In my last blog (Investment Choices), I discussed the different assets in which you could invest. In a much earlier blog (How to retire in 5 easy steps), I discussed the basic steps to retire early. In one of my first blogs (So, you've discovered you're in debt...), I discussed the basic strategies for working your way out of debt.
What all of these blogs assume is that you are able to save money in the first place!
How to save money
1. Introduction
2. Withholding
3. Keep a high credit rating
4. On Line Banking
5. Return on Investment
6. The value of time
1. Introduction
Young adults in high school, college, or just out of college are facing even worse job prospects than older adults. In fact teen unemployment was in the 25-30% range and that's 2.5-3x worse than older adults! These same adults cannot look forward to rich pension plans in which their former employer will pamper them through their retirement years. Nor can they expect Social Security or other government (local, state, or federal) pension plans to pamper them either. All of these are strained to the breaking point and many are likely to go bankrupt (or require a significant cutback in benefits) leaving their dependents destitute.
Besides being depressing, what does all of that mean?
It means that you should rely upon yourself and not others for your financial security. Luckily, if you are a young person, time works in your favor! The earlier you start save the more time becomes your ally.
Back to the top
2. Withholding
Withholding is perhaps the easiest means of saving money. Simply put, you have either your employer or bank pull some money out of your normal pay and pay it into a savings account. Set up the account to accumulate in a special savings account reserved solely for emergencies and long-term savings. Ideally you’ll first put money into a retirement account due to their special tax treatment.
One other thing that you can do is that every time you get a pay raise, place some or even all of this increased pay into your special account. So if you get a 4% pay raise, you could increase the amount going into your 401K or IRA account each paycheck by 4% of your pay. The best part of this process is that the amount you get paid each paycheck will still go up due to the tax deferral of the retirement account!
Eventually, this money will accumulate enough to begin investing (see my blog on (How to retire in 5 easy steps for more information). The beauty of this is that by “hiding” this money before you actually see it, you learn to live without it. You can also reduce your contributions to these accounts to compensate for increased expenses due to some life changing event like the arrival of a baby. Just be sure to use the method outlined in the above paragraph to bring the account contributions back up!
Back to the top
3. Keep a high credit rating
It may seem odd to mention your credit when talking about savings, but at some point in your life it is highly likely that you’ll need to get a loan. If you keep your credit rating high, you will pay a very much lower interest rate than if you don’t. This can save you thousands – in the case of housing tens of thousands of dollars over the life of the loan!
Consider that I’m in the process of refinancing my mortgage from 5.5% to 4.75% and will be saving nearly $200/month. Over the life of the loan (say 20 years), that’s about $48,000!
In summary:
Don’t buy more than you can afford in a month.
Always pay your bills on time.
If you get into trouble, review the materials in my blog on debt: So, you've discovered you're in debt...
Back to the top
4. On Line Banking
This is one of the greatest inventions ever!
Before online banking, I had a great deal of trouble paying all of my bills on time. This was partly because I earned a lot less at that time but really it had more to do with not regularly setting aside the time to do my bills.
With on-line banking, I can set up automatic payments even for bills like the electricity. Sure my estimated payments are not always correct but they are generally pretty close and it is enough to be close in most cases.
My life has also been made easier by looking out months ahead and predicting when large expenses (like property taxes or home owner’s insurance are due). I can ensure that I set aside funds to take care of those expenses. I can also determine when I’m going to have a surplus and set aside payments to debts I owe or into savings accounts with those surpluses. If that money isn’t in my “working” account, I won’t be tempted to spend the money on things I don’t need.
In summary:
Back to the top
5. Return on Investment
The precise definition for Return on Investment is available in many places (e.g. Wikipedia). However, I wish for you to think about this term differently than the conventional definition.
As I mentioned in the How to retire in 5 easy steps, you face two challenges when you save. The first is capital risk, which is the risk that your savings will lose value (e.g. when there is a stock market crash). The second risk is inflation risk.
Inflation is the phenomenon which describes why your parents could buy candy bars for $0.10 while it can cost children $0.50 or $1.00 for that same candy bar. Technically it isn’t the candy bar getting more expensive, it is the money losing value. When inflation is high, this effect is very noticeable. In certain countries with hyper-inflation, prices can change daily! However, when it’s smaller it poses the same problem even if it’s more subtle threat to your savings over long periods of time.
