Monday, October 7, 2013

Could saving for later make you happier now?

Ever had a conversation with a friend, trying to convince them to open an IRA or contribute to their company’s 401k, and had them respond “Eh, you make some points, but I’m good.  It’s not like I make that much money, or don’t need my money now.  Saving for retirement?  Nah.”

You probably have.  Or you’ve had a conversation with a helpful/annoying friend who wants you to save for retirement, open some weird acronym or letter/number combo account, and save for something very far off and non-immediately pressing.

There are lots of good reasons to not do something a friend suggests.  When it comes to saving for retirement, it seems relatively simple to compare what you value more: money now or money later.  Some people want to save, some people have big upcoming purchases or current needs that they choose/need to meet.  The implicit assumption is that you’re in a zero-sum situation: save more for retirement, have less now, or vice versa.  I don’t think that’s true.  Life is not a zero-sum situation.  Parents who go from having one child to two don’t redistribute the love they had for their 1st across two, decreasing how much they love each kid (or so they say …).  There isn’t a finite amount of kindness or knowledge -- teaching or helping someone else leads to a happier and more knowledgeable society, something that benefits us all.  The best way to get ahead isn’t to push someone else behind.

I think that saving for retirement makes your life, your life now, better. When my bank account balance is low (which it certainly has been at times over the last few months), and I have to perform carefully executed fund transfers synchronized with credit card payments, I’m grumpy and resent having to think (read: stress) about money all the time.  When I know the money is there, I can visit with a smile on my face, or just spend my free time not giving a rat’s ass about my bank account balance.  Being in good shape financially gives peace of mind.  Even saving modest amounts (read: your life is none the worse for it), is a step in the right direction.

There are really just a few steps:
1) Decide to save for retirement
2) Figure out how
3) Profit!!

For step 1: You have to save for retirement. If you’re like me (in the US, non-trust-fund-having, young and fabulous), you may receive social security in your old age.  It will most likely be less than what people are currently getting, and it will most likely be significantly less than you need to live on.  You’ll need to pay for health care, food, and other essentials in your old age.  So you need money.  Because of inflation (a moderate amount of which is good for the economy, for several reasons, and so the Fed targets such a rate), your grandparents could buy lunch for a quarter, whereas it now costs at least 5 bucks, and that’s if you’re going to a food truck.  Money isn’t worth as much now as it was before, and that will always be the case.  If you put your money under the pillow (or in a bank account that earns nominal/non-existent interest), you will be able to buy less in the future than you can buy with it now.  No good.  Investing gives you the ability to beat inflation, so that your money grows and buys you more later than it can buy now.

Step 2: Do it.

The good news is that there are two tax-advantaged accounts available to most of us.  A 401(k) (or 403(b) if you work at a not-for-profit) through your employer and an IRA (individual retirement account) that you can contribute to if you have earned income.  Uncle Sam wants a cut of your money, regardless of whether you make it through a salaried job or investments.  However, with these two accounts you get some tax benefits.

A 401(k) is offered through your employer but managed by a different company (ie, Vanguard, Fidelity, Great West Retirement).  For 2013, the max contribution for someone under 50 is $17,500.  With a traditional 401(k), you put in pre-tax dollars, and then pay taxes on money when you withdraw it in retirement.  With a Roth 401(k), you contribute after-tax dollars, and then pay no taxes when you take money out, provided it’s been in the account for 5 years and you’re over 59.5 years of age.  IRAs can also be traditional or Roth, and work in the same way except they are not tied to your employer (you open one yourself), but they are also tied to your earned income and have a much lower upper limit ($5,500 for this year).

Everyone’s situation is different, but generally you want to contribute enough to your 401(k) to get the employer match if you get one, then max out your IRA, then max out the rest of your 401(k), in that order.  What’s important to remember if that these accounts are simply vehicles -- they determine certain things about how your investments are taxed, but you still need to choose how to invest your money.  It can be in an IRA and entirely in bonds, or entirely in stocks, a mix of the two, or all in CDs.  If you’re curious what to do in your individual situation, I’m totally open to doing a case study (with any identifying info omitted).

Life is, in some ways, a really big and really complicated optimization problem.  We have all sorts of desires, preferences, incomes, needs, and environments, and in the end we’re just trying to be happy and productive.  I’m realizing that the binding constraint, usually, isn’t money -- it’s time!  I have a higher standard of life now in grad school, than I did when I was working and making 3x as much.  There are many reasons for this, and certainly not everything is better now than before.  But life can work out marvelously.  Provided a basic income level, we can all adapt to circumstances and be just as fulfilled with more or less money.

So my suggestion -- if you don’t contribute to a 401(k) or IRA, try it out.  Start small and contribute for a few months.  Bet it won’t be cramping your style, and you’ll feel pretty good about this ‘saving for retirement’ thing.  Do you contribute to any tax-advantaged accounts?  Was getting everything set up the worst part?  If not, what was?  If you don't, why not?

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