,000.
* According to Oleg Urminsky, marketing professor at The University of Chicago Booth School of Business, Capital Ideas, “Your Coffee Habit Is Costing You” video, Oleg Urminsky, May 1, 2015.
The Three Methods that Can Help Individuals Keep Spending on Track
Develop Healthy Habits on Budgeting and Prioritization
Life entails many goals, from short- 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 to the right.
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
SSavvy 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 you 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 you buy the latest $1,200 gadget with a credit card, making $100 monthly payments, the total cost will become $1,440. However, if you buy the gadget with cash, the $240 in interest that would have gone to the credit card company could be invested. A hypothetical investment of that $240 earning a 7% annual return, could earn $970 over 20 years. Generally speaking, it is best to get bad debt under control before turning one’s attention toward investing because the cost of it typically is much greater than any returns you could earn through investing.
Spending Guidelines for Every Age
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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