Accounting For Different Kinds of Accounts

It might be useful to think about different kinds of financial accounts and how to use them.  This is the way I do it.

Checking account (for day-to-day expenses).  Despite the fact that many people don’t even have blank checks and the last time I purchased blank checks I probably got enough to last the rest of my life, everyone should have a “checking account”, even if it’s only used to fund ATM withdraws, debit-card purchases, and online bill paying.  A checking account is for your day-to-day bills.  It should have enough money to cover transfers to your savings account (pay yourself first) as well as your regular monthly expenses, such as the rent or mortgage payment, and bills for utilities, groceries, transportation, and other things that you pay for every month.  Whatever spending comes out of your checking account should be replenished by income.

savings_bank_3In addition to your checking account for expenses that come due every month or more frequently, you should also have separate accounts for expenses that come less often.  The first three, like the checking account, should be at a bank or credit union.  The last one should be with a mutual fund company so the money can be invested in stocks.

Short-term savings (once-per-year expenses).  Money set aside for foreseeable and predictable expenses that come once per year, such as birthdays, holidays, and vacations.   

Medium-term savings (once every-several-years or just a few times per lifetime).  Money for foreseeable, but perhaps not predictable, expenses that come less often than yearly, such as an automobile, refrigerator, heating and air conditioning systems, washer and dryer, or a new roof.  Other medium-term goals might include buying a house, college education for your children, or starting a business.   

Emergency savings (unexpected expenses).  For unforeseeable expenses: accidents, medical problems, periods of unemployment, and special opportunities.

Long-term savings (once in a life).  For foreseeable expenses that come just once in your life, such as buying your dream house and retirement.

“Compound Interest” vs “Compound Earnings”

dividend_stocksRepeatedly I see the term “compound interest” used to describe the growth of stock market investments.  I think this is incorrect.

Strictly speaking, you only get interest from bank deposits and bonds.  If you invest any interest you earn by depositing it in the bank or buying more bonds, then you earn interest on the interest — and that’s compounding.

If you invest in stocks, you (might) earn dividends.  If those dividends are reinvested by using them to buy more stock, then you will start earning dividends on the dividends  — and that’s compounding.  But because there is no “interest” earned on stocks, I don’t think it’s right to call it “compound interest”.

Henceforth, I suggest we use “compound interest” only for investments in bank deposits and bonds … and we use “compound dividends” for investments in stocks.  We can also use “compound earnings” in a general way to refer to any investments that grow as their earnings are reinvested in the same investment.

A little further explanation:

The interest you get from bank deposits and bonds arise from a contract: you deposit your money in the bank or you buy a bond (in both cases you are, in effect, lending money and the borrower is agreeing to pay you interest), and the bank or bond issuer is legally obligated to pay you the stated interest and return your money (the principal) to you.

The dividend you get from owning stock is a portion of the profits to which you are entitled because by owning stock you become a partial owner of the company in which you purchased stock.  However, dividends are not guaranteed as there might not be any profits or what profits there are might be used for something other than dividends, such as expansion or development of new products.

The “Nest Egg”

People use the term “nest egg” to refer to their life savings, their retirement savings, what they will live on after they stop working.  “Nest egg” can also refer to any long-terms savings that are accumulated over time for a specific purpose.  I wonder how many people know the origin of the phrase.

nest_eggsAmong people that raise chickens, especially those in the egg business, it has long been known that leaving an egg in the nest will encourage hens to lay more.  Maybe even get a hen started if she hasn’t laid yet.  The practice of leaving an egg in the nest gives us “nest egg” — the nest egg is the egg that’s left in the nest.  Nest eggs don’t necessarily have to be real eggs.  Wooden or ceramic eggs seem to work just as well.  The principle is the same: the egg farmer doesn’t eat or get rid of the nest egg.  The nest egg is quite similar to “seed corn”, the seed that is saved from one year’s harvest for the next year’s planting, rather than being sold or otherwise used.  (Maybe there’s some reason we don’t refer to our live savings as our “seed corn”, but I don’t know what it is.)

