Saving Is a Choice, Not a Sacrifice. When you save, you haven’t lost the money. It's still in your hands. You’ve used it to buy some financial security.
Income Is a Finite Resource. If You Spend It, You Can’t Save It. Everyone has a finite lifetime income. You’ll make only so much, and that will be it. This is true no matter how high or low your income. If you don’t save any of it, you’ll retire on just Social Security.
Economize Now or Economize Later—There’s No Free Lunch. Since you have a finite lifetime income, you’ll have to economize at some point. If you don’t economize during your working years, you will, by necessity, economize when you have nothing except Social Security.
Save for Your Own Sake. When you save, the big winner is you. Indulge yourself, not with a big screen TV, but with a large net worth.
Do You Dislike Money? Your Money Problem May Be Psychological. If you’ve tried unsuccessfully for years to save, you may have a bad relationship with money. Some people feel uncomfortable or even guilty about having a lot of money. If you're a poor saver, a nonsaver or an unsaver, consider whether you have a relationship problem with money. You don’t need to love money. And you don’t need to be greedy. You just need to achieve an emotional truce with money so that you can prepare for future.
Today, with pension plans more endangered than the grizzly bear and Social Security teetering at the brink, your best bet for a comfortable retirement is you. You may have a half-dozen or more jobs in your lifetime. Even if some of the employers offer pensions, you may not work long enough at any of them to qualify. Or if you do, the pension might barely cover the grocery and gasoline bills. Every year, there’s a new study showing that Social Security will provide you with less and less. How can you be sure that, when you’re retired, you’ll be able to load up at the cruise ship buffet table?
The answer is to save. Pay yourself. Begin charity at home. Forget about a 200 inch flat screen TV. Be the person on the block with the largest net worth. If you don’t prepare for your retirement, who will?
The financial world can seem complex and esoteric, with investment products so convoluted they’d confuse a snake. The waters are getting rougher with one corporate scandal after another—hundreds of billions (yes, billions) of dollars of shareholder value was lost in the Enron, WorldCom and other corporate frauds. How can you tell which companies are rotten and which ones are clean?
Don’t be discouraged by the complexities of high finance. Ordinary folks using ordinary means have always been able to provide for themselves, and they still can today. You don’t need to be a financial whiz to accumulate wealth. When it comes to building wealth, motivation and regular saving are far more important than financial expertise. You just need to understand and apply a few basic ideas, which we present. Read on. If you need help with some of the terminology, go to our Glossary.
1. Saving: It’s a choice, not a sacrifice.
For many people, the idea of saving ranks somewhere below visiting the dentist. You feel like you’re depriving yourself of something—a new powerboat, a larger house, a zippier car, or a bigger refrigerator. But saving isn’t about deprivation. The money hasn’t left your hands. When you save, you’ve chosen to have wealth instead of a bigger grill or another TV. You’ve bought a piece of financial security instead of more stuff to clutter up the house. The more you save, the more financial security you buy. Saving builds wealth and gives you a future. If you don’t think about the future, you aren’t likely to have much of one.
The key to building wealth is to save steadily. Don’t focus on the latest financial fad. Don’t think you need an MBA or a Ph.D in Economics. Don’t try to get the inside scoop on the next sure thing. Don’t take the bait when someone promises to double your money in six months. Focus on steadily saving and investing in a diversified portfolio.
We’ve already pointed out that if you save nothing, you’ll have only Social Security when you retire. Take a look at what happens if you save. Let’s say you have a salary of $60,000 a year and put aside ten percent of it, or $500 a month. First, $250 goes into a tax-deferred 401(k) account with a match from your employer of half that amount, and the other $250 goes into an taxable investment account. That totals $500 a month of your own money, plus a $125 per month match in the 401(k) account from your employer, for a total of $625 a month. You may have heard of the wonders of compounding, where investment earnings build on earlier investment earnings. Compounding begins with reinvesting the interest, dividends and other investment profits you get. Reinvesting allows the investment profits to generate more investment profits, which are reinvested in turn to generate even more returns. Compounding is an extremely powerful financial tool. If you save steadily and reinvest your earnings, your portfolio’s growth rate will compound into amounts dramatically larger than what goes out of your salary. Here's an example.
Assume you are taxed at a federal rate of 25% and a state rate of 6%, and your investments earn a moderate 7% annual rate of return (about the stock market’s average for the last century). At the end of 40 years, you will have around $1.44 million. Of this amount, only $300,000 consists of contributions from your salary. The $1.14 million in investment gains comes to a large degree from compounding. This shows that it’s crucial to reinvest your investment gains. Don’t spend them as you go along. Remember: if you love compounding, compounding will love you.
Of course, savings are subject to erosion from inflation. If the $1.44 million you saved is adjusted downwards for 3% annual inflation (which is roughly the historical average), the result is around $428,000 in today’s dollars. (We used the Savings Calculator at http://cgi.money.cnn.com/tools/ to get these numbers.) However, if you increase the amount you save by the inflation rate (which you probably can since incomes for most people keep up with inflation), you will have something around the inflation adjusted equivalent of $1.44 million.
We assume the hypothetical saver in this example makes the inflation adjusted equivalent of $60,000 a year over a 40 year career. That’s a good income, but not quite enough for a yacht. Yet, our saver ended up with the inflation adjusted equivalent of $1.44 million simply by steadily putting away 10% of his or her earnings for 40 years. You don’t have to be a high earner to build wealth, nor do you have to get in on the latest get rich quick scheme. Just make a sound financial plan, stick to it, and you’ll do okay.
Sacrifice isn’t part of this equation. You give up nothing, because you keep the money for the future. And you get long term peace of mind, as well.
No one has a limitless income. For those who are fortunate and have large incomes, the picture will be brighter. But everyone ultimately receives a finite amount of money. Sometimes you can increase the amount of your lifetime income, either by getting a second job or working to an older age. But even if money appears to be a renewable resource, no one can renew it indefinitely. Eventually we all reach the point where we don’t want to work, or can’t work. In the end, we earn only so much money and that’s it.
Seeing as how one’s lifetime income is finite, spent money is gone forever. Whether it was well spent or wasted, it leaves our hands and doesn't return. Of course, everyone needs to spend money in order to live. And you want to live life and not merely exist. But if you save little or nothing, at the end of your life you will have used up all of your finite financial resources, and be left with little more than Social Security.
Salaries and wages create an illusion of financial security. If you have steady employment and are paid a salary or fixed hourly wages, you get a stream of income that appears stable. The predictable arrival in your bank account of a predictable amount of money every two weeks or every month makes it easy to think that you won’t run out of money. People tend to take their immediate experience and treat it as permanent. How many investors thought the stock market boom of the 1990’s would end? Not many. How many homeowners and real estate professionals thought the real estate bubble of the early 2000’s would burst? Probably fewer. But they were wrong. Your current earnings won’t keep rolling in forever. Jobs end, careers end, and everyone stops working eventually. So don’t get used to your salary or wages; and don’t let them delude you into thinking that you can’t run out of money. Have a plan in place for what you’ll do when the paychecks stop.
3. Economize Now, or Economize Later
Social Security pays most retirees and their spouses something in the range of $10,000 to $20,000 a year in 2007 dollars. If you work a very long time and have sizeable annual earnings, you might qualify for an amount in the mid-20s. Some recipients get less than $10,000 a year to live on. Although that’s a lot better than nothing, Social Security barely covers the essentials.
Imagine being 68 and pushing your cart through a supermarket. You select house brand products, and whatever fruits, vegetables and bread are on sale. Meat, poultry and fish have become a less frequent part of your diet. Desserts and snacks have fallen by the wayside. You can no longer indulge in fine wines or imported beer. Toward the end of the month, when money is tight, you start to look more closely at the shelves holding the pet foods. A furtive look comes over your face as you reach for the dog food on sale. You’ve heard that pet food manufacturers make sure their products taste good to humans, in case pet owners taste the stuff before serving it to Fido. You slip a few cans into your cart and hope that the employees of the supermarket don’t notice that you buy dog food only at the end of the month.
If you aren’t partial to the idea of dog food in your diet, then understand that your only choices in life are to economize now or economize later. Having a finite lifetime income means that you cannot spend your money and have it, too. You may have a lot of excuses for not saving, but you can’t buy a loaf of bread at age 68 with an excuse. You need cash for that. If you have no money in your old age for bread, what will you do? Eat cake? Please choose wisely.
Saving is ultimately about you. Financial planning is for your benefit—your life, your retirement, your comfort and your fulfillment. Building wealth isn’t selfish. You are responsible for taking care of yourself, and building wealth is how to take care of yourself in retirement. What happens if you don’t take care of yourself? This being the 21st century, you won’t be left to beg on the street for alms. Your family and society will find ways to take care of you. But you’ll be a burden. Loved by your family, yes, but also pitied. Instead of enjoying respect, you’ll feel embarrassment.
You deserve a comfortable retirement. You deserve caviar and champagne, cruises, and trips to foreign countries. Save now because there are landscapes you want to paint, and volunteer projects in your community that you want to tackle. Build wealth because you cherish the memories of the time you spent with your grandparents, and want to spend time with your grandchildren. Build wealth because there are gifts and bequests you want to make, and good causes you want to support.
Some people have psychological problems with money. Even in America, the free enterprise capital of the world, some people feel, deep down, that they don’t deserve to have money. Or that it’s wrong to be well off. If you can’t save after years of trying, especially if you’ve had a good income, you may have an emotional problem with money. It could stem from a variety of sources, including how you were raised, whether your siblings and friends are doing well or poorly, and personality traits like an impulsive, undisciplined approach to life.
If you think you may have a psychological problem with money, try to see yourself as a worthy and deserving person. Having money doesn’t mean that you are greedy or selfish. A perfectly good reason for having money is so that you don’t become a burden on others. You may be able to find psychologists or other professionals who can help you. Perhaps talking to friends and family will also help. But don’t ignore the problem. The sooner you deal with it, the sooner you can begin building wealth. You don’t have to like money or even feel comfortable with money. And you don’t have to think that greed is good. You simply have to establish an emotional truce with money, so that you save enough to take care of yourself and your loved ones.
You can do it. You can build wealth. It doesn’t take any special education or knowledge. It doesn’t require a college degree or even a high school diploma. Everyone understands the concept of saving. The key is to turn the concept into a reality—your reality. Even if you put only a few dollars a week into a savings account, you have started to build wealth. All you have to do then is keep up the good work. Many people from all walks of life build wealth. You can make yourself one of them.
Now let’s go to the Starting Point for building wealth.