Americans are horrible at saving. We are the worst savers in the world or at least the industrialized world. On average, Americans save something like four percent of their income. Four percent. The Japanese save something like sixteen percent. As a rule Americans also buy more stuff on credit than people in other nations, mainly because we have no savings. So we don’t save and then we spend more money than we have on things we often don’t need. This is not a recipe for success in the 21st century.
As you know the democratization of finance has made you more responsible for your financial well being than the average person in the 20th century ever was. In the 20th century it was common for someone to have one job his or her entire life. One employer and one pension managed by that employer makes things pretty simple. But as you know, that probably won’t be the case for you. Now, if you are fortunate you may only have employers who allow you to move your retirement plan with you. That would be nice but it still won’t be enough. If you want to live well or decently in your twilight years you are going to have to start saving.
How much should you save? I have a simple rule for this that will make saving very easy. You should save as much as humanly possible. If you really want to gain wealth as you progress through life (and why wouldn’t you?), you need to pay off all your debt and save as much as possible. Remember in grade school when they went on about Benjamin Franklin and “a penny saved is a penny earned?” This adage by the roguish founding father has endured even globalization. Let me add to it though. It’s my node for immortality: a penny saved for retirement should be placed in a Roth IRA. What d’ya think?
Franklin: A penny saved is a penny earned.
Kohrs: A penny saved for retirement should be placed in a Roth IRA.
They both have a certain ring, don’t you think? But most of you are probably more familiar with a penny than an IRA. So, it’s explanation time again.
Individual Retirement Accounts. As part of the democratization of finance, in 1974 the United States Congress created the Individual Retirement Account (IRA) for the purpose of allowing persons without a pension plan at work to save up to $2,000 a year and get a tax deduction for doing so. IRAs are available to everyone now. All investment earnings go untaxed until withdrawn in retirement. The money in an IRA can collect simple interest or can be invested in stocks, bonds, mutual funds, etc., and the earnings grow tax-free until the account’s owner turns 591/2 years old. This means you can buy, sell and hold all sorts of investments in the account until you withdraw the funds.
Any money withdrawn before you are 59 1/2 will cost you a 10% penalty. Take out a dollar and it costs you a dime. You must begin to make withdrawals from the account no later than the April 1 following the year you turn 70 1/2. Any money you take out of your IRA at any time will be fully taxed.
The IRA was a pretty good deal but in the late 1990s an even better deal came along. In 1997 Congress passed the Taxpayer Relief Act and simultaneously created Roth IRA. It’s named after Senator William V. Roth by the way.
A Roth IRA allows investors to contribute a limited amount of money toward retirement annually. Unlike an IRA, the contributions you make to your Roth retirement account are not tax deductible. That’s kind of a drag but there are some big upsides. First, all your earnings are tax-free after five years, and your principal becomes tax-free at 591/2. Second, you can withdraw your initial investment at any time without penalty. Third, there is no set age when you have to begin withdrawing funds. However, the account must be liquidated on your death.
Another difference between the two is that Traditional IRAs require holders to withdraw money at 701/2 (but can begin taking money as early as 591/2). A Roth has no such mandatory withdrawal age, which is good because if our understanding of medicine keeps improving, and I think it will, you are going to live WAY past 70. So start saving.
Why you should start developing the saving habit now
I know some of you have enough trouble getting through school, and the thought of saving extra money is ridiculous. For some of you it’s not even an option. I accept this. I am not happy about it, but I know it to be true. Even so, I implore you to get in the habit of saving now. Habits take a while to get engrained in us, but once they are they operate almost remiss of conscious thought. This is as true of our bad habits as it is our good.
When I was in college I had this little game I played called “my thousands.” Whenever I had any left over money from the beginning of a semester I put it in the bank. To that I added what little I could when I could, $15 here, $25 there, and eventually it would get to over $600. When it did I got a little more focused on my saving. If I saw some clothes I wanted or thought about going out to eat, “just because,” I would take that money and place it towards my goal of $1,000.
Once I had met the goal, that thousand became untouchable except in case of a real emergency. You know how it is, once you break a big bill it’s just a matter of time before it is all gone. That same principle is true with $1,000. When I graduated college I had somewhere close to an extra $6,000 in the bank that I had saved over the years. Not bad for a kid who didn’t have a steady job.
The thousands was a game of my own invention. I am not even sure how I started playing it. I just did. You could play the game with whatever rules or title you want, the point is to get into the habit. Let me tell you a little story about a friend who didn’t.
My friend Stinky (not his real name) was making serious money during the dot com boom but, almost like clock work, Stinky would ask me for a loan, which, because I knew he was good for it, I would give him, occasionally with a little sigh or lecture about savings. “I’m just not good with money like you,” Stinky would say.
The difference between Stinky and me, who made less money, was that I lived beneath my means and Stinky lived above his. People do this all the time. So the time to get in the habit of saving money is before you have any. It’s just as easy to go through $10,000 dollars as it is $10. So learn now while you don’t have as much to risk.
One More Thing, Learn More about Investing
Did you notice when we were talking about IRAs that you could invest them in stocks, bonds and mutual funds? Any real idea what a stock, bond or mutual fund is? If you are like most people you don’t. There’s no shame in that. It’s not really taught, at least well, in most public high schools in America, and unless you seek this education out in college, you don’t get it there either.
Many of the people who were in my doctoral program had no idea what these things were. Statistically if you are a Ph.D., you are in the top 1% of educated people in the nation; the top 1% and not even a basic understanding of finance. Kind of sad, huh?
You are going to have to learn the basics about stocks, bonds and mutual funds, because you are probably going to own some. Maybe through an IRA, a 401K, or the retirement plan established by your employer, but you are going to own them. Consequently, you will be better off if you understand what it is you own and how it is best managed.
Two Classes Every College Student Should Take
The plugging and playing with finance and our free agent status means that we should all take two classes. These classes will not be in most of our degree plans, but here’s my logic.
Business. Whether your major is Fine Arts, Biology, or Religious Studies you are going to be involved in business. Many people have a disdain for business because it seems seedy to them. I know this was true for me when I was an undergrad. But to one degree or another we are going to be involved in business. By “one degree or another,” I mean we will own one or work for one or both. There aren’t a lot of other options.
So spend an elective credit and learn a little about business because you will be involved in it most of your life.
Personal Financial Planning. This is the class that will explain to you about stocks, bonds and mutual funds—plus a whole lot more. Just like you will be involved in business, you are going to be doing a lot of personal financial planning so if need be, spend another elective credit and take the class.
If you can’t take these classes become a regular reader of The Wall Street Journal. If your college doesn’t offer a class like Personal Financial Planning, read The Wall Street Journal. Someone once told me that if a person were to read the New York Times cover to cover every day for two years (that would be a feat in itself) that you would have the rough equivalent of a college education. I could never figure out where you get your math or foreign languages but I understand they meant the New York Times was a great source of education.
I am not suggesting that you read The Wall Street Journal cover to cover every day. I just suggest that you start reading it. Read the section that most interests you or is related to your major. The more you read it the more you will understand. The more you understand, the more the other sections will become interesting to you. If you got into the habit of reading The Wall Street Journal a little bit every week, by the time you graduated college, you would have a fairly sophisticated understanding of how business and finance work.
