I get a lot of email from subscribers to our free weekly newsletter. It’s a great opportunity to connect with people and to share ideas about ways to improve our finances. Recently, a subscriber named Wanda emailed me with the following question:
I am married and my husband and I are in our early thirties. I was wondering if you would do a tips article for 30 somethings. We are just now making enough money to dig our way out of student loan debt. I feel like we are so far behind the curve on saving for retirement. Any suggestions?
Financially speaking, your 30s are so important for a lot of reasons. You’ve got a little bit of everything going on–children, buying a home, paying off debt, saving for retirement, saving for your child’s education, career advancement. Because you still have several decades before retirement, your 30s are also a time when it’s easy to lose site of important goals.
Those in their 30’s are also in a bit of trouble, at least according to a recent study by the Urban Institute. The study, Lost Generations? Wealth Building among Young Americans, found that those under 40 are the only group worse off than their grand parents:
Despite the Great Recession and slow recovery, the American dream of working hard, saving more, and becoming wealthier than one’s parents holds true for many. Unless you’re under 40. Stagnant wages, diminishing job opportunities, and lost home values may be painting a vastly different future for Gen X and Gen Y. Today’s political discussions often focus on preserving the wealth and benefits of older Americans and the baby boomers. Often lost in this debate is attention to younger generations whose wealth losses, or lack of long-term gains, have been even greater.
The study even provided a chart showing how net worth for those under 40 has stagnated, while those older than 40 have increased their wealth:
But we can’t be defined by a study. No, we can take matters into our own hands, pick ourselves up by our bootstraps, and rock our financial world.
So in this Part 1 of our series we’ll look at some key financial goals for those in their 30s related to budgeting and retirement. For each goal I’ll share the approach my wife and I took, along with some great resources and tools to help you work through each goal for yourself. In later articles in this series we’ll cover other financial goals for those in their 30’s.
The first step is to assess exactly where things stand in four key areas:
Debt: Write down the balance for each debt, the interest rate, and the minimum monthly payment.
Emergency Fund: Write down how much you have saved in cash and the interest rate it’s earning.
Retirement: Write down how much you’ve saved for retirement.
Life Insurance: Write down how much you have in life insurance, the remaining term, and the annual premium
For some, this exercise may not be a lot of fun. But it’s important. We’ll be using this information as we work through some of the financial goals.
Now at this point you may be wondering about the dreaded ‘B’ word–budgeting. I’m glad you asked.
An effective budget helps you do two things. First, it helps you make planning decisions. For example, a budget can help you determine how much you can afford to spend on vacations, a new car, or an anniversary gift. Second, a budget can help you make day-to-day spending decisions. If your budget isn’t helping with at least one of these, and preferably both, you’re wasting your time.
With fancy online budgeting tools like Mint and my personal favorite, YNAB (You Need a Budget), it’s easy to spend time creating impressive budgets that are totally worthless. You may get some satisfaction out of entering numbers into various categories to see how much you theoretically will have left at the end of the month. But if the budget doesn’t actually inform the planning and spending choices you make, you might as well watch re-runs of Lost instead.
So how do you make budgeting meaningful? What my wife and I do is to budget backwards. Rather than adding up all of our expenses first to see what was left, we started with what we needed to save and invest. For example, let’s assume you need to save 15% of your income for retirement. By budgeting backwards, the first step is to subtract this amount from your take home pay. What’s left is what you have to spend and pay on debt.
The key is to do what works for you. For some, that may mean tracking every dime you spend. For others, it may mean tracking just one or two categories of spending. Whatever approach you decide, keep in mind that the goal is to free up cash to meet your financial goals.
Here are some additional articles on budgeting:
- 10 Online Budget Tools
- A Simple Approach to Budgeting
- How to Fix Your Budget | 7 Budgeting Pitfalls
- Variable Income? 3 Options for Budgeting
This approach raises two important questions. First, how much do you need to save for retirement? Second, should you be saving for retirement while you still have debt? Let’s look at both of these questions.
So you are 30 years old. You have X saved for retirement. Are you on the right track? At first that may seem like a really tough question to answer. It’s not.
In fact, we’ll look at not only how much you should have saved, but we’ll also look at how much you should be adding to your retirement fund each year. How will we do this?
We are going to use ratios developed by Charles Farrell, a lawyer, investment advisor, and author of an excellent book, Your Money Ratios: 8 Simple tools for Financial Security at Every Stage of Life.
According to Farrell, most people need about 12 times their annual income to retire. So if you are making $100,000, you need about $1,200,000 saved, plus Social Security, to retire at a level of comfort consistent with your working years.
Now, keep in mind two things. First, this is a rule of thumb. Rules of thumb are a good start, but they are no substitute for critical thinking. Your situation may be different. Second, you are no doubt asking how a 12x multiple at age 65 helps you now in your 30s. Farrell answers that question for us.
To be on track to save 12x your annual income, according to Farrell, at age 30 you should have saved 0.6 times your income for retirement. So if you make $100,000 a year, your retirement account balance should be $60,000 ($100,000 x 0.6).
Now stop crying and keep reading. By age 40, the multiple increases from 0.6 to 2.4. In other words, over the course of your 30s, your nest egg needs to grow from $60,000 (assuming you make $100,000 a year) to $240,000.
Here’s a breakdown of what Farrell calls the Capital to Income Ratio by age:
Now the big question–how much should you be saving toward retirement each year to hit that magical 12x number? According to Farrell, before age 45 you should be saving at least 12% of your gross income toward retirement. After age 45, the savings rate goes up to 15%.
If you look at the capital to income ratio and realize you’ve fallen behind, you have a couple of options. First, you can catch up if your finances permit you to save more. Second, you can plan to work longer. Third, you can plan to live on a little bit less during retirement. The good news is that in your 30s you still have options. What you don’t want to do is let your 30s get by you without taking action.
Stay tuned for Part 2, where we will look at financial goals for those in their 30’s related to debt.