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«FIVE STEPS TO PLANNING SUCCESS. EXPERIMENTAL EVIDENCE FROM U.S. HOUSEHOLDS Aileen Heinberg, Angela Hung, Arie Kapteyn, Annamaria Lusardi, Anya ...»

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Matt and Josh work at a company that holds a lot of tedious meetings but offers some great perks, like delicious lunches during those meetings. They like free stuff, especially good free stuff like the lunches on meeting days. They like free money even better than free food, so when the coworkers found out that their company matches their 401(k) contributions, they had to take advantage of it.

Their employer provides one-to-one matching of employee 401(k) contributions, up to $2000 a year. For every dollar up to $2000 that Matt (or Josh) puts in his 401(k), his company puts in a dollar too.

It’s like an “invest a dollar, get one free” deal.

Just like the buy-one-get-one free deals at the deli across the street.

So, if Matt invests $2000 of his own money in a 401(k) account, then the company puts in the same amount: $2000. That would be $4000 in his account, because the company matches every dollar.

It’s like Matt is getting a 100% return on his investment.

Twice as much gets invested and twice as much grows in his account.

At Josh’s old job, the company matched 50% of employee 401(k) contributions.

His old employer would add half of what Josh put into his 401(k).

If he invested $1000, they’d add $500, bringing his account up to $1500 before even earning money on investments.

That’s not as amazing as a one-to-one-match, but it’s still a lot of money!

Where Josh and Matt work now, there’s something called a vesting schedule.

They’re “fully vested” after 3 years.

That means that after working at the company for 3 years, employees get to keep the entire amount of the employer match in their 401(k) account, even if they leave the company. But no matter what, money that Matt or Josh or any other employee invests in a 401(k), out of their salary, always belongs to the employee. Even if they get fired or decide to leave the job before being fully vested, an employer can’t touch the money an employee contributes.

Basically, employer matches are like free money.

But if you don’t invest in your 401(k), you don’t get the match.

And if you don’t invest the full amount that’s eligible for the match, it’s like leaving free money on the table.

For their part, Matt and Josh aren’t trust fund babies.

They can’t afford to pass up free money! And the buy-one-get-one-free sandwich deal at the deli across the street makes it their favorite spot to go for lunch!

Don’t Put All Your Eggs in One Basket

As she packs up her grandmother’s china for storage, Kate holds up a bowl and reminds her brother Sam that she was always afraid of breaking it when they were kids. Kate and Sam both miss their grandmother, but they each need to decide what they’re going to do with the money she left them.

Kate tells Sam that she’s going to invest her inheritance.

She knows their grandmother wanted them to each have a little “nest egg” for the future.

Sam recalls how their grandmother always said, “don’t put all your eggs in one basket.” For Kate, not putting all your eggs in one basket makes good financial sense and she tells Sam that she’s going to spread her inheritance money around.

At first, Sam doesn’t understand why just putting your money somewhere safe isn’t enough.

But, as Kate tells him, when you’re investing for the long term, you have to take some risk.

Otherwise, there’s no way to make your money grow because the average amount of money an investment earns over the long run is related to the riskiness of the investment. Riskier investments tend to make more money, while less risky investments tend to make less money.

But that doesn’t necessarily mean that riskier investments are better.

With riskier investments, there’s a chance you'll lose money;7 there’s a trade-off between risk and return.

Kate explains to Sam that each asset in his portfolio, every investment he owns, will have some degree of risk. But what he wants to avoid is having a total wipeout and losing everything he owns all at once. For example, if he owns stock from only one company, then he is betting on the performance of just that one company. If it were totally destroyed, say, by a hurricane, his investment would be in trouble. An individual company can be struck by less dramatic difficulties, too.

That’s why it’s important to invest in a mix of assets and not put all your money in one place.

Sam thinks about what Kate is saying, then tells Kate he’s thinking about investing in the company where he works—the company is growing and Sam is confident they’re doing well.

Kate wonders if he’s been listening to her at all!

She tells her brother that the whole point of putting his money in a bunch of different assets is that if something unexpectedly bad happens to one of them, he'll be cushioned to a certain degree. But if Sam invested in the company where he works and that company tanked, both his job and his investments would be in trouble.

That’s where not putting all your eggs in one basket comes


you shouldn’t have your investments and your job tied to the same company, and you shouldn’t have all of your money invested in one company. Instead, spread it around.

Kate has Sam consider the following scenario: What if you invested in a whole bunch of companies, but they all manufactured umbrellas and all of a sudden, the value of umbrellas plummeted? That might sound unlikely, but think about when the tech bubble burst or when the real estate market crashed.

