As a parent of young teenage daughters, I have a strong interest in helping our younger generations prepare for their financial futures. I am fortunate to have worked with many young adults over the years and have seen how important a good financial foundation can be. However, for every young adult who comes to me as a client with a desire to work toward their financial goals, there are many more without a clue. While personal finance courses are beginning to appear in school curriculums, they are not prevalent and are often a limited glance at this life-changing subject. It is important to understand these three levers that can have a major impact on future financial goals. This is especially important for younger people because they have time on their side.
Young investors and planners have three financial levers at their disposal to impact their work-optional plans: increase savings, reduce expenses, and work longer. Individually, each lever has the potential to improve goal achievement. However, using multiple levers can compound the financial impact. Consequently, mistakes in each can add up fast. It’s important to know how to use each lever and begin setting goals as early as possible. The earlier one gets started, the more time they can capitalize on their opportunities.
Lever 1: Increase Savings
When used early and correctly, this lever has a compounding effect. Setting goals and investing with an appropriate risk tolerance for those goals while considering time horizons, and other factors help us more accurately invest. When we take these into account, we are more likely to get invested and stay invested, where appropriate. We are also less likely to make risky investment mistakes that we cannot recover from in time to fund the goal our assets were intended to fund. In other words, this lever can help us work toward our goals and, at the same time, help us adjust for mistakes.
Personally, I feel like increasing savings is the most important lever. If you are not saving, then you will not have anything for your goal. However, there are exceptions. It is possible for someone to win the lottery or inherit a large sum of money. This is such an important exception that they have a name for it: sudden wealth syndrome. The issue of sudden wealth is a major source of research and many articles have been published on it. In a CNBC article, “Getting an inheritance or winning the lottery can create serious emotional and financial challenges,” by Andrew Osterland, research showed that 15.7% of NFL players filed bankruptcy within 12 years of retirement (link). The article goes on to describe the importance of getting a financial advisor and creating a financial plan when falling into sudden wealth.
We are about to embark on one of the greatest wealth transfers ever made in this country, so we should see increasing issues with sudden wealth. As the boomer generation passes, their children and grandchildren stand to inherit their retirement savings, which is substantial. Stay tuned for more information on this, as time moves forward.
This makes financial advice for younger generations even more important. It may be incumbent on parents and grandparents to ensure their legacies transfer appropriately and are protected. That means careful financial, estate, and tax planning. Paying for a financial plan for heirs is a great way to help with estate transfers. When heirs have a financial plan, they will be less likely to make costly mistakes or waste the “sudden wealth.” If you are interested in a discovery meeting to see if this is something you may be interested in, contact me and let’s explore your options.
Lever 2: Reduce Expenses
This lever needs to be constantly analyzed and lubricated or it might get stuck in an ugly position. If you are full throttle on your expenses, living paycheck to paycheck, then it will be difficult to shift to a lower expense budget. This is especially difficult if you maintain a high expense lifestyle for most of your life. That full throttle lever can rust in place, making it even more difficult to reduce spending in retirement.
Reducing expenses should include tax planning because taxes can eat up a large portion of your income and savings. If you can reduce your taxes over time, the amount of income available for your goals will go up proportionally. This can be as simple as identifying ways to defer taxes on investments or as complex as offering a full tax planning analysis. Depending on my wealth management clients’ needs, I make both available.
When you see the hard figures related to what you are spending and how it impacts your financial goals, you get a better understanding of how important it is to curtail spending. If you have been relying on your 401k success tracker to determine whether you will be able to retire or not, this is a major piece of the puzzle that they typically do not have. It takes some work to put this information together, but it is an essential part of financial planning.
I often meet people who are about to retire and have never engaged in financial planning. Spending is the most overlooked piece of the retirement puzzle when you do not have a plan, and many people have no idea what they are spending. If you are ready to retire and discover that your spending is 50% higher than it should be, it can lead to panic. You have become adjusted to a certain lifestyle and changing that lifestyle at a time when you are worried about moving into a different stage of life makes retirement even more frightening.
With our younger generation, there is an empty canvas ready to be painted. By choosing their paints carefully, they can craft a beautiful retirement. Establishing good habits and getting comfortable with them requires time, and time is a powerful resource that our younger investors possess. They just lack the foresight and motivation to engage in planning.
Lever 3: Work Longer
The final lever is directly related to time. If you are young, you are probably not thinking about how long you might have to work. As we get older, it becomes a more important and prominent thought. I have never seen a young person worried about having to work well into their senior years, but I have seen many people in their 50’s worried that they are going to have to work to age 70 or later.
With a financial plan, you can adjust this lever to see how reasonable it is to make work optional at a younger age. There are a lot of costs to consider well beyond having enough money to replace your income. If you retire before 65, you may have to replace your workplace health insurance with a personal health insurance policy, since you are not eligible for Medicare. If you have pre-existing conditions, this may not even be possible.
Disability is another problem that can wreck your early retirement plans. If you are disabled several years before you planned on making work optional, you may find yourself working for less money to make ends meet. Many companies offer long-term disability with an option to purchase more. You can also purchase a personal disability policy. However, there are a lot of different types of disability policies, and you need to make sure that what you have will meet your needs. A good wealth manager can help you examine your current policy and identify any gaps.
By adjusting the first two levers (increase savings and reduce expenses), you may be able to reduce the number of years you will have to work. However, adjusting those levers can be painful, depending on your time horizon (how long to goal). That’s why it is so important to address this earlier rather than later. Incremental changes are much smaller when there is more time.
There are multiple things to consider for each lever. Books have been written on this subject, and there isn’t enough room in this blog to go over all of them. However, the common factor is time. The younger we are when we start, the more we can take advantage of this factor and the more opportunity we have to correct mistakes. With fewer assets and lower income, our younger generation may have difficulty finding a quality wealth manager to work with them. I believe it is so important that I offer them discounted services. If you are a young professional or have adult children and would like to know more, contact me for more information and a complementary consultation at bud.milligan@milliganwm.com.
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