Inflation risk is the risk that the purchasing power of your savings will decrease over its lifetime. A good investment will provide a return greater than the average inflation rate. So you should ensure that the average return of your investments should always equal or exceed the inflation rate. If it doesn't then your investments are slowly losing value even as their dollar value slowly increases.
This eliminates savings accounts, money markets, CDs, and many other investment types as long-term investment vehicles.
Back to the top
6. The *time* value of money
This is the most important point of this post.
You should start saving early in your life. In fact, you should start saving money as soon as you start earning money whether that’s high school, college, or you’ve started working full-time. If at all possible do not touch that savings unless it is an emergency or when you’re ready to retire.
If you can put aside just $500 per year for your 8 years in high school and college and then only $1000 per year after that for another 40 years, you can easily save more than $1.2 million dollars!
If you just save $1000 per year for 40 years you’ll only save $800,000 dollars! That means that saving $500 per year for only 8 years will be worth $400,000 to you in retirement.
If you wait to start saving money until you get to 40 years old, you’ll need to save over $9000 to save $800,000. If you wish to save up $1.2 million dollars then you’ll need to save over $15,000 per year.
In my blog How to retire in 5 easy steps, I discuss the formula for determining how much money you’ll need. I estimate that most people will require a million dollars or more at retirement. The easiest way to get this amount is to start early. If you start saving just a little money in your early 20s (e.g. 10% of your income), it will compound into a large amount later.
If you are older, then the only things you can do is to save a higher percent of your income or to work to an older age. You can be sure that whatever money Social Security has promised to you, you will actually get quite a bit less, simply because our government can’t afford to pay off this entitlement. One method our government uses to pay out less in Social Security is to keep its annual inflation adjustment smaller (usually less than half) than the actual inflation rate.
Please include the decline in the real purchasing power of Social Security in your retirement planning.
Back to the top
Proceed to my next finances blog, How to save money.
Return to my previous finances blog What you should do this week.
What all of these blogs assume is that you are able to save money in the first place!
How to save money
1. Introduction
2. Withholding
3. Keep a high credit rating
4. On Line Banking
5. Return on Investment
6. The value of time
1. Introduction
- the current generation of Americans will inherit the worst financial mess this country has ever produced (by some estimates your personal share of national liabilities exceeds $300,000).
- unlike earlier generations, few of the current young adults have seen their parents have to scrimp and save.
- you will very likely not get a pension from your employer and Social Security will by necessity become very much less generous than it currently is.
Young adults in high school, college, or just out of college are facing even worse job prospects than older adults. In fact teen unemployment was in the 25-30% range and that's 2.5-3x worse than older adults! These same adults cannot look forward to rich pension plans in which their former employer will pamper them through their retirement years. Nor can they expect Social Security or other government (local, state, or federal) pension plans to pamper them either. All of these are strained to the breaking point and many are likely to go bankrupt (or require a significant cutback in benefits) leaving their dependents destitute.
Besides being depressing, what does all of that mean?
It means that you should rely upon yourself and not others for your financial security. Luckily, if you are a young person, time works in your favor! The earlier you start save the more time becomes your ally.
Back to the top
2. Withholding
Withholding is perhaps the easiest means of saving money. Simply put, you have either your employer or bank pull some money out of your normal pay and pay it into a savings account. Set up the account to accumulate in a special savings account reserved solely for emergencies and long-term savings. Ideally you’ll first put money into a retirement account due to their special tax treatment.
One other thing that you can do is that every time you get a pay raise, place some or even all of this increased pay into your special account. So if you get a 4% pay raise, you could increase the amount going into your 401K or IRA account each paycheck by 4% of your pay. The best part of this process is that the amount you get paid each paycheck will still go up due to the tax deferral of the retirement account!
Eventually, this money will accumulate enough to begin investing (see my blog on (How to retire in 5 easy steps for more information). The beauty of this is that by “hiding” this money before you actually see it, you learn to live without it. You can also reduce your contributions to these accounts to compensate for increased expenses due to some life changing event like the arrival of a baby. Just be sure to use the method outlined in the above paragraph to bring the account contributions back up!
Back to the top
3. Keep a high credit rating
It may seem odd to mention your credit when talking about savings, but at some point in your life it is highly likely that you’ll need to get a loan. If you keep your credit rating high, you will pay a very much lower interest rate than if you don’t. This can save you thousands – in the case of housing tens of thousands of dollars over the life of the loan!
