Small Changes, Big Differences in your Retirement plan

The Power of 1% 

  How Small Changes Can Make Big Differences in your Retirement Plan

We have all heard that something – something 1% more, or something-something 1% better every day will have a massive effect on your life over the long run. How small changes can make big differences. It makes sense, if you could mathematically make yourself 1% better or more each day, you will be significantly better than you were at the beginning of the month or beginning of the year. It is a worthy pursuit. But it is very hard to calculate unless you are talking about running miles or lifting weights.

The concept is that a small change over a long period of time will have a massive impact on you and your life if done for a long time. This can be applied to so many things. Even an aircraft that is 1 degree off will land in a very different location than what was scheduled. But today I want to apply it to your financial life. Specifically, your 401k or retirement plan.

The “Power of 1%” is a motivational abstraction, why would I want this idea applied to a boring, old 401k plan? Because just 1% could make a massive difference in your life. These small changes can make big differences in your retirement plan. This one concept could make your retirement and life unimaginably better, and totally change the way you grow your wealth. Just 1% can be the difference between barely scraping by, to being a comfortable millionaire.

 

Power of 1%

 

The true key is to simply increase your 401k contribution by 1% at the beginning of the year, each year.

 

Let’s talk about how.

 

You have a 401k retirement plan and let’s say you are saving a decent amount of your money at 5% of your income, and your employer is either matching your contribution or putting in a percentage of your salary, depending on where you work.

Let’s take three pilots for this example, each in different stages in their career. 1. Rookie 2. Senior FO 3. Fully Tenured Captain that was flying bi-planes back in the day (joking). Pay will remain the same for easy math.

The Rookie makes $100,000 per year and is deferring 3% of his salary each year. In 5 years he would have put away $15,000 into his 401k. 3% seems like a lot, but over 5 years, that is only $15,000 for his retirement. Now let us see what would happen if he increases his deferral by just 1% each year. If he starts at 3% and increases each year by 1%, he will be at 7% (Year 1 was 3%) and over that time he would have contributed a total of $25,000! That is an extra $10,000 or 67% more than what he was normally doing.

Small Changes Big Differences in your Retirement plan

The Senior FO makes $250,000 per year and is deferring 5% into his 401k each year. When he retires in 10 years, he would have contributed $125,000 into his 401k. Not bad! But if he plans to retire, he should definitely do more. If he increased his contribution just 1% each year for 10 years, He would add $216,500 over his time, almost twice as much if he stuck with the 5% rate. Remember, you can only max out your side of the 401k contributions up to $19,500 each year, plus another $6,500 if you’re 50 or more, which is the case here. But you can always take that money and put it somewhere else. (Hint, hint Backdoor Roth Conversions) Here is the example:

Small Changes Big Differences in your Retirement plan

The last person is a Captain that will be retiring in 3 years. He has 3 years to put away as much money as possible. His salary is $350,000. He will need to put away 8% of his salary in order to meet his max of $26,000. Since he doesn’t have a lot of time to scale up every percent, he should just try to contribute as much as possible before he retires. If he maxes out, he will have $78,000 over 3 years! The more you can contribute to your 401k the better life will be.

 

The Tale of Two Pilots

 

Now let’s look at another example of how small changes can mean big differences in your retirement plan.

David and Susan both went to Metro State University to be pilots. They both were very good students, graduated from school, both worked for a regional liner and they just started flying for the same major airline. David loves to snowboard, vacation around the world, and party. He says  “As long as I’m covering my financial bases, I can do the things I enjoy.”

Susan loves to ski, read books, and spend time with her family. Living a comfortable life is important for her and she wants to make sure she can do the things she enjoys in the future. 

On their first day, they sit down with HR, and they are asked how much they want to start deferring in their retirement plan. David, whose friend told him to defer as much as he can, announces he will start with 5% of his $150,000 salary going to his 401k. When Susan sits down with HR, she says she can’t defer any dollars into her 401k because she wants to finish paying her student loans first. But she promises next year she will start with 1% of her $150,000. And the next year, 2% and so on. 

At Year 10, they both start getting paid $250,000. And at Year 20, they are making $300,000.

25 years later, after they both have amazing and fulfilling careers, they bump into each other at the DIA breakroom! “Wow!” They say for they haven’t seen each other for a long time. After a while of catching up, they talk about their retirement accounts. 

David smiles and boasts “I’ve been saving 5% of my salary since the first day I got here, and now I have saved $282,500 of my salary” as he calculates in his Excel spreadsheet:

“Very impressive!” Says Susan, as she tabulates how much she has saved. She started saving with nothing, but she promised she would increase her contribution by just 1% each year. After she does some math, she shows David how much she has saved. Smug David leans forward and stares, mouth open, at the numbers from Susan’s tablet…

“You saved $439,500?! Wow! I thought you said you were doing none, how did you beat me? That’s almost twice as much as I’ve saved, and I’ve been doing 5% my entire career!”

“Slow and steady wins the race” Susan smiled. 

Just a small change can make a huge difference in your retirement plan. And just because you start off slow doesn’t mean you’re out. Don’t get discouraged, just try to be 1% better. Like Susan!

 

What’s Next?

 

If you are just starting out or in your mid-career, increasing your retirement plan contributions by just 1% this year will have a huge impact on your retirement accounts and life. This doesn’t even factor in the potential increased growth that your account could receive. Lastly, your salary regularly increases with inflation, usually around 2% to 3% each year. If you just took 1% from that, you would hardly notice the change in your cash flow. 

This strategy is something relatively new but is gaining more traction among plan sponsors and large companies. Many of them are automatically enrolling employees into automatically increasing their deferral, or at least strongly encouraging that their employees increase their 401k contribution each year. Hopefully, these examples have made it clear the importance of growth for your retirement. 

