How to save more, even as inflation bites into income

Saving money could become more difficult in the coming months, with inflation a problem and tens of millions of Americans without even a modest emergency fund.

Tax season is over, which means two out of three Americans have recently received a refund, which is a nice cushion. But for many people, the hard work starts now.

Here are several tactics and strategies, some quite simple, that could make saving easier.

Reframing the problem

Workplace 401(k)-style plans can be a great way to accumulate money, combining tax advantages and employer matching funds with the convenience of diverting money from every paycheck. . But many people still underuse these programs, perhaps because they don’t understand what it entails.

Participants in 401(k) programs must start by deciding what percentage of each paycheck they want to save, but the percentages confuse many people, according to a study by researchers at Carnegie Mellon University, Cornell University and UCLA. Rather than talking about percentage savings, employers could encourage participation if they explained it by giving up a penny or two of every dollar earned.

Financial advisor George Fraser helped popularize this penny approach. In meetings with potential 401(k) participants, he often throws pennies on the floor to see if anyone picks them up. Few people do. “Pennies don’t make sense to most people,” said Fraser, managing director of the Fraser Group at RBG in Scottsdale. “But they can really add up.”

The academic study, conducted in association with the Voya Behavioral Finance Institute for Innovation, randomly divided 401(k) participants into two groups. Workers in the first group were asked what percentage of their salary they could invest in their retirement programs. People in the second group were asked how many pennies they could save for every dollar earned.

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Workers who were asked to set a percentage voted for an average savings rate of 6.9%, while those who thought in pennies opted for a higher rate of 8%. The impact was most dramatic among low-wage workers, the researchers said.

Employers who automatically enroll workers in 401(k)-type programs tend to report higher participation rates, as do those who gradually increase employee contributions over time (unless workers opt out). ). Explaining savings choices in terms of pennies, rather than percentages, could further stimulate participation.

Other Ways to Boost Savings

Although the study focused on increasing pension plan participation and contributions, there are other applications. The pennies approach could also be used to build a rainy day fund or add money to health savings accounts, for example. Having a rainy day fund can be the difference between dealing with unexpected expenses or having to max out credit cards or resort to high cost payday or auto loans.

Additionally, people could use the penny framework to allocate their money to multiple accounts at once. For example, the academic study suggested that people might want to divert, say, six cents of every dollar earned to a retirement plan, plus two cents to an emergency fund, and maybe another two cents to a savings account. health savings.

This research, while simplistic, may help illustrate the basic concepts better than traditional approaches. “In this industry, we tend to overeducate,” Fraser said.

Also, the terminology used in finance is often unnecessarily complicated or vague and possibly misleading, he argues.

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Play less, save more

Everyone deserves time for fun, hobbies, and hobbies, but many people might overspend on non-essential activities if it puts their finances at risk. Often the sums seem insignificant, but they can add up.

In 2021, for example, Americans spent $60.4 billion playing video games. The average gamer spends around $76 per month, $912 per year, and over $58,300 over their lifetime. according to All Home Connections, a gaming and technology research company that surveyed over 1,000 gamers about their gaming habits. These figures include spending on Internet, games and equipment. Lifetime total assumes 64 years of play, ages 16-80.

This is a large sum of expenses which, instead, could be used to amass a large nest egg. The average gamer would generate more than $271,500 at retirement age if they invested the average monthly outlay of $76 and could earn an average annual rate of 6% from age 16 to 65, according to All Home Connections.

The same analysis could be applied to other non-essential expenses, from travel to movie tickets. Obviously, people should be able to spend however they want, even on things that might seem non-essential to others. But the study illustrates the potential of cutting costs here and there and pouring the money into investments for long-term growth.

The analysis is similar to the one made five years ago by Fran Kinniry, investment director of the Vanguard group. He cited a daily cup of coffee at Starbucks to illustrate how today’s spending decisions can affect long-term wealth accumulation.

Kinniry figured you could save at least $1,260 a year, or almost $3.50 a day, for every cup you brewed at home rather than buying from a restaurant. If you invested that $1,260 for 30 years, earning 6% per year on average, you would generate about $106,000.

To simplify the tax impact, he assumed the money was invested in a low-cost balanced mutual fund and held until age 59½ in a Roth Individual Retirement Account. Roth IRA balances grow tax-deferred and withdrawals are tax-free.

Decide between needs, wants

If money starts to tighten a bit, more Americans will likely start paying more attention to budgeting. Sticking to a budget isn’t always easy, in part because keeping track of all those expenses can be tedious. This is where relatively simple approaches like the 50/30/20 rule can help.

This concept of budgeting is based on the notion of dividing your expenses between needs, wants and savings/debt reduction on a 50/30/20 basis. Needs or necessities of life such as grocery bills, utility costs, and rent or mortgage payments should be the priority of your budget, accounting for 50%. Wants come next at 30%, followed by savings and/or debt reduction at 20%.

Some items are not easy to categorize. Most people would consider leisure travel a luxury and therefore a necessity, but what about a gym membership? It can be seen as a need or a want, depending on how you perceive your health and fitness.

The 50/30/20 approach therefore requires a bit of thought, planning and analysis, like other types of budgeting. But it could be a decent option for people looking for simple guidance and a discipline framework.

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Carol M. Barragan