Thus, the next egg is something akin to what economists call “capital”: money or some other asset that is used to make money.  Eat your nest egg, and you’ll have fewer eggs.  Eat of your seed corn and there’s no crop next year.  Spend your retirement savings, and it won’t be there to provide for you when you need it.

The Saving Road to Independence

Here’s inspiration from a century ago from The Baltimore and Ohio Employees Magazine (February 1916):

The Saving Road to Independence

For Men and Women of Limited Salary

DEBTS accumulate rapidly. Savings accumulate just as rapidly! It’s therefore a matter of determination, first, whether it shall be savings or debt.

Money will either serve or rule you. The minute you save your first dollar and begin to think of safe investments you are master of the situation. So reflect NOW. Do not regret later.

saving_roadMany people today are closing the door of opportunity by failing to lay aside some part of their earnings—thus condemning themselves to a life of continuous hard work. Your problem is one of persistence, not one of existence. So be up and doing!

Saving is the springtime of prosperity. To be effective, it must be practiced daily. It’s the steady, consistent, aggressive saving that makes men and fortunes. Save to the limit of your possibilities!

It is not enough to make money. You must make your money work for you. Putting your money to work means investment, and investment cannot begin until you have learned, or until you have an earnest desire to learn, to save.

Economize, but in the right manner. Avoid foolish, extravagant expenditures; save your money and invest it carefully while saving. You will always be in a position to live well and view the future complacently. Isn’t it worth while? A man who has always intended to start tomorrow has nothing. He is a slave to pay day.

Every dollar you save and invest brings you just one dollar nearer the goal of prosperity—the time when interest on your investments will provide for your comforts.

Prosperity begins when a man invests his savings or surplus capital intelligently. The man who saves his money will always have an opportunity to invest it. If he invests wisely, he will soon become a man of means and of credit.

Be prepared! Being prepared is half the battle. More men and women learned the value of ready money during the last financial depression than ever before during a similar period. Cheap investments abounded on every side and a man with ready money was master of the situation.

What of tomorrow? Are you prepared for it? For any emergency that may arise? Commence TODAY to fortify yourself against sickness, misfortune or financial difficulty, by saving and investing your money systematically. There is no time to begin like now, which, spelled backwards, means success.

Work hard! Plenty of work is your greatest need. It keeps your mind clear, your body strong and your appetite good. And see that your work accomplishes something. Your days are numbered— your earning period is short. Make each day show a satisfactory result. The best results are obtained when you save, invest and realize.

Nothing makes a feel safer, happier and more courageous for life’s battles than a nest egg in the shape of good investments. It destroys fear of a rainy day and enables him to grapple with the big things.

If you have failed so far to lay aside any money, try again today.

To be a capitalist it is not necessary that you have several thousand dollars in the bank. A man with five dollars is a capitalist just so soon as he decides to make that five dollars work for him—to place it so that, with other sums he may add to it regularly and systematically, he will save, invest and realize in the shortest space of time consistent with safety.

Remember that interest in our work means interest on your money. Get the habit of doing things! Go it alone! You can succeed.

Net Worth, Year 2

A year ago I wrote a post about my net worth and the convenience of having it automatically calculated in an online financial tracker. net17

Since then, my net worth has increased by over $140,000—from about $706,000 to about $850,000.

About 80% of the increase (~$117,000) has been in the investments category.  This is mostly the result of the mutual funds in my retirement account going up along with the stock market over the past year.  Also, all the dividends that those shares have earned have been used to buy more shares.  Of course, I’ve made additional contributions during the past the year.  Breaking it down, the amount of the increase in investments from appreciation and reinvesting dividends was between $90,000 and $100,000 and the rest was additional contributions.

About $13,000 of the increase in my net worth is an increase in the (estimated) value of my house.

Another $8,000 of the increase is the reduction in the amount I owe on my home mortgage.

The remainder of the increase is a temporarily large amount of cash in my checking account.

