Frugal Living

5 Steps to Budgeting and Saving for Retirement Effectively

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Budgeting and planning for retirement can be a boring, gruesome task that takes a toll on one’s self worth. Before you know it, after doing some calculations, you may find that you are in an even bigger financial hole than you thought you were. One of the biggest mistake a person can make is neglect their finances. The saying, ignorance is bliss has its time and place. When it comes to personal finance, the saying definitely does not hold whether you like it or not.

However, do not fear. The fact that you are now taking initiative of your finances is a victory in itself. Follow these simple five steps, and you will be on your way to saving for retirement effectively, while reaching financial independence much quicker. Who knows, you may even retire earlier than you would’ve imagined.

Step 1: Be frugal and realistic

Set goals and budget, while being true to yourself. Take the time to set a fixed amount of your income and rate it by how much happier your standard of living would be if you were to increase or decrease your spending.

One habit that has worked with me before purchasing something is deeming what I am buying a necessity or a luxury good. If I find out that the item is a luxury good, more often than not, I probably don’t really need it. This technique has kept me away from many spending sprees and impulse shopping.

Another good method is to use cash when going out instead of a credit card. There is something about counting something tangible as cash and seeing it whittle away that often prevents impulsive buying. Credit cards on the other hand, while great for its cash back, may backfire for those who aren’t the most disciplined because everything is just a swipe away.

Step 2: Create an emergency fund

The definition of an emergency fund is a nest of money you do not touch for anything, unless you absolutely need it. The nature of the fund is to prepare for the unexpected. For example, god forbid, a car accident, unexpected travel, or medical expenses. An emergency fund should be liquid in the sense that it should be easy to access the money for whatever reason. If you were to ever draw from the emergency fund, the first priority should be to replenish it.

FDIC-insured saving and checking accounts are the main choices for storing emergency funds – the reason being the money deposited can be liquidated at anytime in a hurry. FDIC insured means that the government backs up to $250,000 of bank deposits in the event of something drastic occurs. In other words, your money is insured and secured by the government.

The emergency fund should be a nest of funds amounting to about 3-6 months of your typical monthly expenses.

Step 3: Max out your employer matching

If you have a job that rewards you for contributing to your retirement with employer matching, the next step is to maximize your employer matching by contributing just enough contributions to get the max amount of free funds from employer matching.

For example, if your employer offers you to contribute 6 percent of your salary from your payroll and they are willing to match 25%. In this scenario, you just received a guaranteed 25% increase in contributions to your retirement with no adverse risk to your money. It is essentially free retirement money so be sure to maximize your employer matching.

If your job does not come with employer matching, skip this section.

Step 4: Payoff high interest debts

The rule of thumb I like to follow by is to pay off any loans above the interest rate of four percent. Anything of lower interest rate, may be considered a low-risk. A low interest loan may be better off used for other avenues for financial flexibility or investing, which I’ll go into detail in future posts. However, anything above the interest rate of four should be prioritized and paid off.

I personally believe that having lots of debt can cause a huge psychological burden on anyone so I’m a huge believer of paying off a loan as soon as you can. Having lots of loans can invoke lots of negative thoughts on one’s self-worth and may be a demoralizing experience.

Step 5: Contribute to an IRA

Last, but not least. There are many tax benefits of contributing to an IRA. One being that an IRA is a vehicle in which you can save for retirement with tax-free growth or on a tax-deferred basis. In other words, your retirement money won’t be taxed and will be inflated because it has the added benefit of it being taxed free. The time you will be paying taxes will be when you take out your money during retirement. The maximum annual contribution you can make to an IRA is typically $5,500. I personally have a Roth IRA with Vanguard, which I love. Other low expense ratio IRA providers are Fidelity and Charles Schwab. I highly recommend a Roth IRA because you are able to take out your contributions (not earnings) at any time. Additionally, if you are a first-time home owner and are thinking about a home mortgage, you may withdraw up to $10,000 without any penalization. Tax benefits like these make the Roth IRA hard to deny.

By the time you reach step five, you should already be in good hands, financially. If you still have some money leftover that you want to contribute to retirement even more, you should consider parking your money into an employer 401K or Simple IRA.

Fun fact

When you need more money during retirement, your home may be exactly the asset you require. However, instead of applying for a standard home mortgage, consider a reverse mortgage. It is a special retiree home loan that will give you the income you need and allow you to borrow it worry free while you live in your home. The only limitations are you can only borrow a percentage of equity determined by a reverse mortgage calculator and you cannot stop using the home as your primary residence. If you do, the loan will be called in when you move out. You will then have a short time to repay what you owe or allow the home to be sold. While enjoying the financial freedom a reverse mortgage offers, you are also responsible for paying taxes and taking care of all matters of upkeep relating to home ownership.

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