A few weeks ago, I mentioned the "latte factor", coined by author and personal finance expert David Bach - it's about how minor incidental purchases add up over time to ruin people's finances and could derail your savings and your retirement plan. After wanting to hear more of Bach's thoughts on saving and budgeting, I picked up his book "The Automatic Millionaire". It was a quick read (took me about 2 hours to get through 220 pages) and had one very intriguing point: if you pay yourself first and make your savings automatic, you don't have to do anything else to have a solid retirement fund. No budgeting. No hairpulling. No kidding.
Okay, so I'm generalizing a little bit. Bach goes into more detail and has some pretty compelling stories from individuals and couples who have paid themselves first. One couple he worked with made a combined gross of $55,000 a year (in early 2000 wages PLUS they live in the Midwest where expenses are lower); however, they were able to outright own two homes (no mortgages), put two kids through college, and have a million in the bank by the time they were 55! What the what?! The couple went back to never carrying any debt (paid for everything in cash with the exception of their first home) plus they paid themselves first with automatic 401K contributions.
Bach pretty much sold me on his idea. If you aim to put 12-15% of your pretax earnings into a retirement account (401K, 403b, IRA, etc), you don't necessarily need to worry about budgeting for specific categories, like housing, groceries, etc. I'm a little Type A (I see my husband snorting at this declaration) so I'd like to know ballpark amounts of what I'm spending every month. But I can see how if you took the guessing out of how much you need to be saving for retirement and just did it, your worries would be gone.
Two great points I took away from "The Automatic Millionaire":
1) When you're talking about "paying yourself first", ask "how many hours did I work for myself this week?". Use your pretax hourly wage and compare with how much you're saving. Are you working 1 hour for yourself, 10 hours? It puts it in perspective if you might be saving less than you should.
2) Did you know the government didn't start taking taxes out of your paycheck until 1943? They thought people could save and pay at the end of the year! Those feds are smart though, and now take it automatically out of your paycheck. If only we were as smart as the IRS!
I'd love to hear from you all about this!
Who thinks "The Automatic Millionaire" and David Bach are right - if you just worry about your retirement savings, then everything else will fall into place? Or do you think everything needs to be budgeted just so?
I have to say I agree and I disagree. I think that paying yourself first absolutely makes sense. If you have that money automatically debited out, you never touch it. This way you are more likely to save for the long haul.
ReplyDeleteHowever, I disagree with the fact that then you never have to budget for groceries or anything else. What happens when you overpsend on groceries and don't have enough money left in your account to pay your electric bill that just came in? It just doesn't make sense to me.
Being type A has really helped me get a grip on my fiances. I know what bills have been paid and what to expect. That way I can make educated decisions about if we have the money to spend on incidentals such as a nice dinner our or home improvment supplies.
Can you explain Point 1 again? I'm potentially post-lunch fuzzy, but I didn't understand it (and I want to!).
ReplyDeleteIt depends on the kind of person you are, and also how much extra income you have relative to your "natural" level of expenditure. For example, I pay myself first, but I'm naturally conservative in what I buy so I'm not likely to go over budget even without a formal written budget, and if I do, I have enough extra income that I can cover it for a month or two (normally this goes into "extra" savings).
ReplyDeleteThe nice thing about paying yourself first is that once you set it up, you don't ever have to worry again about retirement savings. You just set it and forget it.
While you're figuring out how many hours you worked for yourself, give a thought to how many hours you worked for Uncle Sam too. You might be surprised just how much of your work is going to the government.
Great comments everyone!
ReplyDeleteFrugal Femme - I totally agree with you about knowing what you're spending.
Jo - For point 1, let's say you work 40 hours a week and make $10/hour pretax. If you're saving $50 dollars a month, that means out of 160 work hours, you've worked 5 hours for yourself. You've paid bills, gone out to eat, etc - but you've only paid yourself 5 lousy hours. Granted, $50 saved is better than $0 saved, but maybe looking at how much you're paying yourself can help you readjust your saving strategy.
BrewerDave - I don't want to know how much I'm working for Uncle Sam. :)
Saa - thanks for reading!