Last year, I included my old used car (which was worth only about $2,000) in the “Property” category.  I have removed it, after recently buying a “new” pre-owned car.  However,  I have not added that car nor the debt which I will temporarily incur.  The value of the car and the debt would more-or-less offset each other.  I will probably pay off the car debt next month by borrowing roughly $15,000 from one of the retirement investment accounts.

This may be the first time that my net wealth has shown an over-the-year increase that is larger than my annual income.  (I wasn’t watching closely in previous years.)  This seems like quite a milestone on the road to retirement.

Buying a New(ish) Car, Saving $500,000

Some months ago, the driver’s side window of our minivan stopped working and wouldn’t go down.  Next, as it got warmer, we noticed that the air conditioning wasn’t able to do much to cool the air if was much over 75° outside.  And there was that self-inflicted damage to the car’s front grill panel, which occurred years ago, that I had fixed (literally) with duct tape and coat-hanger wire.

Then, a few days ago, came the straw that broke the minivan’s back, so to speak: the annual safety inspection.  The news wasn’t good.  The car wouldn’t pass inspection with a non-functioning window.  The inspection also showed that the headlight lenses were fogged up with road-wear scratches and needed restoration and one headlight had water inside the housing assembly.  All in all, it looked as if the car needed at least at least several hundred dollars worth of work to make it pass inspection (the window, the headlights) and more hundreds of dollars to make it comfortable (the air conditioning) and hundreds more to make it less of an embarrassment to drive (the front end grill).  It was a 2004 model, so it seemed reasonable to use it for a trade-in and buy another car.

Given that our time with this particular 2004 Honda Odyssey (“Redrock Pearl” a.k.a. “Burgundy” with “Ivory” interior, evidently) has come to an end, it seems a good time to get an idea what it cost.

car_invoiceWe bought our 2004 Honda Odyssey for $16,551 on March 9, 2010.  That price included a 2-year warranty (which was probably not worth what we paid for it).  It was a remarkably dependable car.  We had only two completely unexpected repair expenses, which totaled about $1,700.  (Of course, we did have the usual driving and maintenance expenses for gasoline, oil, coolant, transmission fluid, brake jobs, a couple batteries, and a serpentine belt.  But those would have been more-or-less the same regardless of which minivan we purchased.)  Let’s say that the cost of the car itself was about $18,250.

We drove the car regularly from March 2010 to May 2017, over 86 months total.

Considering the cost of the car and the time we used it, we spent about $210 per month or about $7 per day.  (Again: this is only the cost of the car itself plus major repairs, and not the total cost of driving, which would have to include operating expenses.)  Incidentally, the odometer was showing about 60,000 miles when we bought it and had reached 180,000 when we traded it in, so the cost of the car for 120,000 miles of driving was about 15¢ per mile.

Looking back, I am pleased that we purchased a used — ahem, “pre-owned” — car.  Had we purchased a new car in 2010, it would have cost about twice as much, meaning we would have spent about $400 each month on just the cost of the car itself.  In other words, over the past 7 years, we’ve been able to save and invest roughly $15,000 (which is, coincidentally, approximately the cost of the car itself.)

This method of saving money — buying used cars, paying for them as fast as possible, keeping them for a long time — allows us to save and invest over $2,000 each and every year.  This can easily amount to perhaps $100,000 ($2,000 per year for 50 years) worth of investments over a lifetime.  An extra $2,000 per year, with compounded earnings, for 50 years might grow to $500,000 or more.  A half-million dollars for driving used cars?  Sounds good to me!  Remember: In order to have at least $1,000,000 in your retirement account by the time you need it, you need to save several hundred dollars each month (more or less, depending on when you start investing and the returns you get on your retirement investments).  The savings you get from buying used cars can go a long way towards the amount you need to save each month.

We were so happy with our old car — the Honda Odyssey — that we decided to get another one.  And guess what?  It’s the new car that we could have bought 7 years ago!  Yep, we now own a 2010 Honda Odyssey that will probably be saving us money for the next 7 years.

Past Performance Does Not Guarantee Future Results

My thoughts on investing in mutual funds.

