Save for Retirement Without Skipping Vacations

The retirement problem is real.

Working Americans are saving far less than they should be in order to retire comfortably: about $6.6 trillion less, according to recent survey by Boston College’s Center for Retirement Research. (Yes, that’s “trillion” with a “t.”)

There are many reasons for this retirement gap — and many ways that you, the individual investor, can try to personally “beat the average” when it comes to retirement preparedness.

In this post we focus on one problem in particular: our habitual tendency to compartmentalize our financial decisions.

Financial Buckets and Suboptimal Decisions

We compartmentalize in order to organize our financial lives. We have monthly necessities like housing and food, we enjoy discretionary spending like concerts and pedicures, and we need to save for near-term goals like buying a car, going on vacation, and retirement. By creating separate “buckets” for each of these major categories, we can keep track of what’s coming in, what’s going out, and what to prioritize.

The problem arises when we make individual decisions in one category without taking the larger context into account. When this happens, it is often the longer-term priorities that suffer.

Either we put longer-term goals off, figuring that we can come back to them later, or we create false trade-offs. “If I start saving for retirement now, I can’t take that nice vacation next year,” you might say.

Saving for retirement starts to seem like a strict diet: to get to your goal, you have to give up all the things you love.

Find the Right Balance

As many of us know, those strict diets and other virtuous resolutions we make on New Year’s Day tend not to last too far into the year. It’s hard to constantly deny yourself the things that make life enjoyable.

What any successful dieter could tell you is that long-term success depends on balance. Making a few small changes — portion control, timing your large meals earlier in the day, or snacking on fruits and vegetables rather than potato chips — is more likely to keep the weight off than going on an intense two-week juice cleanse.

The same can be said of balancing short-term goals like vacations with long-term prerogatives like retirement. Successful retirement planning is not about sacrificing everything else along the way. Rather, it’s about finding that right balance between enjoying today and ensuring that you will be comfortable tomorrow.

Set Achievable Benchmarks

That’s fine, you may say, but where do I start?

Here’s one suggestion. If you have a company 401(k) plan, contribute enough each month to maximize your employer’s matching program. This is a benefit in which your employer matches your contributions, up to a defined limit. (They might match dollar for dollar, or they might match a certain percentage, such as 50 cents for every dollar.)

Don’t leave the money on the table. Take advantage of this match.

Now you can figure out how much you have left for other goals like vacations. Remember that whatever you contribute to your 401(k) is tax-deductible, and that may mean a bigger tax refund next April. Maybe you can use that bigger check from Uncle Sam to take a nice vacation in August. Or maybe you can stockpile those tax returns for a couple years – and then use it to fly to Hawaii.

Short Term Goals Need Strategies, Too

We normally don’t think about investment strategies for short-term goals like saving for a vacation. Asset allocation, investment selection, tax optimization – these seem like decisions for a long-term investment goal like retirement.

The problem with thinking like this is that, in today’s environment of 0% interest rates, you might as well just put the cash underneath your mattress. Real short-term interest rates are negative, meaning that you will actually lose purchasing power by keeping all your short term goal funds in a traditional bank savings account.

Think Like an Institutional Investor

What’s a good alternative to the traditional savings account? You may want to take a page from the world of institutional investing.

Nonprofit endowments and foundations tend to follow variations of the “4% rule.” This states that you should keep a diversified portfolio of assets mostly intact — but you can safely withdraw around 4% of the portfolio value per year (within prescribed risk parameters). The investment committees responsible for stewarding the foundation’s portfolio try to meet the 4% requirement, plus build some spare capacity.

Of course, as an individual you are not bound by the same operational constraints as a professional charity. Your spending needs may be 0% one year, 2% the next and so on. But setting up an investment account for your periodic short term goals – separate from your 401(k) and other retirement accounts – may be a wise way to plan for those goals.

For example: Let’s assume that you can put $50,000 into your “short-term spending portfolio.” You invest this in a mix of stocks and bonds.

During years when the market is high, you might withdraw 4 percent, or $2,000, to spend on a Florida or California beach vacation. During a down economy, you might decide to skip a vacation. In other words, you yourself can follow the “4 percent rule” for your discretionary spending. Over time, your base will grow.

Fortunately there are plenty of resources available to help you manage your money. Making sure you are saving enough for retirement should be first and foremost — and services like Jemstep are there to provide the advice and guidance you need. If you plan wisely, there’s plenty of opportunity to have fun along the way.