One of the most memorable lessons from my days at Harvard Business School was the day my professor posed this question: “What is your biggest fear?”
He wanted us to write it down, but what we didn’t expect was when he asked us to share our fear with the person sitting next to us. To my surprise, the guy sitting next to me — an investment banker who made a lot of money — had written the exact same thing that I did. We both feared running out of money.
Fear and lack of confidence are two of the biggest factors that hold women back in financial literacy compared to men, and the answer to overcoming that is deceptively simple: gain more confidence by focusing on what you can control: career, spending and savings.
Because of major life events such as the death of a spouse, divorce or the need to assist elderly parents, there’s a 95 percent chance that women will be the primary financial decision-maker at some point in their lives.
To do that with confidence, women need to get a stronger grasp on basic math.
I’ve created the 30/20/10 framework below to help women understand where their money goes, and how to be more purposeful about saving and investing.
For most women, their largest expense is their home mortgage or rent. When a major life change occurs, such as divorce, some women discover that they can’t afford their home on just one income.
Power Tip #1: Affording your nest (30%)
Your rent or mortgage monthly payment should be no more than 25-30% of your after-tax income. For someone who makes $100,000 after-tax, that means your rent or mortgage should be no higher than $30,000/year or $2,500/month.
Imagine that in 10 years, you will gain 100 lbs. If you could do anything in your power to prevent this, would you? Of course, you would, because you know you are in control of what you eat and how much you exercise.
Now let’s reframe that question. Imagine that in 10 years you will be completely broke. If you could do anything in your power to prevent this from happening, what would you do?
UCLA psychology professor Hershfield and his colleagues found that when they showed their subjects age-advanced photos of themselves, then gave them a hypothetical opportunity to put money into a savings account, the subjects put twice as much money into the account as those who were not shown the photos. When they could identify their future selves, they were far more interested in saving for that person.
So how much do you need to save?
Power Tip #2: You’ve got the Power to Save (20%)
Try to save 20% of your after-tax income in your 401(k) plan and/or your savings account. If your after-tax take-home earnings are $100,000, that’s $20,000 per year you should be saving! As Warren Buffet once said, “Do not save what is left after spending, but spend what is left after saving.” Your future self will really appreciate that you did this today!
What if you could boost your savings with some savvy investing?
Unless you’re getting promotions or huge bonuses, most people will only get cost-of-living pay raises that are pegged to inflation, which is about 2% per year. However, the cost of some goods such as health care, college tuition and food is increasing at a faster rate, so you’re effectively taking a pay cut some years.
One great way to grow your investment is to put a portion of it in the stock market.
Power Tip #3: Invest for Long-Term Growth (10%)
Over the last 40 years, the S&P 500 index has returned 10% on average, and that’s a much better return than inflation-anchored pay increases. Yes the market rises and falls, but if you are investing for the long term, you don’t have to worry about the short-term ups and downs.
When should you start saving and investing? Right now! The benefits of compound interest are much more valuable over the long term.
Power Tip #4: Take Advantage of Compound Interest (It’s like free money!)
Let’s say you’re starting to invest for retirement and you have an initial investment of $20,000 from the example above. Based on the “Rule of 72” — which is a simple way to determine how long it will take an investment to double based on a fixed annual rate of interest — and a return of 7.2% per year, it will take a decade to double your money to $40,000.
Just like when you buy a house and make a mortgage payment each month so that in 30 years you will pay it off and own it, think of retirement savings as being indebted today to your future self. Pay it forward so you can be fabulously financially secure!
Here’s a great compound interest calculator from the U.S. Securities and Exchange Commission. And here’s another calculator that shows the difference between compound interest and simple interest.
Lastly, it’s important that you spend your disposable income wisely and really think about each purchase you make. Your future self will really appreciate you investing for her and not spending money on things you don’t need. How many shirts do you have in your closet that you have never worn? What if that money could have been invested in instead? Think of your future self and what she would want you to do.
Power Tip #5: Create a Household Budget & Stick to It
Budgets can be intimidating to women, but it’s easy and you only need to know how to add, subtract, multiply and divide.
Women still lag behind men in retirement savings, household savings and earnings.
In a recent survey by the Transamerica Center for Retirement Studies, only 47 percent of women say they are building enough for retirement compared with 62 percent of men.
Now is an excellent time for women to seize the day, disrupt that trend and get more engaged in growing their wealth so they can secure their financial future.
Running the numbers can help you understand why your money isn’t working for you, and a financial planner can help you understand your needs and your desires, set specific goals, and create a roadmap for getting there.
It’s one of the easiest things you can do to gain confidence in financial decision-making, and it all starts with basic math that’s as easy as 30/20/10!