You probably know you are supposed to invest 10-15% of your gross income annually over 30-40 years in order to secure a comfortable retirement. If you did not know that, now you do. Your gross income is the amount you are paid prior to taxes or any other deductions (annual salary or hourly wage). Over the past 12 years, my husband and I have each typically saved 5-10% of our gross income, and often received an employer match in a tax-advantaged account. For the first ten years, we saw such little growth in our portfolios, that we made a point not to bother looking at them much. After the ten year mark, we saw them start to rise in value. It was very gratifying after all those years of saving and investing.
In a way, although we had smaller salaries at the start of our marriage, it was much easier to invest and save. Other than the cost of our condo mortgage, my graduate degree and a new-to-us car, for both of which we saved and paid cash, we had no other costs. After those big ticket items, all our income was discretionary. Those were the days.
Our current situation is a little different. Prior to discretionary income, we account for:
· Mortgage – primary residence
· Mortgage/fees – condo (covered by rent)
· Line of Credit – primary residence
· Childcare for 4 children
· Property tax – more residences and more vehicles
· Upkeep on two properties and vehicles
· Charity – we doubled our charitable giving over the years
· Tax – I pay more as an independent contractor, and we now deal with a higher income tax bracket
· Investing: 13%
I suppose you might argue that investing and charitable giving are discretionary, but we tend to view 8-10% of combined gross income to charity and 6% of combined gross income to retirement as required expenses. How did we grow our investments while watching our discretionary income decreased?
1. Every time we received an increase in pay, one of us increased the percentage automatically deducted into our 401k/Thrift account.
This is probably one of the least painful ways to grow the amount of our investments. I received a sizeable increase a few years ago, and increased my personal contribution toward a 401k account from 6% to 10%. Because the raise was nearly 10%, we never noticed the reduced income. I was already investing 6%, so I effectively increased the amount I was investing by 4%, leaving me with a 6% raise. When my husband started a new job, which also included a raise, he also increased his contribution by 3%. Until we max out our personal accounts, we are committed to increasing the amount we contribute by 1% with each increase in pay.
2. We kept our total housing costs to less than 25% of our net income.
This was probably our most painful method of increasing investing. There is simply no way we could have increased the amount we invested had our primary residence been more than 25% our net income. Net income is your income after taxes and other deductions, also know as “take home” pay. Income tax and mandatory withholdings, such as social security, make up 30% of our gross income. If you are curious about this, take a look at your paystub. Even though our bank was more than happy to give us a mortgage for 30% of our gross income, we took a mortgage on a fixer-upper that was 15% of our gross income; saved cash for a large part of the renovations; and then took out a loan once we had saved enough that the combination of the loan and mortgage were less than 25% of our net income. This took a fair bit of commitment when dealing with leaky pipes.
3. We improved our investments.
I had a more moderate risk portfolio until I got into my 30’s. At that point, I switched to a much more aggressive equity-heavy position. After reviewing my husband’s portfolio recently, we will make some changes to his current approach. Because our condo is steadily gaining in value, and represents a safe income stream far into the future, we are comfortable with a higher-risk approach.
4. We got smarter on taxes.
In the last five years, I started to pay more attention to how much we paid in taxes, and began noticing ways to save on income tax. One recent move was to switch from an IRA to a Roth IRA. I had been considering a Roth IRA for a little while, but cannot contribute directly due to our combined gross income level. After some research, I realized I could gradually convert money in my IRA over to a Roth IRA. Although I pay the tax in the current year, which is painful, taking that tax hit now means I will likely pay less tax in the future. Yes, I am banking on the idea I’ll be in a higher tax bracket in 20-30 years. Not to mention, you can make withdrawals for qualified education expenses, a far superior choice to the extremely limiting Education Savings Accounts. I was squeamish about this recent switch, because we like to have our cash now. I decided to mentally call the tax I was paying in the current tax year part of my “investment strategy” and found it easier to bear.
As you can see, there was nothing dramatic about how we increased our investments for retirement. We were simply committed to making it happen.
Nerd Wallet has a very nice breakdown of the benefits of the Roth IRA, which you can read here.
Photo credit: Jonathan Pavluk