Part I

I just finished reading a lengthy newspaper article about a certain money manager, a fellow who founded an investing company and offered mutual funds and similar investments to wealthy people looking for profitable places to put their money.  I won’t mention his name because his name doesn’t matter.  If I were writing this a few years earlier it would have been some other money manager.  A couple years from now, and it will be yet another money manager.

The story is always the same.

In this particular case, it started about a decade ago.  This particular man got lots of people to invest their money with him, based on whatever his particular investing ideas and strategies were and what the economy was doing at the time, … and … it paid off, in a big way.  The investors got huge returns and our money manager earned a lot of money for himself.  Everyone was happy.  Our money manager was featured on the cover of the personal finance magazines.  He was the golden boy.  Everyone (or, so it seemed) thought that he was THE one.  He had it all figured out. He knew what to do.  He couldn’t lose.  What would he do next?

Then, times changed.  Contraction became recovery.  Recovery led to expansion.  The crisis in this industry or that sector ended.  Some other industry becomes the next big thing.  Or the opposite happens.  Then something else happens.  Or doesn’t happen.  The economy evolves.  Or doesn’t evolve.  Things continue to happen.  In other words, the world goes along much as it has for the past several thousand years.  Our money manager now finds that the huge returns have become losses. Shares in his special mutual fund that used to increase in value by 20, or 30, or 50% every year are decreasing in value each month.  His much touted new offerings lose value immediately.  Then comes the article in the newspaper.  This man used to be so great.  Now everyone’s wondering if he can turn it around.   Can he change losses to gains?  Can he be great again?

Past Performance Does Not Guarantee Future Results.

If you read about investing long enough, you see the same story over and over. Only the name changes.  The star money managers of last year are replaced by this year’s new stars, who, in turn, will be replaced by next year’s stars.  They come and go as quickly and regularly as the pop stars who are revered by teenagers.  You don’t even need to read to observe the spectacle.  Just look at the covers of the personal finance magazines and note the names of this year’s stars.  Wait and see if you ever hear of them again.  If you do, is it because they’re still succeeding, still beating the market?   Or is it because they’re the subject of an article like the one I mentioned above?

Many money managers can, and do, beat the market (that is, obtain investment returns that are better than the average of the entire stock market as a whole) for a year, maybe a couple years, perhaps even a few years.

investing_for_profitWhat tends to happen to almost all of them, though, is this: They have a few good years, a few bad years, a few average years, and then more of the same.  Over time, it’s generally the case that most money managers do about as well as the market as a whole. It’s basic mathematics: the average of a set of numbers is (usually) the average because many of the numbers in the set are equal to or are close to it.  In other words, the average is the average because it’s typical.

Mutual fund companies are sometimes pretty sneaky too; if a particular fund has done particularly poorly, it often ceases to exist.  It gets liquidated, merged with another fund, and is soon forgotten, much like the way some Soviet leaders got  airbrushed out of memory once they had fallen from favor.  Getting rid of under-performing funds raises the average of a company’s remaining funds, making it appear that all of a company’s offering are “above average” like all of Lake Wobegon’s children.

There are a very few money managers who can consistently beat the market year after year for decades. If you want names, here are a few: T. Rowe Price, Jr.; John Neff; Peter Lynch; and of course, Warren Buffett.  Let’s say that these, and a few more like them, are the real geniuses among money managers.

But let’s remember, these real geniuses can only be identified in retrospect.  At the start of their careers, how many investors correctly predicted how successful Lynch, Neff, Price, and Buffett would eventually become?  Were any of the investors of the 1940s, 50s, or 60s so confident that they invested ALL of their money with one of these geniuses?  I doubt it.  Most likely, the people who invested with T. Rowe Price or Warren Buffett when they were just getting started also had other investments.  In other words, they diversified their investments.  That’s financial for “don’t put all of your eggs in one basket”.  Because they diversified, some of their investments yielded huge returns, others didn’t do as well.  Maybe there were some losses that were offset by the large gains.  For many of them, maybe most of them, the bottom line probably showed returns that were pretty close to the market as a whole.

