Competitor: This article comes from Julie Rains.
Entry Category: Best Ways to Earn and Save Money
Finding the time to focus on finances is not easy. And, if you share financial responsibilities with someone, carving out the hours needed to make decisions together can be a challenge.
The process can be arduous: research financial products and services; educate yourself on options; consider tax consequences of money-related moves; look at fees for account openings, maintenance, and closings; decide on a course of action that meets your needs and goals; and follow through on a plan.
Sure, when you get started, you may be excited about the endless possibilities. But the demands of day-to-day life can overwhelm the novelty of making complex financial decisions, especially as you move from one of life’s milestones to another. Plus, you’ll often need to revisit your decisions at regular intervals to make adjustments based on changes in your circumstances, introduction of new products and investment offerings more suitable to your needs, changes in tax legislation, etc.
There are scenarios, however, in which you can mindlessly save money and even build wealth. Consider these techniques for putting savings on autopilot:
Set up a direct deposit for your savings account
Arrange a direct deposit of a portion of your paycheck to fund your savings account automatically. Choose an amount that you can live without for long periods of time. For example, you might arrange for a deposit of $100 per pay period or per month.
In a few years, you should have set aside 3-6 months of living expenses as an emergency fund. Rather than stop when you reach a certain number, keep saving automatically so that you will have cash when needed.
Use the money during financial emergencies or crises, such as unexpected home repairs or months of unemployment. Or, access the money to help with a life transition, such as a leave of absence for the birth or adoption of a child, extended travel, or start-up of a new business.
You will probably spend and replenish these funds over the years. But if you never use this money, the account balance will steadily increase. For example, if you set aside $100 each month for 30 years and earn interest of 1%, the account will grow to over $40,000.
Max out your 401(k)
Enroll in your employer’s 401(k). Decide whether you want to defer taxes now with the traditional type or skip taxes when you withdraw the money later with the Roth version. Examine and choose investment options. Consider the quality of the plan using outside resources.
Sign up to contribute the maximum amount, which will vary depending on the plan’s design (which may limit contributions to a certain percentage) and IRS regulations that allow you to contribute $12,000 in a given year. For mindless investment, set up the contribution as a percentage of your paycheck rather than a specific dollar amount so that you won’t have to make changes when you receive a pay raise.
Over time, the value of the 401(k) should increase significantly if your employer offers a quality plan with low fees. For example, if you contribute $8,000 each year for 30 years and experience investment growth of 6%, the account balance will grow to more than $600,000. Employer matches (if available) will increase the account’s value.
Periodically, review and update investment options and account allocations. Pay attention to fees as those will reduce your overall return. If you change employers, roll funds over into a self-managed or advisor-directed retirement account. Or, keep the account with your former employer if you are pleased with the investment returns, account administration, and fee structure.
Set up automatic deposits to an IRA
Open an IRA, either the Traditional or Roth version. Choose your investments among offerings that might include individual stocks, mutual funds, certificates of deposit (CD), or other holdings. Figure out the best way to execute your investment plan; that is, find out how to acquire mutual fund shares or contribute to a CD regularly, possibly setting up a brokerage account, buying directly from mutual fund companies, or working with your bank or credit union.
Fund the IRA by setting up automatic deposits, which may allow you to avoid having to come up with $1,000 or $2,500 to open the account.
Contribute the maximum amount possible each year. Unless you earn too much money, you can contribute up to $5,000 each year. (Note that you can lower your modified AGI by contributing to a traditional 401(k) and become eligible to fund an IRA if you are otherwise limited.)
Let the IRA grow. For example, if you contribute $5,000 each year for 30 years and earn an investment return of 6% each year, then your account balance will grow to nearly $400,000.
Periodically, review your investments, update your holdings, and change financial institutions to accommodate your investing needs.
Contribute self-employment earnings to a SEP-IRA
If you generate income from self-employment, you can establish a SEP-IRA and contribute a healthy portion of your annual earnings to this account. Select investments in the same way that you make choices for an IRA. Enlist the assistance of your tax advisor and financial institution representatives to help you comply with IRS regulations.
After the account is set up, contribute about 15% of your annual income (if you own the business, you can contribute up to $50,000 or 25% but the IRS uses a more complex calculation that reduces this percentage if you are self-employed). Because of IRS rules and income uncertainty, funding the SEP-IRA may not be as simple as an automatic set-up with the traditional or Roth IRA.
A couple of ways to mindlessly fund the account are 1) use money from your cash reserves or 2) set aside 15-20% of your net income each month in anticipation of SEP-IRA funding. Make deposits at year-end or before April 15 of the following year when you know the exact amount of your income. Replenish your cash balance with an additional tax refund that you may receive as a result of SEP-IRA contributions.
Save part of your freelance earnings or consultant billings to build wealth. For example, if you generate $30,000 from self-employment annually, you may be able to set aside $4,500 each year in a SEP-IRA. After 30 years, if you earn 8% return, then the account will be valued at more than $500,000.
Similar to the IRA, periodically review your investments, update your holdings, and change financial institutions to accommodate your investing needs.
Set up automatic deposits for your Health Savings Account
Fund your Health Savings Account (HSA) through automatic deductions from your paycheck or from your checking account. If you have a high-deductible health plan that is HSA-Eligible, then you may be able to set up an account through the health plan provider. But you should also have the option of setting up an account with another financial institution that is a qualified HSA trustee. Consider and choose various savings and investment options, which may range from FDIC-insured savings accounts to stocks, bonds, and mutual funds.
Similar to the cash reserve fund, the purpose of this account is to have cash available when you need money for medical expenses. Generally, you will use and replenish the fund. The advantage of the HSA is that you can get a tax deduction for contributions, enjoy tax-free investment growth, and pay no tax when you take out the money for qualified medical expenses.
The account value may grow if you have a really high deductible and really low need for health care. For example, if you contribute $2,500 each year for 30 years and earn 3% each year and don’t touch the money, the value will increase to more than $115,000. In retirement, you can take distributions for non-medical expenses that will be taxed at ordinary income rates, similar to a traditional IRA or 401(k).
Periodically, review your health plan and choose a better option (which may not have a health savings account). Also, analyze and update the investments associated with the account to maximize its value to you over time.
Get a short-term mortgage
Get a 7-year, 10-year, or 15-year mortgage on a residence that you’ve acquired for a fair price. Make sure that you can afford the payments and can handle additional home costs.
The value of a shorter-term mortgage is not necessarily the cost savings associated with reduced interest over the life of the loan. You can get those benefits simply by paying extra on the principal periodically. The advantage of the shorter-term mortgage is its mindlessness.
You don’t have to consider how much extra to pay at any given time. You don’t have to consult with your spouse about whether you should use a bonus check, gift from your parents, or tax refund to reduce your principal. Plus, when mortgage rates go down, you don’t have to bother with refinancing to take advantage of lower rates.
Simply pay the monthly payment, no more and no less. In 7-15 years, you’ll be mortgage free. Depending on the value of your home, your net worth will include $100,000 to $300,000 (or more) of real estate.
Just remember to have insurance and property tax bills sent directly to you and not the mortgage bank after you pay off the loan.
To build wealth and accumulate a million (dollars) of assets over a working lifetime, you’ll need to take advantage of 3-4 of these mindless ways to save. You may find that automating your finances frees up your time and energy. Then you can focus more on earning, finding fun ways to spend less, and generating the funds to set aside for regular savings, 401(k) plans, IRAs, HSAs, home mortgages, and more.
Have you been able to save mindlessly? How often did you revisit your decisions and change your course of action?