Consider that I’m in the process of refinancing my mortgage from 5.5% to 4.75% and will be saving nearly $200/month. Over the life of the loan (say 20 years), that’s about $48,000!
In summary:
Don’t buy more than you can afford in a month.
Always pay your bills on time.
If you get into trouble, review the materials in my blog on debt: So, you've discovered you're in debt...
Back to the top
4. On Line Banking
This is one of the greatest inventions ever!
Before online banking, I had a great deal of trouble paying all of my bills on time. This was partly because I earned a lot less at that time but really it had more to do with not regularly setting aside the time to do my bills.
With on-line banking, I can set up automatic payments even for bills like the electricity. Sure my estimated payments are not always correct but they are generally pretty close and it is enough to be close in most cases.
My life has also been made easier by looking out months ahead and predicting when large expenses (like property taxes or home owner’s insurance are due). I can ensure that I set aside funds to take care of those expenses. I can also determine when I’m going to have a surplus and set aside payments to debts I owe or into savings accounts with those surpluses. If that money isn’t in my “working” account, I won’t be tempted to spend the money on things I don’t need.
In summary:
- Set up your on-line account (or find some other way) to ensure that you pay all of your bills in a timely manner.
- Plan your account months in advance to ensure you’ll have the funds you need.
- Identify potential surpluses and consciously decide what you plan to use that money for (pay off debt, increase your savings, building a emergency fund, etc.).
- Do not fritter your money away.
Back to the top
5. Return on Investment
The precise definition for Return on Investment is available in many places (e.g. Wikipedia). However, I wish for you to think about this term differently than the conventional definition.
As I mentioned in the How to retire in 5 easy steps, you face two challenges when you save. The first is capital risk, which is the risk that your savings will lose value (e.g. when there is a stock market crash). The second risk is inflation risk.
Inflation is the phenomenon which describes why your parents could buy candy bars for $0.10 while it can cost children $0.50 or $1.00 for that same candy bar. Technically it isn’t the candy bar getting more expensive, it is the money losing value. When inflation is high, this effect is very noticeable. In certain countries with hyper-inflation, prices can change daily! However, when it’s smaller it poses the same problem even if it’s more subtle threat to your savings over long periods of time.
Inflation risk is the risk that the purchasing power of your savings will decrease over its lifetime. A good investment will provide a return greater than the average inflation rate. So you should ensure that the average return of your investments should always equal or exceed the inflation rate. If it doesn't then your investments are slowly losing value even as their dollar value slowly increases.
This eliminates savings accounts, money markets, CDs, and many other investment types as long-term investment vehicles.
Back to the top
6. The *time* value of money
This is the most important point of this post.
You should start saving early in your life. In fact, you should start saving money as soon as you start earning money whether that’s high school, college, or you’ve started working full-time. If at all possible do not touch that savings unless it is an emergency or when you’re ready to retire.
If you can put aside just $500 per year for your 8 years in high school and college and then only $1000 per year after that for another 40 years, you can easily save more than $1.2 million dollars!
If you just save $1000 per year for 40 years you’ll only save $800,000 dollars! That means that saving $500 per year for only 8 years will be worth $400,000 to you in retirement.
If you wait to start saving money until you get to 40 years old, you’ll need to save over $9000 to save $800,000. If you wish to save up $1.2 million dollars then you’ll need to save over $15,000 per year.
In my blog How to retire in 5 easy steps, I discuss the formula for determining how much money you’ll need. I estimate that most people will require a million dollars or more at retirement. The easiest way to get this amount is to start early. If you start saving just a little money in your early 20s (e.g. 10% of your income), it will compound into a large amount later.
If you are older, then the only things you can do is to save a higher percent of your income or to work to an older age. You can be sure that whatever money Social Security has promised to you, you will actually get quite a bit less, simply because our government can’t afford to pay off this entitlement. One method our government uses to pay out less in Social Security is to keep its annual inflation adjustment smaller (usually less than half) than the actual inflation rate.
Please include the decline in the real purchasing power of Social Security in your retirement planning.
Back to the top
Proceed to my next finances blog, How to save money.
Return to my previous finances blog What you should do this week.
You sure are a quiet bunch :)
ReplyDeleteInteresting blog!
ReplyDeleteThanks!
ReplyDelete