Because we can’t accurately predict the future, I think we have to accept as a given that there’s no way to say today which of today’s money managers will be the geniuses of decades to come.  Much like the investors of previous decades, all we can do is diversify.  This means investing in several different mutual funds.  Do this, and  you will probably have a few investments that do better than average, a few that do worse, and it will all even out … you will do as well as the market as a whole.  This is especially likely over the span of decades.

Doing as well as the market as a whole — it’s not like that’s a bad thing.  Doing as well as the market as whole is pretty good.  Save and invest consistently throughout your working life, earn 5, or 6, or 7% year, on average, over a long time, and you have an excellent chance of being able to retire happily.

Part II

But wait! There’s one thing I haven’t mentioned yet.

It’s this: Money managers are expensive.

They, and their staff of assistant money managers and other related financial experts, don’t work for free.  They need to be paid.  Their salaries, bonuses, and other expenses are charged to the investors or come right out of the money people invest.  Mutual funds come with various fees and “loads” (purchase fees, redemption fees, exchange fees, management fees, service fees, etc.).  Added together, they take quite a bite.  The ongoing management fees are often more than 1% of the fund’s assets, paid every year.  That might not sound like much, but over time it reduces investor earnings significantly.  A mutual fund that earns average (that is, equal to the market as a whole) returns “on paper” actually gives its investors less-than-average returns once the various fees are deducted.

The only way all those fees can be justified is if the money manager consistently delivers significantly higher-than-average returns.  As explained above, most money managers can’t deliver … and, looking ahead, it’s just as impossible to select the mutual fund with the money manager that will outperform the market consistently for decades as it is to predict the future.

So, what if I told you there was a way to get average returns and pay the lowest fees possible?  Are there mutual funds that (almost) don’t charge any fees?  The answer is yes: Passively-managed index funds.

To understand what passively-managed and index mean, let’s compare them with the actively-managed funds that we’ve looked at above.  Actively-managed simply means having a staff of money managers who are actively making decisions as to what stocks a fund should buy and which to sell.  The traditional job of a mutual fund’s manager.  Money managers employ a basic investment philosophy for the mutual funds under their management (“growth”, “income”, or “value” for example), but they are able to freely buy and sell stocks as they see fit.

Now, compare the traditional actively manged fund with the the passively-managed fund.  Instead of having a money manager making day-to-day decisions, the passively-managed fund follows an explicit formula.  Generally, this means investing only in companies that are part of a certain stock market index.  The S & P 500 is one example of a stock index.  You might think of it as basically the 500 largest American corporations.  (Actually, it’s a little more complex than that; companies are selected for inclusion on the index such that the index is representative of industries in the United States and other additional factors are also considered.)

(Stock market indexes, and there are many, are separate from mutual funds.  They were originally created as a way of gauging the overall health or direction of the stock market.  Indexes have been around longer than mutual funds.  No one thought of creating a passively-managed mutual funds, based on stock market indexes, until some decades after actively-managed mutual funds became a common way to invest in the stock market.   John Bogle, who deserves the title of real genius as much as anyone, is known as the man who first popularized index funds for average investors.)

The important part: Passively-managed mutual funds are much less expensive to operate than actively-managed funds.  Why this is so is simple: No need to pay for expensive money managers.

Because a passively-manged fund tracks a given index, it earns average returns more-or-less by definition.  If you want the average returns of the S & P 500, then you buy shares in an S & P 500 index mutual fund.  If you want the average return of the entire U.S. stock market, there’s a fund for that.  There are others as well.

The fees charged by a passively-managed fund are significantly lower than those charged by actively-managed funds.  This means more of your money is working for you, instead of paying a money manager and his staff.  The difference over decades of investing are significant.

Don’t just take it from me.  Do some research.  Learn more about index funds.

If you want a hint, here’s one word:  Vanguard.

