The Path to Financial Security
December 06, 2013
The need for personal security seems to be hard-wired into humans, reinforced by eons of experience since early man first ventured from the trees to seek an existence in a hostile world. Modern man no longer worries about saber-toothed tigers or the availability of sufficient prey; the object of today's fears are rooted in future employment status, global economic events, and government actions that can complicate or devastate comfort and security.
Ancient man prepared for the future by learning to preserve food, rationing supplies for use at a later date. Civilized man prepares for the unknown by storing up modern-day units of exchange in the form of currencies, savings accounts, stocks, and bonds. While our ancestors' savings were subject to the perils of spoilage, physical theft, and pests, our own savings are subject to their modern day equivalents - chance, taxes, and inflation.
As it was then, so it is now - the path to financial security isn't always easy or clear. That said, with guidance on what to save, how much to save, and when to save it, you'll have the tools to start developing a stockpile of financial security for the future.
The Decision to Consume or Invest
The decision to consume or save has plagued mankind for centuries. Aesop, the ancient Greek storyteller, used the fable of the ant and the grasshopper to illustrate the importance of preparing for days of necessity. "Why bother about winter? We have got plenty of food at present," said the grasshopper, only to die of hunger when the harsh days of cold eventually arrived.
No matter your income level, savings is only possible when you make the decision to consume less than you earn. Some people, like the grasshopper, mistakenly think that good times will continue forever. They believe their skills will always be in demand, good health everlasting, and age will not diminish their capabilities or competence. Perhaps some are right, but the vast majority, like the grasshopper, discover that rainy days, even rainy seasons, are inevitable. Failure to build financial security by saving during the good times will likely result in tragedy later.
Your Definition of Financial Security
How do you define financial security? Does a person with $10 million in the bank feel more secure than a person with $100,000? It depends, of course, on the person and his or her circumstances. Financial security is, at its essence, extremely personal. How much money you need to feel financially secure depends upon your:
Age. An older individual with the financial responsibilities of a family and home, along with an ever-looming retirement, likely needs more money in the bank to feel financially secure than a newly-minted college graduate. Paradoxically, the younger you are, the greater the opportunity you have to achieve financial security simply because you have time on your side. The money you save today can be compounded for the future, earning interest as you build a secure nest egg. If you delay saving, playing catch-up comes at a significant price. According to the Bureau of Labor Statistics, for every 10 years you delay saving for retirement, you must save three times as much each month to catch up.
Relationships and Responsibilities. Beginning a family, buying a house, and educating children are major financial liabilities usually undertaken as a 20- or 30-year old and completed between the ages of 40 and 50. Thus, the amount of money necessary to feel financially secure grows quickly in mid-life as these events take place. At retirement, the funds necessary to feel financially secure must equal the income needed to maintain your current lifestyle until you die - possibly longer than 20 years. It may not be pleasant to think about, but failure to plan ahead could result in tough times throughout your golden years.
Health. Unless you're genetically blessed, maintaining good health, particularly as you get older, is expensive. According to a 2013 Fidelity Benefits Consulting study, a 65-year-old couple retiring this year needs $220,000 just to cover out-of-pocket medical expenses for the remainder of their lives. If you have a chronic illness, you may need significantly more. As government policies about healthcare change, the funds you need for the future may also change, but it's better to prepare for the worst and hope for the best.
Purchase Ratio of Necessities to Luxuries. Trying to distinguish what we need from what we want has always been difficult. It's especially difficult in a free market society rife with sophisticated marketing, psychological manipulation, and the ability to defer payments with credit. Being resistant to instant gratification reduces the amount of funds you need to feel financially secure. The ratio you feel comfortable with is highly personal, and something you have to determine based on your income level, how much you hope to save, and what your family's lifestyle is like.
Tools of Financial Security
As you pursue the goal of financial security, you should take advantage of the following tools to quantify your goals and maximize your achievements:
Budgets. Accurately projecting your income and rationally determining how much you spend, including how much you regularly save, is critical to amassing the funds necessary to meet your goals. Furthermore, budgeting encourages discipline in all aspects of your financial life - how much you save each period, what you purchase, and the investments you make.
Investment Scholarship. Learning the advantages and disadvantages of various investment vehicles, their potential risks, and unique opportunities, is essential in making successful investment decisions. Whether you take the time yourself to learn the nuances of investing, or rely on the advice of a professional counselor, knowledge is key to long-term rewards. You should never make or keep an investment you do not understand, always keeping in mind the old investment adage: "There is no free lunch."
Tax Planning. The U.S. Tax Code is incredibly complex and full of opportunities to reduce or eliminate taxes for those willing to take the time to learn its intricacies. While paying taxes is required, there's no law saying you should pay more than you owe. Use the tax advantages available to you to increase your annual net income while saving the difference.
Insurance. The consequences of some events are so dire that they necessitate the risk of their occurrence to be transferred to another party. For instance, no parent should ever bear the risk of death without life insurance, as the consequences of an unexpected demise would be catastrophic for the surviving family. Insurance, property and life, is an over-looked and under-used component of financial security, and is just as important as your initial decision to prepare for the future.
Financial security is largely a state of mind, and is readily available to most who seek it. The feeling of security is not a specific sum of money, but a determination that you're prepared for whatever the future may hold. Setting a financial objective, understanding the factors that help or hinder you along the way, and acting with discipline and persistence will lead you to your personal definition of financial security.
How much do you want to save in order to feel financially secure?
---Mike Lewis is a retired business exec who writes about personal finance tips related to budgeting, investing, and money management.