The Wheel of Interest

As Cara and I were talking the other night, and I was rambling on and on about 401ks and inflation, she threatened to create a ‘wheel of interest’. Only this time there’d be a new category. Financial freedom. You see, ever since I discovered this website back in July, I’ve been on a planning, investing and savings kick.

We’re all told it’s important to save for our future, invest in company retirement plans, especially if there’s an employer match, and to work hard so you’ll (maybe one day) be able to retire. And that’s really about it. Then we’re thrust into the workplace and find ourselves as “adults”. Car payments, mortgage payments on McMansions, and crazy spending seems to be the norm these days. The problem is, the time to get serious about retirement is really years before you plan to retire, when you're just getting a handle on 'life' in general.

I figured I was ahead of the game in many ways- in college I worked as a lab tech making a few bucks on the side to cover my projects. I spent summers and part time my senior year at a company I then joined upon graduating, all the while investing in their 401k program to get the match. Used cars were the order of the day. No credit card spending or debt. And in the meantime, I was saving money up to buy a parcel of farm land that would provide a place to indulge in my eccentric construction projects but also provide farm rent to cover things like property taxes and insurance. This ended up being 50 acres just north of town despite my original intent being only 10.

Sounds good, right? Well, here are some things to ponder….

In today’s market, money sitting in a savings account will lose its value faster than inflation. Hmm, this is where I've always kept my cash.

The average inflation rate is around 3%/yr. That means you are better off locking in a loan on a (slightly used*) car, or mortgaging a house at a rate of 4% or less than you would be paying cash or renting. In fact, you will actually be money ahead in the mortgage at the end of the term even if property values did worse than inflation. Plus the interest paid is deductible. Meanwhile, invest the cash you were going to use and put it in an index fund. Just don’t let it sit in savings.

For several years I ‘trusted’ the default settings on my 401k, and although I occasionally logged in to see if I could create a better mix, I was really shooting in the dark. The fact is, few people take the time to really investigate the investment mixes. As it turns out, these providers are not offering their services out of the kindness of their hearts. You’ll find the option mixes you’re assigned typically have very high expense ratios by default and lots of other little hidden fees. Of course you don’t notice, because over the course of years you don’t notice what’s happening behind the scenes. This is death by a 1000 paper cuts. Do some research, and reallocate your investments so it benefits YOU. If the investment options your provider offers are especially bad, consider contributing only the minimum to get the company match and put the rest in an IRA. Remember, this is compounding money. The more you have, the more it generates, so a few bucks sapped off in fees now potentially equals a lofty sum lost 20 years from now.

And you know what happens with you put a dollar into your 401k or traditional IRA? 1. It’s all pre-tax money so $1 invested really does have $1 earning power. 2. If you contribute enough (and this could involve multiple accts or maxing accts), you can lower your tax bracket which means you put several grand in your pocket in reduced taxes at the end of the year without giving anything away. And 3, as if that wasn’t enough, when it comes time to withdraw that money, it’s taxed at your retirement rate, which could be 15%...down to 0%. It’s a triple win. None of these things are secrets, but it took having them spread out in front of me like so many playing cards to see the obvious. “I’ve been leaving money on the table without realizing it, and spending summer afternoons in a beige cubicle just trying to make up for it.”

Okay, that sounds well and good. Now, about that financial freedom thing. At age 33, how could I even begin to think about retirement? Well, for one, retirement doesn’t mean doing nothing for the rest of your life, it means doing what you want to do before you’re too old to enjoy it. If you want to work on your own terms, fine. If you want to travel, so be it. Bottom line? It means freedom. But here’s the deal… I’m already behind the 8-ball and didn’t know it. So, I’m throwing down the gauntlet; time to put a long term plan into action. I’ll post a follow-up in a few months to see what’s working and what’s not. Time to get serious.

*let someone else take the depreciation hit while still enjoying a competitive APR from the local bank/credit union on an “almost new” vehicle; rates increase with age.