In last week’s column, I adumbrated the formidable financial challenges that young Orthodox Jewish families face vis-a-vis most American families. Our spending priorities include high-ticket items such as yeshiva education and charitable giving. And many of our basic expenses such as food and shelter are on the high end of the spectrum. The conclusion was that a typical young North Jersey Orthodox Jewish family of four requires a basic income level that is nearly double that of the average New Jerseyan.
Because of this income challenge, a robust financial plan is particularly important in determining a long-term path to financial stability. Creating a financial plan and acting proactively to stay on track with that plan provides a burgeoning young family with the confidence that they can meet their financial obligations while realizing achievable financial goals.
Let us once again refer to our young couple who live happily in Bergen County with two young children. Let us further assume that both spouses are employed and collectively earn $150,000 in income per year. While that level of income is considered relatively high in comparison to the average American family of four, I posited that this level of income in many cases might only cover non-discretionary expenses with little available for savings. And as we know, as the children grow up, those expenses will also grow.
Now we can safely assume that as the couple succeeds in their respective careers, their incomes are likely to grow, hopefully at a faster pace than their expenses. Thus, discretionary income will also likely grow. That discretionary income can be an important source of savings.
One of the important bits of advice I try to impart to younger couples is that despite their challenges balancing the family budget, it is of paramount importance to contemplate long-term savings needs. Bar/bat mitzvah celebrations, college tuitions and weddings are among the many high-cost items that require advanced planning from a financial standpoint. Despite the day-to-day financial challenges, young families are advised to look carefully for any available funds to help plan for future needs.
Planning for Retirement
One of the most critical long-term needs, which requires planning well in advance, is retirement income. With the secular decline in availability of employer-defined benefit plans (i.e., pensions), we all need to save a prodigious amount for retirement living. Social Security is one important source of meeting retirement income needs. But given the high cost of living in the Orthodox Jewish world, Social Security income is far from sufficient.
One of the most effective ways to save for retirement is with an employer-sponsored 401(k) plan. Many of these plans feature matching contributions from the employer. Thus, 401(k) plans are highly beneficial vehicles for wealth accumulation. Let us look at an example of how effective these plans can be.
Let us assume that an employee is offered a plan where the employer matches half of the employee’s 401(k) contribution up to 3%. If the employee earns an annual salary of $100,000, and contributes 6% of that income into the plan each year, he/she will be adding $9,000 per year into the plan. As a result of the matching contribution, the participant will have effectively generated a 50% return on their contribution (the employer’s 3% matching of the employee’s 6%). I do not know of any investment where one is guaranteed a 50% return on day one, even before investing the funds! An added benefit of the 401(k) contribution is that it reduces one’s taxable income (although taxes will be paid when funds are distributed at retirement). The resulting tax benefit means that the effective cost of making that contribution is much lower than the nominal $6,000. The nest egg that one can build over one’s working career by consistently making these contributions goes a long way in addressing income needs for a couple’s retirement years.
It’s Never Too Early to Start
In December 2018, I was interviewed by Rabbi Ronald Schwarzberg, director of Jewish career guidance and placement at Yeshiva University’s Center for the Jewish Future. The purpose was to help create resources for aspiring pulpit rabbis on specific topics related to their future pastoral duties. Our session was focused on how rabbis can better counsel congregants on financial issues and stresses. We examined how families can avoid the pitfalls of poor financial planning and budgeting. One of the points I emphasized was the importance of beginning savings programs as early as practical.
Let us again focus on our young couple who are considering making an employer-sponsored 401(k) plan the centerpiece of their wealth accumulation strategy. Let us assume that one of the spouses (age 25) is qualified to begin making annual contributions of 6% of his/her $100,000 salary, which will be matched with 3% from the employer sponsor. The spouse consistently makes similar contributions for the next 40 years. Let us further assume the equity returns for the 40-year period are on the low end of historical 40-year returns of the S&P 500 average. Based on our proprietary modeling of this scenario, the portfolio could easily grow to over $3 million.
Now, let us examine a similar scenario, but where contributions are deferred until the age of 45 and continue through retirement at age 65. Thus, the total contributions will be half the total in the first scenario. In this case, the portfolio is calculated to grow to just under $500,000 by retirement.
The Power of Compounding Returns
One may ask: If one is contributing only twice as much in the first scenario as in the second scenario, why is the portfolio valuation at retirement more than 6 times higher? Let me explain the difference in simple terms. When the couple that begins saving 20 years earlier reaches the age of 45, they are projected to have accumulated $500,000 already. They have saved $180,000 but their accumulated wealth has already grown substantially. Now, they will be investing another $180,000 over the next 20 years, which is projected to grow to another $500,000. But using similar rates of return, the $500,000 that they already accumulated in the first twenty years is expected to grow to $2.7 million. Thus, their plan at retirement could grow to $3.2 million ($2.7 million from the contributions of the first 20 years and $500,000 from the contributions of the following 20 years). This clearly demonstrates the potentially prodigious benefits of investing over longer periods of time.
There are substantial benefits for young Orthodox Jewish couples beginning their retirement planning early. 401(k) plans offer a great opportunity to build a substantial nest egg for retirement. Starting early and staying with the program can lead to substantial benefits. The tax benefit of the 401(k) contribution is just icing on the cake.
Even if one does not have access to a 401(k) plan, one can utilize other vehicles that have similar benefits, including IRAs. If one makes the maximum contribution to an IRA (which is currently $6,000 per individual per year) over a 40-year period, he/she could accumulate over $2 million by the age of 65.
Admittedly, it is difficult to find the means to save for the future, given the many immediate demands on one’s income. But when making a financial plan, one needs to take a very hard look at each expense line item. One needs to decide whether each expense is absolutely necessary, or merely a luxury. If a couple can find a way to set aside some funds each year to invest over a long period of time, they will likely be afforded the opportunity to live a more comfortable life.
Jonathan D. Caplan, a former Wall Street executive, is president and founder of wealth management firm Caplan Capital Management, Inc. with offices in Highland Park and Hackensack. He holds a BA from Yeshiva University and an MBA in Finance from New York University Stern School of Business. You can find other recent investment articles by Jonathan at www.caplancapital.com/blog.
The views presented are those of the authors and should not be construed as personal investment advice or a solicitation to purchase or sell securities referenced in this market commentary. The authors or clients may own stock or sectors discussed. All economic and performance information is historical and not indicative of future results. Any investment involves risk. You should not assume that any discussion or information provided here serves as the receipt of, or as a substitute for, personalized investment advice. All information is obtained from sources believed to be reliable. However, we do not guarantee the accuracy, adequacy or completeness of any information and are not responsible for any errors or omissions or from the results obtained from the use of such information.