It’s smart to invest in many different kinds of companies and investments. Basically, you want the ups and downs of your investments to be as unrelated to each other as possible so that if some do badly, others will offset those losses.

That’s why it’s a good idea to spread your investments across different countries, too.

Sam looks at his sister with a warm smile. She really is as smart as their grandmother. As they finish packing up their grandmother’s china, Sam is already thinking about ways to go about keeping his “nest egg” of investments in lots of different baskets.

Inflation and the Plaid Shirt

This is the story of how a very cute plaid shirt inspired Lisa to save more for the future. Lisa and Beth were shopping together when Beth spotted the shirt and knew it would look great on Lisa.

But when Lisa saw it, she had a flashback to the 90’s, the last time plaid shirts were trendy.

The new shirt cost $50 and Lisa remembered paying $30 for similar shirts back then. So the word “inflation” popped into Lisa’s head.

Inflation describes price increases over time. Lisa realized that not only do shirts that used to cost $30 now cost $50, but lots of things that used to be $30 are now $50. When inflation rises, the same number of dollars buys less. So the price of a shirt, and other things like haircuts and groceries, can get higher.

Let’s say inflation increases at 4%.

Something that costs $100 at the beginning of the year will cost $104 at the end of the year.

Which doesn’t seem like a big deal, until you consider that, on average, everything is going to cost a bit more.

If your income doesn’t increase, you can’t buy as much as you used to because prices are higher.

Even if you’re making more money than you used to, it still might not be enough if your income didn’t increase as much as the cost of what you normally buy.

When Lisa had her plaid shirt “aha” moment, she realized that prices are higher now than they used to be and they’re probably going to be even higher in the future.

Her friend Beth understood that part, too.

But Beth could not figure out how a shirt could go all the way from $30 in the 90’s to $50 now when it doesn’t feel like the prices make such huge leaps from one year to the next.

Lisa explained that it’s because the price increases build upon one another.

Let’s say inflation increases at 3% every year for 20 years.

A $100 bag of groceries will cost $103 after one year. After 10 years, it will cost $134 dollars, and the 3% just keeps adding up to more and more money so that after 20 years your $100 bag of groceries costs $181. In other words, your $100 groceries cost almost double, closer to $200, 20 years later.

–  –  –

$181 $156 $134 $116 $103

–  –  –

Lisa knows that when she thinks about how much money she’ll need for the future, she needs to consider how much more things will cost.

Since her paycheck won’t buy as much as it used to, she needs to start planning. And if she forgets about inflation, then wearing her cute new shirt will remind her!

Take Advantage of Tax-Free Assets It’s payday and roommates Becca and Emily are making plans to go out for the evening.

Emily touches up her makeup as Becca opens her paycheck, only to discover that while she made $800 that week, the check is for only $640. She hates how much they take out for taxes!

Emily explains that the reason she signed up for a 401(k) retirement account when she started her new job was to protect her money from getting eaten up by taxes.

But Emily’s explanation simply confuses Becca, who doesn’t understand what a retirement account has to do with taxes.

Emily sits down with her roommate to explain. Everyone pays income tax on their salary. For example, if you’re in the 20% tax bracket, then 20% of your salary goes to the government and you don’t get to use it.

But if you start a traditional 401(k) retirement plan, you can contribute pre-tax money to that account. You can contribute a portion of your salary straight to investments, without paying taxes on it, so there’s more money for you.

With a 401(k), your contributions grow tax-free.

You don’t pay taxes on the account until you retire, when you probably won’t be earning as much and therefore will be taxed in a lower tax bracket.

While this sounds like a good idea, Becca asks what would happen if she wanted to take money out before retirement. Emily explains that if she withdraws money before she is 59 and a half, she will have to pay taxes and will get hit with a penalty fee, too—so it’s not usually a good idea.

But the problem for Becca is that she doesn’t think her employer offers a 401(k) plan.

Emily explains that there are other options.

IRAs are another type of retirement account and you don’t have to get them through your job; you can get them yourself. As with 401(k)s, there are traditional and Roth varieties. Traditional IRAs protect your money from taxes when you put money in. And Roth IRAs protect your money from some taxes at the end, when you withdraw money during retirement.

Those aren’t the only types of retirement accounts available that protect money from taxes.

Lots of non-profit and government jobs offer similar types of retirement accounts that work in the same general way as 401(k)s and IRAs.

When you’re saving for retirement, it really pays to take advantage of these types of accounts and not give any more away in taxes than you have to!

That’s why Emily contributes to a 401(k).

Becca and Emily head out the door to their usual happy hour spot, with Becca thinking about how great it is to have friends who can give you financial advice and Emily thinking about whether the cute new bartender will be at happy hour!

APPENDIX C: Video Links

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