Income is the sexy side to any budget, though often times its the hardest to change. It feels good to see that paycheck hit your bank account. Then you think another split second about all the bills and expenses you have to pay, grab that glass of scotch and head to your man cave in the garage to sob. For most people working an 8-5 job, the belief is that your paycheck is it and that your income is pretty fixed and that for any budget you have to live within the strict confines of those paychecks. That doesn't always have to be the case.
In this post I don't really want to focus on finding a second job or offering tips to make money after you get off of work. What I want to look at is how to make money 24/7. "It takes money to make money". Make your money work for you. The compound effect of earnings on your income can be drastic and is the essential key to saving for retirement. Besides being Michael Jordan or Mary Kate and Ashley Olsen (forget about Full House, I'm talking straight to VHS "It Takes Two" baby!!), most of us will not make a vast sum of money in a short time, enough to retire off of. That being the case, it is essential to make compounded earnings build your nest egg and then do your darndest to live off the income that nest egg can produce (I think reading that sentence would make Darwin cringe).
Albert Einstein once said "The most powerful force in the universe is compound interest." You can take that to the bank. Some areas of focus:
1. 401k's
2. Investments
3. Equities
4. Bank Accounts
The 401k is the BASIS for most retirement portfolios. Acting like an investment account it can typically be made up of equities, bonds, cd's etc. and can be tailored to suit your personal risk aversion. More importantly, a traditional 401k is tax deductible, meaning you have preserved the basis of your savings and it can grow that much faster not having been trimmed by Uncle Same. There is a Roth 401k which is the opposite (pay taxes now, no taxes later on the realized gains). Really these two are the same, but have different tax strategies involved which I can go into in further detail elsewhere. There are IRA's, Roth IRA's and other retirment vessels but we won't get that deep now. What's important to take away, is that this is an EASY chance to really save LONG TERM, by having money directly taken from your paycheck and put into an investment account. With certain exemptions (which I will talk about elsewhere) you can't touch it until you reach retirement age, so its really like a caterpillar in a cacoon for 40 years doing nothing but growing into a beautiful butterfly. Here is the best part...MOST companies will match your contributions (percentages will vary) up to a certain amount. ITS FREE MONEY!!! As an incentive program, they will add on to your savings with a company match that will not only provide free money the day you get it, but ALSO earn investment or interest earnings over the life of the 401k. Its truly a beautiful thing in that every time they match your contributions, that "bonus" will keep generating revenue until you retire. If you work somewhere that has a match you are kicking your own butt by not contributing to your 401k. Its leaving money on the table and absolutely foolish. As a rule of thumb, I would shoot to put at least 7% of your paycheck in your 401k, more is always better and if you get a raise, rather than having more spending money, bump up your contribution rate.
Investments are a key to any retirement portfolio. Unlike a 401k, having your own investments provides greater liquidity and access to your money without any penalties should you need or want it before retirement. The key to managing your investments is diversification. Spreading it out over a number of assets (assets that appreciate - cars and watches don't count). Retirement is based a lot on luck in the sense that your portfolio could be way up or way day right at the time of your retiring. Someone who retired in 2007 probably did not feel good in 2009 with the market collapse that would have eaten away at their retirement cushion with no income to fill the gap. Conversely, someone ten years away from retirement in 2007 could be investing in a number of things at historic lows and ride the gravy train until their retirement under the assumption you usually make the most money in your life right before retiring. Diversification is the way to avoid as much of this "luck" as possible, its all a timing issue. Spreading your wealth over equities, bonds, real estate and commodities can provide you with growth opportunities across the board but not subject you to the harshest of realities should one of those investment platforms tank right before your retirement.
Equities, or stocks are a great start in seeing growth or income. Historically, the stock market has provided the largest returns out of any investment vehicle. With it comes more risk and bigger fluctuations, but if you are young, a suggestion would be to invest more heavily in equities as you can ride out the ebb and flow of the market over very long periods. Additionally, focus on large cap multinational stocks with good balance sheets and large DIVIDEND YIELDS. This is where a company pays you for every share you own a certain percentage of what they make. With companies like AT&T paying around 6% or Pepsi and McDonalds each paying out 3% each, even in a flat position in stock appreciation, you will still be earning more from the dividends that you would in a money market or CD account.
As you get older and become more risk adverse (avoiding risk) bonds and real estate may be a better play. They still carry solid historical growth, though smaller than the stock market but typically carry less risk. As long as you structure these investments so that you have access to your funds down the road, this may be a more solid investment strategy than stocks in the latter part of your career. But the key is to always own as many of these as possible. The percentage of your portofolio it makes up is what you will tweak as you markets change and as you come closer to retiring.
What you should try avoiding is first NOT SAVING and secondly HOLDING CASH. Putting large amounts of cash in your Bank of America account will do nothing for the growth of your income and increasing your potential budget. I'm not saying don't put anything in the bank, but if you have more cash than you have budgetted to spend in the next 6-12 months, its time to think about what that money could be earning somewhere else.
Think of it this way: If you had $10K cash making 1% in the bank (that's generous right now) you would make $100 over the course of the year. THAT'S EXTRA INCOME, this is a good thing when you compare it to spending it on a car or buying a bunny hutch for your office. But lets compare that to buying $10K in large multinational stocks paying an average dividend yield of 3%. We won't speculate as to whether or not the stocks go up or down. Just keep in mind that more often than not they go up but you can't rely on that. That 3% yield has now generated $300 in income. Finally lets take that $10K and put it into commercial high grade bonds (such as GE debt) at 5%. Now in a year, your savings makes $500. That's a lot of scotch or butter, but lets continue down this path. If you didn't spend that income but reinvested it in the same product, that $500 dollars would generate $25 the next year, so your original $10K investment would have earned you $500 in year one and $525 in year two. That's compound interest baby. You extend that out 20 or thirty years and you're talking about some serious income.
That, ladies and gentlemen, is how you boost the Income side of your budget. Its slow, its not as sexy and you have to show some self control. But in a world of making choices, saving and investing your income can open a whole lot of doors for you down the road.
Sincerely,
Coco
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