My favorite phrase to live by, live well below my means.
All it means is, to spend less then what I earn. Earn $1,000, spend $500, save $500. 1000-500=500. Save the $500 for a year and have $6000 at the end of the year. Earn a return on the $6000 and it just keeps building. The reason to do this is to build up an asset base. I've received questions and people coming to me for help with their finances. This is the basis of what I tell them, I use a lot of hand motions too.
When my money makes me enough money to retire living the same lifestyle and more, it is the ultimate goal for retirement. The only way to do this is have large enough principal to create interest/dividends/cash flow which covers our lifestyle and then some without touching principal, rather reinvesting excess back into principal so it keeps building. Basically, its compound interest. Let's say we have $10 million dollars at retirement. Our expenses are $100,000 a year. We need to make at least $100,000 a year in interest/dividends/cash flow or 1% to cover our expenses. Let's say we are ultra conservative, we throw it all in savings which earns us 3% return a year totaling $300,000 a year. After taxes, let's say we have $200,000 left over. After chopping off $100,000 for our yearly expenses, we have $100,000 left over. We reinvest the $100,000 back into our $10 million and after another year of interest we have $303,000 at the end of the year, $3,000 more than the previous year. Rinse and repeat.
My main point:
I know this was simplified beyond belief, though it makes this example easy to understand. The basis of this is how do we even get to $10 million dollars? Earn an income, save some of it, invest it, and let compound interest do its thing, while you still invest in the principal. While I don't have those eye popping statistics of what happens with percentages when you invest and over time, I can tell you it's worth doing if you want a lot of assets for an early retirement.
This is where the rich get richer and poor get poorer phrase gets out of hand. The person investing and producing a return on principal is the one getting richer. The one which chooses to live paycheck to paycheck instead of saving part of their disposable income, and thrives on credit, is the one getting poorer because the ones giving out the credit are getting richer. They are using their principal to lend out money to get a return, just like banks or anyone who loans money or gives out credit cards. When I say living paycheck to paycheck, it applies to the people who earn more than they need to spend. For example, a person earning 6 figures, can still live paycheck to paycheck because they are living beyond their means by buying more than they earn. While a person earning $50,000 a year can save money in every paycheck because they live below their means. It really doesn't matter how much a person makes to save, from $30,000 to 10 million a year. Any money saved, is principal built! And our goal for retirement is a large principal earning us living expenses and then some! (To reinvest of course).
It's never too late or early to invest, especially us early twenties, we have time on our side.
My savings plan:
Enough about the theory and let’s get dirty with the details. This next section is explaining what I do.
(Un)Luckily, I am a single guy with no wife or kids. My expenses are very low and my income for my age is high. With this situation, I save 50% of my income.
For some people it may be difficult to instantly chop off 50% of their income. What I do is have direct deposit, 50% into my checking earning 1.50% annual yield(at ING Direct I'll write about my experiences with them later, let me know if you want a referral $25 if you sign up and open with $250 or more) and 50% into my high yield savings account (I'm changing it around from ING Direct to other companies, and currently in the application process for another which is one of the highest in the nation with all the rate cuts). With this, I automatically save 50%. I started saving for my emergency fund (will talk about this later) in March and maxed it to my goal of $10,000. Now the rest of my savings goes into another savings account for investments. This is not the only place my savings stops at.
I max out my Roth IRA contribution per month ($416.66) to reach the $5000 max for 2008. My Roth IRA automatically takes 416.66 out of my checking at the end of every month, I will make it $5000 with any additional deposits needed. Also, automatically, from the same investment firm my Roth is at, my 3 529 college savings account deduct $25 each from my checking. A total of $491.66 in savings a month combined with the 50% into my savings. Again this is not where the savings stops at.
Anyone ever heard of rollover minutes? The minutes a person does not use from the previous month rolling over to the next month to have the ability to be used. With the money in my checking, I don't spend everything I have left over after all my bills (I love paying bills as much as I love saving.) From month to month I may have a hundred to a couple of hundred left over which adds up.
While my savings plan is aggressive, it will not work for everyone. Especially those with kids and other obligations. Though I can recommend this plan to those who make enough (can easily adjust the percentage to fit bills and income) and have less obligations. Of course if a person makes a lot, covering bills and kids, and save even more, by all means do it! The goal is to build principal through savings and investment. This savings plan is only part of my plan to build the nest, there is also investing (will be covered later.)
- $416.66 a month from checking ($5000 a year)
529 college savings
- $25 for account 1 a month checking ($300 a year)
- $25 for account 2 a month checking ($300 a year)
- $25 for account 3 a month checking ($300 a year)
My main point:
Save as much as you can after affording our life styles and as early as possible. Remember, we all still gotta live life to the fullest!
Compound interest is our best friend.
If you have trouble spending what you save, if you have the ability split your paycheck direct deposit into different accounts, do it. It separates the already saved amount out of our minds and we may not consider it in our discretionary spending, though I recommend discipline as well.
Any questions or comments let me know.