Old, But Good, Advice

Browsing through an old issue of The Sabbath Recorder (A Seventh Day Baptist Weekly, published by The American Sabbath Tract Society, Plainfield, N.J., vol. 76, No. 10.), I found some financial advice from Charles Grant Miller in the form of a story. This was reprinted in the March 9, 1914 edition.

The Saving Habit

They tell a story down in Washington about the late Senator Hoar’s improvidence. A rich friend was riding to the Capitol with him on a street-car, and Mr. Hoar was expressing wonder at the ease with which some men acquire wealth.

“I have had a good income all my life,” he explained, “but never have been able to get ahead. I would like to know how money is accumulated.”

At that instant the conductor came along and Mr. Hoar handed him a nickel while the rich friend turned over a ticket.

streetcar_ticket“There is one way in which you might acquire money.” said the friend. “You could save twenty per cent by buying six tickets for a quarter, and that is a pretty good investment. The habit of saving money grows upon one, and that is a better investment still.”

This is a good deal more than a jest.

The oversight of small investments lying close at hand leads to half the world’s financial miseries.

Of course, none could get rich by investing in street-car tickets. Nor can one get rich merely through small savings in a bank. But it is generally found that the investment in street-car tickets and the savings in the bank go together, and with them go a lot of other frugal habits.

There is no more flexible law of nature than that one frugal habit begets another, and that frugal habits beget riches.

We hear of great fortunes made in a moment. But that is not the common way.

Ordinarily a great fortune is built up like a stone wall — a stone at a time.

The young man who declines to lay the first stone, because it comes so far short of a wall, will never make progress in financial masonry.

It is a sure thing that the young man who considers it not worth while to save small amounts will never have large ones to save. He is first cousin to him who declines to go to work until he can start in at a big salary.

The first savings of Mr. Rockefeller, Jay Gould and the first Vanderbilt all look pitiably small, even to the average laborer of today. But they were seed from which sprang not only increased profits but increased enthusiasm in business-building.

Small savings and investments if constantly added to and the income compounded, grow marvelously in time.

And the saving of money is a habit that grows more marvelously even than compound interest.

— Charles Grant Miller, in Watchman-Examiner.

There’s a lot of good food for thought in that story.  Let’s look at it point by point.

Income Alone Isn’t Enough

“I have had a good income all my life,” he explained, “but never have been able to get ahead….”

As long as spending is equal to income, there will never be wealth.  This is only common sense.  Or, rather, I should say, it should be common sense.  But actually, it’s amazing how uncommon this bit of wisdom is.

Imagine a water tank with water flowing into it thru a pipe at the top.  If there’s another pipe at the bottom of the tank, then the tank will never be filled: The water goes out of the tank as quickly as it goes in.  Now imagine the pipe at the bottom has a valve that can be used to reduce the amount of water going out of the tank.  If the valve is set to allow only 90% of the water to exit the tank, then the tank will fill with water.

Checking accounts work the same way.

If people spend 100% of all they earn each year, year after year, what will they have accumulated when they stop working?  Think about it.  The answer, of course, is … nothing; those people will have nothing.  (And if spending is greater than income, that’s real misery.)

Don’t be one of those people who end up with nothing.

The best way to accumulate wealth is to live on less than your income and regularly save some percentage of your income and invest it so it grows.  The Richest Man in Babylon recommends that you save at least 10% of your income.

Don’t Pass Up Good Deals

“You could save twenty per cent by buying six tickets for a quarter, and that is a pretty good investment….”

Whenever the savings you get from buying something* are greater than what you could otherwise earn if you had invested the same amount of money, then you should buy it.

In the example in the story, tickets cost 5¢ for 1 ticket, or 25¢ for 6 tickets.  If purchased one at a time, 6 tickets would cost 30¢, which is 20% more than 25¢.  There’s no investment that is certain to yield a 20% return; that was true in 1914 and it’s true today, and even moreso in the short time and with the small amount of money it takes to buy and use 6 train tickets (a rider might use 2 each day).