Do you have a financial plan? Please reach out for a complimentary discovery meeting with our CERTIFIED FINANCIAL PLANNERS™ to help give you a clear path to a successful story. Susan would 🙂

 

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3 Questions to ask before making any financial decision

 

Whether it is hiring a financial advisor, picking a mutual fund, or refinancing your mortgage it is a good idea to ask a lot of questions when it comes to your money. However, if you only ask a few, here are our top 3 questions to ask before making any financial decision.

 

What is the investment philosophy?

 

Make sure to ask yourself if the investment makes sense to you. It may be great for 99% of the population but is it a fit for you and your current situation. Does it match up with your risk tolerance and timeline?  Really take the time to contemplate this.  Further, do you understand it? Or is it too complex? Understanding this will help move you forward in a meaningful way.

 

Do I trust the person giving the advice or offering the investment?

 

Simply put, what is your gut telling you about who is behind this. What is the person’s credibility and credentials? Was it your cousin Eddie spouting off a stock tip at the family reunion? Or a longtime friend and financial advisor who has been in the industry for years? It may seem like a no-brainer to ask this question, but it is sometimes easy to get caught up in the hype of the product and the potential returns.

A quick way to tell if an advisor truly has your best interest in mind is if they are CFP® (Certified Financial Planner)- learn more on that here, but in short, it means they are a true fiduciary and must have your best interest in mind regardless of commissions. Trust is so important, don’t take it lightly.

 

What is the downside risk, and can I afford it?

 

What can you stand to lose? Sure, look at what the potential of the investment is, but don’t ignore the risk. Make sure the amount you invest matches your risk tolerance. The old saying stands true here- “Don’t put all your eggs into one basket.”  Before you make an investment decision know the risks.

Short and simple, those are the top 3 questions to ask before making any financial decision!

Are you considering an investment and aren’t sure if it is right for you? Asked these questions and are still unsure? We are here to help…just give us a call.

 

Is Insurance an Investment?

Is Insurance an Investment?

 

The simple answer is no. You don’t view car insurance as an investment, so why would life insurance be?

If insurance is not an investment, why do we have insurance? Simple, it is for protecting your assets and for protecting your loved ones.

Think about this… You have car insurance and home owner’s insurance, but why?  It’s so you will be covered if you get into an accident, or stuck in an unreal hail storm, or if the water heater breaks and floods the basement, or in the unlikely event your house catches fire.

In all these cases people purchase insurance to make sure that they are not going to have to pay the full amount to get back to whole after something terrible happens. That’s it.

We have yet to meet a person that bought car or homeowners insurance as an investment thinking they were going to make money or get returns off the insurance.

Why is life insurance different?

It’s so that your loved ones are taken care of if something happens to you.  If you are no longer here, who or what is going to replicate the income you generate? Most people say that if they pass on early or unexpectedly they want their family to be able to maintain the same quality of life.

 

The important questions to ask yourself are:

 

  1. How much do I need to achieve the goal?
  2. What is the most effective and inexpensive way to achieve that goal?

 

There are certain factors to think about that will help determine what kind of insurance to buy and how much. These factors include your time frame, health, and resources (other investable assets).

When you ask these questions you are looking at insurance from a needs-based approach. It helps you find a solution that fits your particular situation.  When acting from this point of view, very rarely does a whole life or universal life product make sense.  Term life insurance normally gives you the greatest amount of coverage for the least amount of money.

 

Why do people say life insurance is an investment?

 

Well, have you ever gone to see a movie and walked out a little disgruntled saying “Man, the best parts were in the trailer, why did I even go?!”  That is the feeling most people get when they buy insurance as an investment. The story or sales pitch was better than the product and the only winner was the one selling the insurance.

In the end, people often say “my advisor said it would be like a forced savings that I can borrow against, but I have no idea what it is” or “they said it grows tax-free or something like that” It is one thing to waste your money on a $15 movie, it is another thing to waste thousands of dollars on insurance you think is an investment but in reality doesn’t meet your needs.

If your financial advisor has tried to pitch you insurance as an investment, you don’t have a financial advisor, you have a salesperson. 

Insurance is not an investment.

 

Here are some facts on whole life insurance, universal life insurance, portfolio or permanent life products that should help bring some perspective:

 

  • They cost a lot more to get the same amount of coverage as a term policy.
  • There are hidden fees.  You can find them buried in the 8 pt. font 20+ page contract. Are you are up for some “light” reading?
  • These products pay big commissions to the insurance salesmen, which they do not have to disclose to you.
  • If you borrow against it, your death benefit will be reduced, and your loved ones will be left with less.
  • If you do mix investment with insurance, i.e. you ‘invest’ in insurance products like endowment or money back plans, your returns are bad, limited at best. Usually less than 3 or 5%.
  • When you die with a cash value, they only pay out the face amount, not the extra money you’ve put into it. Your extra investment vanishes- they keep it.
  • And finally, you are borrowing the money so there is interest to be paid, which means you pay even more.

 

These products have many moving parts and are quite convoluted. Many clients come to us asking for help to understand what they bought from someone else and how it works.

In most cases, we end up having to call the insurance company to get full indoctrination of the product so that we can understand that if this happens, that happens, and so forth and so on. Whole life and universal life products simply have too many variables.

 

Insurance unfortunately is unnecessarily complicated, but it doesn’t need to be.

 

If you understand that insurance is not an investment, the picture can comes into focus. Term life is more than often the best solution for the lowest cost. The best way to buy it is through a broker or advisor that shops several companies to get you the best deal. Which, by the way, is what we do.

We’d love to discuss this more with you and truly find a solution that meets your needs, so give us a call and join us around the fire.

 

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