Monday, April 14, 2014

Stealth Savings

I've found, over the years, that the best way to save and invest is to a) automate it, and b) save before you have a chance to spend it. I like to call this "stealth savings".

If you're fresh out of school, and just starting your career, you may think that you'll always have time to save later on..."someday". Unfortunately, "someday" seldom just leaps up and whacks you on the head with a two by four and gets your attention, so it's best to make "someday" today. This is actually the best possible time to start the saving and investing habit, and the best shot you've got at using the effect of compounding over time to grow your net worth.

You see, when you first start that new job as a new graduate (or for those of you starting career #3 later on), you have the chance to set up automatic payroll deductions before you even receive that first paycheck. The human tendency to rapidly grow accustomed to spending whatever amount of money you have in your checking account works in your favor, if you make sure that a certain percentage of your income is sent away before you ever see it, to go to work growing and compounding for you.

The first thing to fund at your new employer is your 401K plan. This subject has been thoroughly explored by personal finance bloggers for ages, but I'm just going to tell you what I told both of my children when they headed out on their own after college. At a bare minimum, contribute enough to your employer's 401K plan to take advantage of every bit of the match that they offer. I've seen a 50% match up to the first 6% contribution from a number of employers so often it's probably the "standard" that 401K custodians offer. Rule #1 - get every penny of matching funds that you can. It is FREE money, TAX FREE! Well, actually tax-deferred, but that's another day's topic.

There is absolutely no better way to get a guaranteed return on your investment. I can think of no other investment out there that will get you a 50% immediate return, before any compounding. Even if the matching percentage is lower, as long as it's better than the average returns of the equities market (historically between 8% and 12% long term), take the free money!

Now, I actually recommend allocating no less than 10% to your retirement - and some financial planners will recommend 15 - but you can spread that out between 401Ks, IRAs and Roth IRAs, if you have them set up. However, as a newly minted baccalaureate, you probably haven't gotten around to it yet, so the 401K is quick, easy, and painless.

After that, you'll get your first paycheck, and within a few months, you'll have become accustomed to living on the net amount, while happily knowing that your retirement is being at least partially funded and that you're getting better returns than anyone with a hot stock tip around the water cooler.

One other opportunity that's often made available by employers is called an ESOP (there are a couple other acronyms out there, too) or Employee Stock Ownership Plan/Program. These have sometimes gotten a bad rap because of companies like Enron that played fast and loose with the accounting, and encouraged their employees to invest heavily in the plan, as well as loading up their 401K with company stock. If you see this sort of hype happening at the company you're joining, RUN!

For most well-established companies, however, the risk involved in an ESOP plan is minimal, and the upside can be quite nice.

While I, personally, have never had an ESOP available where I worked, my wife has been able to take advantage of them twice in her career. And when Mama's happy...well, you know.

The first ESOP plan we encountered allowed her to put a certain amount of money in company stock, deducted regularly from her paycheck, and the company contributed a 100% match to purchase the stock, up to a maximum dollar figure which I can't recall just now - it was fifteen years ago. We were all over that like white on rice! We weren't exactly high rollers at that time, busily raising our family, but she contributed $25 a month, the company contributed $25, and the net effect was a 100% automatic return. Unless the stock's value went to zero, it was very difficult to lose money on the deal. By the way, the company she worked for was very stable, had been in business for decades, had a good business model, etc. That's not to say you shouldn't give this a shot if you're working for a high tech start up - just don't play with money you have to have to pay the bills. I'm sure Bill Gates' early employees are happy they took advantage of the stock plan at Microsoft.f

The first part of the stealth strategy, then, is participating in any automated savings plan, especially those that get matching money, offered by your employer. If you're self-employed, you're gonna have to do it the hard way.

So, here's the second part of my stealth strategy. Whenever you get a raise, put at least some of that raise into an automated savings/investment plan. You'll never miss the money this way. The least painless way to do this is, for example, if you get a 4% annual raise, instantly allocate 2% more to your 401K contribution. Then, you get half of the net raise in your take home pay, which you can spend on a few little rewards, or increase your lifestyle slightly, while half of the gross (pre tax) raise is going directly to your retirement plan. Do this regularly over your career and you'll be a happy camper when you're ready to retire.

Alternately, you can increase your contributions to an IRA or Roth account, if you've got one set up by now. Your financial planner should have gotten you all set up, right? Or, you can increase the money you're putting away in company stock. As long as it's not cutting into your basic living expense budget, it's usually a good strategy.

In our case, my wife went from contributing $25 a month to $50, then to $100, then $200, over about five years' time. When she finally left the company, she had a pretty substantial investment nest egg of their stock. Additionally, it paid quarterly dividends which were DRIP'd (see Get Rich Slowly's great article on DRIP investing) back into the plan. We ended up making a lot of money on that stock by the time it was all gone. We sold little bits of it here and there, to take advantage of other opportunities.

The second time she participated in an employee stock plan, it wasn't a "match" type of plan, but gave a fixed discount on the price of the stock for money contributed throughout the course of the year, purchased for her at the end of each plan year, based on the lowest price, either at the opening of the year, or at the closing of the year. Even if the stock went down in price, you couldn't lose money!

That plan also offered dividend reinvestment, but we declined it, and had them send my wife a dividend check every quarter, so she'd feel like she was getting some immediate, concrete benefit from the plan. Once every three months, she'd get a nice little "mad money" check from the company, and get to spend it on fun stuff for herself. Use whatever strategy motivates you best.

The point of this tale is not "Woohoo! Look how much money we made!", but that we did it without ever really noticing that the money was not in our budget, because we used the stealth tactics of a) automating the investments and b) investing the money before we ever got the chance to spend it. When you combine those tactics with the effects of free money from an employer match, price subsidy, the compounding effects of dividend reinvestment over time and price appreciation over time, you, too, can have powerful results.

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