Apply this to your daily life.  Suppose you eat a can of beans each week — so once a month you buy 4 or 5 cans.  Now suppose the grocery store has canned beans on sale.  Say it’s buy 5 and get 1 free (like the deal on tickets in the story).  How many cans should you buy?  Your usual number, maybe 5 cans for a month of bean eating and get 1 free?  That’s okay, but not good enough.  Why not buy enough for a whole year?  Buy 50 and get 10 free!  They won’t go bad in a year.  (Check the labels.)  Remember, a penny saved is a penny earned.  Do you have any opportunity to earn a 20% return on the additional money that you’re spending on canned beans?  No.  The stock market won’t do that well, certainly not with 100% certainty, and neither will bonds nor savings accounts.  So, what are you waiting for?  Put those cans in the cart and get to the cash register!

Some years ago, a large grocery store chain closed the local store in my neighborhood.  For a couple weeks everything in the store was marked down 30%.  Then, in the final week, everything was 50% off.  My wife and I went to the store twice that last week and spent about $400 each time.  A total of $800 spent to get $1,600 worth of groceries.  It was mostly bottled, canned, and boxed goods, of course.  We were eating breakfast cereal, spaghetti, cooking oil, and canned beans from that haul for months thereafter.  But we doubled our money with those 50%-off purchases.

Every time I see a good deal on basic foods or cleaning supplies, I make it a point to stock up if I think I could use them within the next year.

* that means something that you definitely need and will use and won’t spoil or expire before you use it.

Make Saving A Habit

“The habit of saving money grows upon one, and that is a better investment still.”

Like lots of other things you should do — like eating right, exercising, being polite to stupid people — making a habit of saving money takes practice.  The more you do it, the easier it becomes.  Efficient use of money should be your goal, it should be foremost in your mind each and every time you buy something.  You can strengthen your money-saving habit by reading books and magazines, listening to radio programs and podcasts, and watching videos about personal finances.

Just as buying when you see bargains is a good financial investment, developing the savings habit is a good investment of your time and willpower.

… one frugal habit begets another, and that frugal habits beget riches.

The more you practice the efficient use of money — frugality — in one part of your personal financial affairs, the easier it will be to apply it to others.

Slow And Steady Is the Surest Way

We hear of great fortunes made in a moment. But that is not the common way.

It’s the unusual, the uncommon, that most often receives the most attention.  (As the saying goes, “1,000 planes safely land today” isn’t likely to be a newspaper headline.)   So, it’s the rare cases of people getting rich quickly that gets the most attention.  A fortune made slowly, acquired through years of working, saving, and investing is the more common occurrence, but you are unlikely to read much about it unless you make an effort.  Your best chance to acquire wealth, in fact, it’s almost a certainty, is the tried-and-true method of living below your means, spending less than your income, saving at least 10% of every dollar you earn, and investing the savings to earn long-term compound growth.

Accept the Fact That You (Probably) Have To Start Small

It is a sure thing that the young man who considers it not worth while to save small amounts will never have large ones to save.

Don’t wait until you have a large income to start saving.  Start now.  Right now.  Chances are good that your income will grow as you advance in your career.  But small amounts you save and invest now have the advantage of having more time to grow.  To grow the kind of personal fortune you’ll need to be secure after you retire, you will need to invest…

Small Amounts … … For a Long Time
Middle-size Amounts … … For a Mid-length Time
Large Amounts … … For a Short Time

Just remember, at least 10%.  That percentage of a small earnings will be a small amount, and as your earnings grow, that same percentage will be a larger amount of larger earnings.

The Most Important Thing to Remember

Small savings and investments if constantly added to and the income compounded, grow marvelously in time.

It’s all right there in one sentence

  • A small amount, just 10% of your earnings,
  • consistently put aside and invested,
  • subjected to the miracle of compounding.

That’s all you need to know.  That’s all you need to do.

Think About Spending in Annual Terms

Changing the way you think about money can help you change your spending and saving habits.

You probably have a good idea of how much money you earn each year:  Your annual salary, your gross income (that’s the total you earn before any deductions for taxes, insurance, and of course, … your contribution to your retirement savings account).

