How to give yourself a raise

Just glad he saved his money.

Workers can spend about $3,000 a year on coffee and lunch, according to a recent survey by Accounting Principals, an accounting and finance placement firm based in Jacksonville, Fla.

"Don't think of it as $3,000, but rather what $3,000 per year would be in 20 or 30 years if invested at even low interest rates," says Burton Malkiel, an emeritus economics professor at Princeton University in New Jersey.

By saving $3,000 every year—that's $250 a month—you'll have a nest egg of $90,000 in three decades.

And they probably don't charge for coffee at The Home. Even if they do, you won't remember to drink it.

The unpleasant reality of saving for retirement

The retirement savings plans that many baby boomers thought would see them through old age are falling short in many cases, The Wall Street Journal reports.

The median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement, according to data compiled by the Federal Reserve and analyzed by the Center for Retirement Research at Boston Collegel. Even counting Social Security and any pensions or other savings, most 401(k) participants appear to have insufficient savings.

Megan McArdle, the business and economics editor for The Atlantic, writes:

Most people  likely to be reading this blog should be targeting a savings rate in the range of 20-25% of income, more if they can manage it.  Since this is approximately five times what the average American household is saving, this notion is likely to be met with fierce resistance by readers who can name an endless list of claims on their income: mortgage, utilities, car, kids' activities, clothes, visits home to see the family . . . 

Say you're a 40 year old couple with 100,000 a year in after-tax income, and you save 5% of that, the way ordinary Americans do.  (Assume further that it all goes in retirement).  $5,000 a year at 5% until the age of 68 will leave you with $293,000 in retirement funds, which works out to about $1,000 a month in combined investment returns and withdrawals if you assume that you will live to 88.  On top of your Social Security benefits, your household will probably net about $4,000 to $6,000 a month.  But you're used to living on almost twice that.

This will mean rather dramatic changes in how we measure the good life.

Confounded compounded interest!

We know that the earlier in life you can start saving the better. It's the power of compound interest.

If you begin saving for retirement at 25, putting away $2,000 a year for just 40 years, you'll have around $560,000, assuming earnings grow at 8% annually. Now, let's say you wait until you're 35 to start saving. You put away the same $2,000 a year, but for three decades instead, and earnings grow at 8% a year. When you're 65 you'll wind up with around $245,000 -- less than half the money.

However. Tara Siegel Bernard, a personal finance writer at The New York Times, throws some cold water on this rosy scenario.

The problem is that even if you do everything right and save at a respectable rate, you’re still relying on the market to push you to the finish line in the last decade before retirement. Why? Reaching your goal is highly dependent on the power of compounding — or the snowball effect, where your pile of money grows at a faster clip as more interest (or investment growth) grows on top of more interest. In fact, you’re actually counting on your savings, in real dollars and cents, to double during that home stretch.

Now my skill with mathematics, and hence my skill with money, is laced with magic, delusion, error and confusion, but I think I understand what she's getting at: the compounding kicks in in a big way at the end.

“The way the math really works out is unbelievably dependent on the final few years,” says Michael Kitces, director of research at the Pinnacle Advisory Group in Columbia, Md. “I just don’t think we’ve really acknowledged just what a leap the very last part really is.” 

Kitces explains the chart on the right:

While it is true that the client has accumulated $1,000,000 by the end of the 40-year time horizon, it's notable that after 30 years, the client still has less than $450,000! And of course, at that point the impact of a marginal $300/month of savings is fairly negligible; the client will succeed because of the investment returns. With an assumption of "just" 8% in growth, the classic rule of 72 means the client will double her wealth in 9 years.

Accordingly, by this savings approach, the best way to have $1,000,000 in 40 years, is to have $500,000 in 31 years, and then quickly double your money in the last decade and retire!

Let's roll out another scenario.

Consider the numbers for a 26-year-old who earns $40,000 annually, with a long-term savings target of $1 million. To get there, she’s told to save 8 percent of her salary each year over her 40-year career. Yet after 31 years of diligent savings, her portfolio is worth just slightly more than $483,000. To clear the $1 million mark, her portfolio essentially must double in the nine years before she retires, and the market must cooperate.

In my math brain, the market always cooperates, but I think I've read somewhere that it actually doesn't. Duh.

The problem, of course, is that twenty-somethings don't have money to save. I'm not sure I have an answer for that, except a radical change in how we view consumption in those years. Or lucking into a period later in life when some fool is paying you a huge salary and you can hide more under your mattress.

God bless us all.

Cutting back: how one family did it

"A couple years ago, I decided I wanted to have a baby and quit my job," Jaime Tardy says. "But there was a problem. My husband and I were in debt, and I made two-thirds of our household income. So I couldn't just quit."

Here's what she and her husband did.

I started out by sitting down and adding up all our debt -- which ended up being around $70,000. The first thing I thought was, 'Wow, we really need to start getting rid of this. We should sell our car right away.'

After some prodding, my husband got on board too. We sold his car and were able to immediately get rid of $19,000 of our total debt. After that, we knew we were totally doing this.

Craigslist and eBay became our best friends, and we sold everything from a kayak to a weight bench and a computer monitor.

My husband did some website design jobs on the side to make some extra money, and we printed out a budget each month so we knew exactly how much we could spend and what we would be spending it on.

We saved on gas costs by limiting the amount of driving we did, and we put ourselves on a grocery budget of $300 a month. On top of that, we cut out cable, lowered our phone bill as much as humanly possible and switched our car insurance twice in one year to find lower rates.

By the time I quit my job for good -- which was less than two years after I started the budget -- we had paid off $70,000 in debt and put $23,000 in the bank as an emergency fund.

The importance of saving now

It's worth repeating: start saving now. Here's an illustration from LearnVest:

If you contributed to a Roth IRA every year starting at age 20, you could retire as a millionaire! Here’s why time is your biggest asset: 

Chelsea and Katie both put in $24,000 over the years, but Chelsea began putting in money ($50 per month) at age 25 while Katie began saving ($100 per month) at age 45. Even though they both put in the same total amount, by the time they reach age 65, you can see that Chelsea will have almost twice as much money to retire with as Katie. Thanks to compounding interest, Chelsea’s savings have earned more interest on interest over time than Katie’s.