For the purposes of this discussion, let’s say we’re talking about someone who earns $50,000 per year (which is pretty close to the average in the United States).

Saving more means spending less, and that means carefully considering everything you buy.  One thing that might help is to think of your spending in annual terms, which means multiplying a thing’s cost by the number of times during a year you spend money to buy it.

If it’s an expense you have, say, 5 times a week, then you might multiply that expense by 250.  (5 times a week × 50 weeks per year.)  Then compare the annual expense to your annual income by looking at it in percentage terms.

Let’s say you buy coffee every workday: maybe it costs $2.30 per day.  $2.30 × = $575 per year.  $575 is a little over 1% of a $50,000 per year.  So you ask yourself:  Is it worth spending over 1% of your total income for your daily coffee?

(If you’re not clear on the calculation, it’s the annual expense divided by the annual income, which in this example is: $575 / $50,000 = 0.0115.  Multiply the answer by 100 to put it in percentage terms: 0.0115 × 100 = 1.15%, which, as stated, is a bit more than 1%.)

Maybe you spend $25 each week for something, maybe it’s beer and pizza at a restaurant or bar, or movie tickets, or whatever.  Do that every week for a year and that’s $1,250.  ($25 × 50 = $1,250.)  That’s 2.5% of a $50,000 income.  Is it worth it?

a_new_hatMonthly expenditures are easily annualized and percentaged (or maybe it’s “percentualized”?).  Just multiply by 12.  Do you buy $100 worth of clothes that you don’t need each month?  That’s $1,200 per year, which is 2.4% of a $50,000 income.  Or maybe your cable TV bill is $120 per month.  That’s $1,440 per year, which is  nearly 2.9% of a $50,000 income.  Is it worth it?

Ask yourself:  Is it worth it?

If you’re adding a good-sized percentage of every dollar you earn to your retirement savings, if you have wisely invested your retirement savings and seen them grow from the compounded earnings they generate, and if the total of all your retirement accounts is several times your annual income … then maybe you can reward yourself by paying someone to make your daily coffee.  Maybe you can afford a weekly outing for pizza and beer or a movie.  Maybe cable TV isn’t a a big deal.

But, if you’re spending 6% of your income on coffee, pizza, beer, movies, and cable TV …and you’re not putting 10% (at the very least) to 15% (or more) of your income into your retirement savings accounts … then I would suggest that you think it over.

O Fortuna

FortunaI’m sure it could be explained away as the workings of my subjective mind.  Just my imagination.  But it sure seems like my luck is better when I have money in the bank, ready money, cash on hand — as opposed to living paycheck to paycheck.  I don’t just mean that having ready cash allows me to take advantage of opportunities that present themselves (“luck is what happens when preparation meets opportunity”, as Seneca the Younger tells us).  I mean that I seem to be unlucky in the sense that bad things happen when I don’t have much money, but someone those bad things seem less likely when I do.

Take, for instance, a car repair (that I can’t do myself).

At times when I haven’t had any money in my savings account and was spending everything that was coming in for rent, food, gas, and the other essentials … that’s when my car wouldn’t start one day and after getting it towed to the garage I’d hear that it needed over 1,000 dollar’s worth of repairs to make it go again.

But, if I’ve got plenty of money in my savings account (I mean, at the same credit union where I keep my checking account — not my retirement savings) and I find money left over each month after I pay all the bills … if the car won’t start then … the news from the garage is that the car only needs some $100 part and it will be good as new.  And that’s when I’m glad that I have all the money for any repair that might be needed.

It’s as if Fortuna smiles on me if I’ve saved money for those emergencies, but she punishes me when I have nothing saved.

At other times when I’m working on some DIY project, some lucky thing happens and the whole things ends up costing less than I had expected.  Like going to the store and getting something for free for filling out a credit card application.  Or, after seeing you working around your house, your neighbor offers you something for free.

Again, Fortuna smiles on me when I work for myself (and pay myself, instead of paying someone else).

Well, it sure seems that’s the way it works.

The song: