Buying a home is the American Dream and the dream of many people around the world. But, housing is costly and a bank won't give you a loan to make the purchase if you don't have some money to put in, a down payment.
Saving for a substantial down payment isn't easy - it takes persistence and focus, but the payoff is a home to call your own or an investment property that may generate income for you and your family for years to come.
1. Figure out how much of a down payment you'll need
The first step is always getting to our down payment goal - if you don't know how much you're going to need to save, you'll have a tough time getting there.
A lot of people start right away before doing a minimal amount of planning/prep work that's needed to articulate a goal properly. This occurs both in finance and in other aspects of life. It's not good to start things without goals - make sure to take the time to set an appropriate goal before you begin on any complex or challenging journey.
So, how do you figure out how much of a down payment you'll need? It's pretty easy with some basic math:
2. Figure out how much you'll need to save every month from reaching your down payment goal
Once you have the estimated/projected down payment number from Step 1, simply determine when you'd like to buy your house and calculate how much money you'll need to save each month from reaching that goal.
For example, let's us the $10,000 down payment from Step 1. If you want to buy your house in 2 years, you'd simply divide $10,000 by 24 months to get $416.67 per month. This is obviously a relatively small down payment goal - yours will probably be bigger, but simple round numbers are good for examples.
3. Decide where you'll park the savings until it is time to make your house purchase and put the actual down payment
The final planning step following Steps 1 and 2 is to determine where you'll keep your money. For the vast majority of cases, your money should be kept safe and sound in a savings account or some sort of liquid money market account. This is because most people will be looking to buy a house within a few years - at this time horizon, investing in stocks, bonds, commodities, crypto, or almost any other alternative asset is too risky.
If your home purchase goal is farther out, more options might be on the table. Say you want to buy a home in 5 years. In this case, you could expose your savings to some risk - you might be able to put it into a very safe and low-risk ETF or mutual fund that holds a large portion of the fund in low-risk securities or cash.
Another critical consideration is to store the money separately from other accounts. You'll want your down payment account to be separate and only for the down payment, nothing else. Don't mix it with your emergency fund, your kids' college funds, or your general wealth-building portfolio. By keeping it separate, you'll help to mitigate the risk of pulling that money out for other things (but not entirely).
4. Start saving!
To save more money, you'll need to do two key things:
Saving money is hard - most people are terrible at it, and it doesn't seem to be something most human minds are good at. However, it's possible to save a lot and enjoy doing so. The key is to find areas in your budget that can be cut out (e.g., restaurants and expensive memberships) while maintaining the discipline to actually put the saved money into saving (instead of spending it elsewhere).
To earn more money, there are many options in modern economics. Today the world has many side hustle opportunities available, most right from your smartphone. It'll take some energy and force you to spend some time away from friends and family, but if you do it for a short period of time, it can be well worth it. Six months to a year of intense side work can change your financial picture - it's not well paid, and it's not easy, but if you can muster the energy and the time, there's room to make some decent extra cash.
Extra cash is very beneficial to your down payment goals. Relying only on your current income might be enough, but getting some extra money every month can skyrocket your savings goals. For example, if you're able to save $1000 a month but also are able to side hustle and make another $1000 per month, you'll have cut your time to house purchase in half!
Economic recoveries and bull markets move slowly; recessions and downturns move fast. So, be prepared...
Do you think that once a recession looms on the horizon, you'll be able to make preparatory moves to sustain your financial investments and your portfolio? If so, you're probably wrong. You're taking on too much risk and not effectively managing the risk within your portfolio and your financial life if you naively think that pre-recession prep isn't necessary.
Recessions come too quickly for most people - it'll probably be the same for you
Too often, people fail to take prudent steps to prep for recessions, market corrections, or economic downturns - they think they'll see the signs close to it and will be able to make the needed financial adjustments. This is incredibly hard to do, however, and most people fail at it.
The main reason it's hard to do is that, unlike economic recoveries and expansions, recessions come quickly and don't tend to give warning signs until after things are already bad (so, they're not really warning signs in this case).
There's too much prep work to do pre-recession
There is too much to be done to prep for a recession, and there might not be enough time to do it if you wait for some sort of warning sign to begin. These things may include the following:
The above items are essential if you want to both protect your financial and non-financial worlds during a recession. It's also important if you're going to thrive post-recession because of recessions, market corrections, and economic downturns bring asset prices down. The smartest investors are those who are eagerly awaiting a recession with a list of quality firms and other assets to buy up at low prices.
It's hard to find great firms at any time
Generally, quality firms are those who have healthy balance sheets, strong and growing earnings, proper management, and are engaged in businesses that are not readily open to competitive entrants. This is an entire field of study, however, and there isn't enough room in a single article to even begin to delve into this topic.
Sometimes luck gets in the way of us achieving our financial goals. Other times, we get in our own way. Don't make these classic financial mistakes - they have significant long-term consequences to your financial life.
1. Buy into the financial markets during market euphoria and sell out during the middle of an economic downturn: Far too often, people buy high and sell low instead of the often-stated "buy low, sell high" mantra. This has a lot to do with behavioral psychology and cognitive biases. A surefire way to take substantial steps backward in your financial life is to buy stocks (or any other asset) during a boom only to sell during a recession - this will result in capital losses, which are devastating to your financial portfolio.
2. Keep no cash cushion for the unexpected: Without a cash cushion (often called an emergency or rainy day fund), you'll need to sell less-liquid assets during harsh times for you and your family. Harsh times almost always do come, so neglecting to have a proper emergency fund in place will likely mean you'll end up selling assets at non-ideal times. Non-ideal is a good scenario. In fact, you could end up having to sell during a market correction or a full-blow recession (where asset prices can quickly drop by 50%). You can't afford to sustain such capital losses - having a cushion of money set aside as an emergency fund will protect you from this.
3. Fail to invest your savings: The first step to building wealth is saving - if you can't put money aside, you're going to have a hard time building real wealth in a sustainable and lasting way. Some people can save well, but they are afraid of investing. These people are often diligent and reasonably hard-working adults who don't like to take perceived risks. What they don't realize, however, is that for the most part, saving alone is not enough - you must invest your money at reasonable rates of return so that it may grow. Without growth, your wealth will only depend on your ability to earn income, and every year your wealth will slowly be eaten away by inflation.
From time to time and quite often, we find ourselves in need of extra money. Maybe we're paying down some credit card debt or maybe we need a few extra grand in order for us to take that vacation or maybe we need $10,000 more to be able to afford the down payment on the house we want.
Whatever it is that we need, we are lucky enough that living in a capitalist society allows for ample opportunities to earn side money. This isn't easy to do and your success will depend on many factors, including your skills, your grit level, your energy level, and the amount of time you have to devote your side hustle. But, if you're lucky enough to be able to take advantage of some opportunities that currently exist to earn side money, you could very quickly change your and your family's financial picture in as little as six months.
1. Drive for Uber/Lyft or another good ride-sharing service: Not a great job -- more of a gig in today's parlance -- but an excellent way to make extra cash for a short time if you've got the energy and the drive for it. You could put in a ton of hours and, over the course of six months, take major leaps forward in terms of your financial life. You'll need to have a reasonably new car and be able to pass a background/driving record check.
2. Charge scooters: Mobile electrics scooters like Bird, Jump, and Lime are taking over city centers and downtowns all over the US and the world. These scooters need to be charged and most companies have set up Uber-like/gig-like approaches where people can charge them overnight for a fee. The pay is not going to be great here - you'll earn a bit of money on each scooter. You'll also need cheap transportation, the ability to stay up for hours at night, and cheap electricity to make this worthwhile. But, if you fit the mold for this, you can earn some extra side cash. This is not a sustainable long-term solution to your money problems - the pay is too little, it requires a lot of energy, and the price of electricity makes it prohibitive for some people.
3. Start a blog, and do it well: You could always start a blog or a website on some niche topic, write amazing SEO-optimized content, and make money from ads. This is incredibly popular, especially in the US. There are a ton of resources available all over the internet on how to do this. This is a path that will take a while and where your patience will be tested - you'll be spending a lot of time, energy, and some money upfront to build out a good online presence. The key is not to get your hopes up too high about what's achievable.
4. Participate in focus groups or other research groups: A great way to make extra money is by participating in focus groups, research groups, or other such types of surveys. The best of these are in-person. You can search online to find some consumer research-type firms in your area and sign-up - most usually have an easy way to sign-up to receive updates. You'll periodically get updates with requirements (eg. age, type of car you drive, gender, preferences, consumer choices, etc.) and you can sign-up for them. The pay can be pretty solid - you can make a few hundred USD in just a couple of hours (sometimes more and sometimes less).
5. Tutor: If you're intelligent and have some solid knowledge about a particularly challenging topic (eg. organic chemistry, introductory Calculus, or Russian), you can tutor people and possibly build a sustainable side business that has the potential to generate extra money for you and your family. This is something that will take time to build and develop - starting a tutoring business is, in fact, starting a business, but it's not a business that requires much upfront cost. There are tons of websites online that facilitate student-tutor matching, but you can go the old fashioned route and post fliers up at local colleges, community colleges, high schools, churches, your local library, and other community centers
The above aren't the only ways to make extra money with a side gig. There are plenty of opportunities available to earn extra cash on the side for people who are smart, hard-working, and willing to put themselves out there a bit. Of course, the more skills and education you possess, the easier things will be (eg. charging scooters vs. tutoring differential Calculus), but there's no stopping you from taking a few steps forward in your financial life if you're gritty and willing to put in the work.
Too many people read lists like the one above, but never take a single step - a lot of us seem to just feel good enough searching on Google and reading the list; we too often get complacent and self-satisfied too quickly and don't actually pursue any of the above money-making opportunities. Others are eager to make extra money and change their financial picture, but are too timid to pursue anything out of their comfort zone. Avoid these pitfalls and mental traps - keep moving forward, both financially and non-financially, one step at a time.
1. Wealth allows you to obtain more comfort: Wealth and money allow you to have more things, better things, and get them faster. We all know that money doesn't buy happiness, but money can definitely buy you a lot of physical comfort(s).
2. Wealth allows you to make those you love comfortable: More important than making yourself comfortable, wealth allows you to improve the physical circumstances of those you love, whether that means helping your kids with a down payment, providing a good home for your family, taking care of your ailing parents, or giving a much-needed gift to a friend. Making the lives of those you love better is one of life's greatest joys.
3. Wealth allows you to affect the world: You can affect the world without having much wealth – some of the most influential people throughout history didn't have much in the way of resources, wealth, income, or power. But, having wealth does help make an impact on the world. If you've got a ton of money, you can help strangers by leaving large tips, or you can help college students by funding scholarships. With wealth, the options are almost endless.
4. Wealth allows you to demonstrate your value-creating abilities: If you're able to create value for other people, businesses, or organizations, you'll end up having money come your way most of the time. If you don't have any money, it's hard to argue that you've created a lot of value (of course, you could be a big spender). Real wealth, obtained in morally correct ways, is a big sign that you've done some things right.
5. Wealth opens up more opportunities for you: You surely don't need wealth to succeed, but having it helps a ton. If you have the money, a lot of doors open for you - they might be professional doors, they might be social doors, or they might be health-related doors. Wealthy people are able to utilize far more of this world's resources in getting the thigns they want:
The illusion that anyone can build wealth and reach financial success – a personal finance myth propagated by the personal finance media
Widely propagated on personal finance blogs, YouTube videos, magazine article, and on personal finance-related TV shows is the idea that anyone can get out of debt, save money, and build real wealth as long as they just try hard (both in educating themselves about money and in actually doing what's needed). This idea about personal finance and wealth building is a fiction, however. Not everyone can achieve financial success because financial success and lasting wealth depend, in part, on luck.
In modern Western Civ, people tend not to like to chalk up success (both of the financial and non-financial variety) and well being to luck. But, in many cultures around the world and in many periods throughout history, chance was understood better, and people didn't have as much resistance to accepting how much of a role luck plays in their lives. In finance, as in everything else, luck plays a huge role.
Whether or not you have a job that can provide you with enough income depends on so many factors, including whether or not you have skills that will provide value to other humans. To have such skills, you'd have to have gone to school or have developed them through some sort of apprenticeship (an apprenticeship could range from very formal to very informal). Whether or not you had the opportunity to develop skills, then, is at least in part determined by luck. What if you were born in a harsher place, to a more discordant community, or a less well-off family? Would you still be where you are today with a decent/good/great job? Maybe not. Likely not.
Beyond just the skills you possess, your disposition is dependent deeply on genetics and on how the first few years of your life went. Even the desires to save, to read personal finance blogs, to become better, or to move forward with your life may not be entirely yours – you might be lucky to have them, owing them in part to your parents (genetics) or your first few years of life.
Can a homeless man build wealth? Can a single-mom work three jobs while dealing with depression and build wealth? Can a crippled veteran who was deeply abused build wealth? Can a devastated black man who has only been taught that the world is dark and harsh build wealth? Can a family from the former Soviet Union whose members (especially the family's leaders) have deeply dysfunctional and ingrained problems understanding how to function in a capitalist society build wealth? Maybe, but it's not that easy.
A latte-sipping college-educated person with a relatively healthy mind, decent health, a neutral disposition, and without deep financial/family/psychological burdens stands a far better chance than the people described above. When the financial and personal finance media propagates lies about what's possible and what's not possible, they are abdicating their real moral duty in favor of clicks, views, likes, or short-term gain.
At the beginning of your wealth-building lifetime, it's your rate of saving and investing that matters more than your rate of return
People in the investing and financial world fetishize rates of return. Often cited and mentioned in financial articles is financial/investing genius Warren Buffet. Since 1965, Buffet has generated (thru 2017) approximately 21% annually. This is astonishing and deserves both praise and diligent study, but for most people who are in the early stages of their investing lifespan, it isn't relevant or useful.
The reason it's not relevant or useful for most people who are in the earlier stages of their investing timeline is that a focus on investing rates of return is useless and distracting. It's not the rate of return that matters most for a twenty-something or thirty-something investor. Instead, it's their rate of saving and investing that matters far more.
Barring ridiculously large and deeply improbably investing returns, getting more return won't be as beneficial as saving more. Imagine you have $1000 today, you can get an astonishingly high 50% return, or you can save another $1000 and get a100% gain effectively. If you've got $10,000, this becomes harder to do unless your income is very high. At $100,000, it's very hard to save an additional $100,000 - you'd likely want to start giving proper focus to investing returns. At $1 million, you'd likely begin to see more gains from investing than from saving. Obviously, these numbers need to be adjusted depending on income, but the core principle remains the same - if you don't have a lot of capital to work with, stashing away more capital is going to be better for you than trying to finesse something with the small amount of capital you do have.
Figure our your "why" for saving, investing, and building wealth - it'll help you financially and emotionally
A lot of well-educated people in today's modern economies save and invest a lot of money relative to their less-educated or less well-off counterparts. But, too often, these people in advanced economies lose sight of what they are saving and investing for.
It's not for anyone -- especially this blog -- to opine on why people should be saving and investing. But, it is troubling when most people can't come up with an answer quickly.
When you can't think of an answer quickly, it means you haven't thought about the question/problem long enough. In the case of saving, investing, and attempting to build wealth, that's a problem - if you haven't thought about "why" you're trying to build wealth, you're doing a disservice to yourself and your community (e.g. your immediate family, broad family, friends, etc.).
The point of building wealth is to use it - you can use it soon, you can use it far into the future, or you can put measures in place so that your wealth is used when you are dead. If your wealth is never used, it is clearly wasteful. If you don't think about how it's going to be used, that doesn't mean it won't be used; that doesn't mean you're wasteful. You're not - you're saving and building wealth. BUT, by failing to think about how you'll use your wealth, you fail to
It would do you a lot of good -- both financially and emotionally -- to grab a cup of coffee once a year and go for a long calm walk while thinking about your "why" (or any similar clam and contemplative activity).
Expand Your Understanding of the Investment Possibilities that Exist
Most people in the western world have an overly narrow view when it comes to investing - they usually think one of those places for storing money:
Even the above list is broad - most young people today don't readily buy bonds or invest in bond funds (even though the overall bond market is bigger than the equities market). Unless you're lucky enough to have had your grandma buy you a bond, you've probably never owned one and you might not even really know how one works.
So, that leaves us with equities or cash - is there nothing else? Of course, there is something else -- most people have been doing other things with capital rather than buying equities or saving cash -- throughout history. You just have to open your eyes to the broader investing and capital allocation universe that's out here.
Of course, you shouldn't be foolish - equities (eg. stocks, mutual fund, and ETFs) and cash are better understood and offer a lot of advantages. But a person can also invest in:
getting even deeper and more complex, you can invest in things aren't aren't even assets but things that might bring a return later on. These might include:
Again, no one here is saying that you should forget the bread and butter that cash and equities offer the broad swath of the investing public - far and away these should (for most people and in most situations) make up the majority of your saving and wealth-boiling plan. However,r it's smart to lift your head up once in a while to see other possibilities and opportunities available if only to build a better and more comprehensive understanding of what capital allocation, investing, growth, return, and success really mean in your overall financial life.
You can't save your way to riches if you don't have a big enough income to save just like you can't dig a big hole if your shovel is tiny. Too many people, too many financial websites, too many financial advisors, too many financial shows have for too long advocated saving with a deep lack of attention to the more important sid of the equation: INCOME.
Of course, even if you have an enormous income but still manage to spend it all, you won't build wealth. But that is not at all relevant to what we're discussing here. What we're saying is that there are simple mathematical and physical principles govern the world we live in and based on these principles there's something we know that's true:
the maximum amount you can save is your full income - this would be not possible in most cases it would require not spending anything
So, if you're earning $30,000 a year but are the most magnificent saver in the world, the most you can possibly save is $30,000 but realistically you'll be considered an ultra-saver if you manage to save $20,000 a year.
Contrast that $30,000 per year example with someone who earns $300,000 a year - clearly that individual has a much bigger shovel and has a lot more room to take advantage of saving. In effect, this person who makes $300,000 can benefit more from saving because the more he/she saves the more they can put away for building wealth up to their income. In effect, if they can spend $10,000 a year like the person in the $30,000 example, they can save a huge pile of money every year and build a lot of wealth.
People should be focused on saving, but they should equally (if not more intensely) be focused on generating more income for themselves os that they can put more money aside. This is easier said than done and that's the reason most financial resources tend to focus on saving rather than increasing income - everyone simply wants to pick the low-hanging fruit.
In Antiquity, Family and Community Provided a Safety Net in Retirement
Throughout most of human history, the idea of retirement as we know it today didn't exist. People simply worked their entire lives either hunting and gather or farming (after the Agricultural Revolution) -- if they were lucky enough to survive into adulthood -- and when they were too old to work, they relied on their families to take care of them. An old person might rely on younger siblings, children, and nieces and nephews within the family or community to take care of them. While doing this they probably still had to do some work - the idea of not working at all is a deeply modern notion and even very old people in ancient times still likely cared for children, did chores around the house, and performed other familial duties (eg. arranging marriages, representing the family to other communities, and advising younger family members).
Although life was incredibly harsh with humans having to face both natural disasters and man-made dangers in the form of banditry, war, pillaging, or abandonment, most human societies operated in a way where the elders and those who were unable to work were taken care of by family. As time moved forward and as humans settle down this was more and more true - while a hunter-gatherer tribe might leave an old person to die, a farming community would likely be able to provide for the elderly because life was calmer and a bit more stable in terms of movement and physical danger.
Obviously, no one in their right mind living in the first-world should want to go back to a hunting and gathering lifestyle and especially a farming lifestyle (as farming was likely worse than hunting and gathering for overall human well-being). However, we can't deny that the family bonds that existed in the past that effectively created an organic safety net for the elderly no longer exists today.
Safety Nets Such as Welfare Provide Retirement Security in a Changed World
As the world moved forward modernized, nations around the world began creating public, centralized welfare systems to take care of those who were too old to work and had to enter a stage of retirement or diminished income-earning capability. In the United States, during Roosevelt's New Deal during the Great Depression, the Social Security system was created - this was a system where old people who were no longer working could receive income from the government (meaning from those who were earning income). In effect, this wealth-transfer mechanism sought to replace the old traditional familial and community retirement safety nets that had long since been eroded over the centuries following the Industrial Revolution.
It is difficult to argue that a safety net for old people who can no longer produce income through their labor and who don't have a large enough retirement nest egg to live on is a prudent idea - it is deeply natural to humanity to take care of one another. The difference is that instead of taking care of each other locally, we started taking care of each other on a grand national scale. This creates its own problems and perverse incentives, but it fundamentally is in line with our human nature. If done in a prudent and conservative way (something that is far from guaranteed), such a retirement safety net can at once benefit the economy through stabilizing things and benefit society through creating a better and healthier moral landscape by taking care of retirees.
Retirement Saftey Nets in Jeopardy - Self-reliance is Key
However, today the Social Security system -- a system that hasn't even been around for a century -- seems to be in jeopardy (it is projected that in 2037 Social Security trust fund reserves will be exhausted and where 100% of payments will no longer be able to be made). A system designed at a time where there were few retirees living into their 60s and 70s compared to the working population is under stress in the world where Baby Boomers are aging rapidly with access to world-class health care that will allow them to live into their 80s and 90s reliably and in good numbers. Many believe this system will not be able to sustain itself. This will be further exacerbated if unemployment increases over the coming decades due tot he rise of artificial intelligence. Young people today should not rely on Social Security to be around when they are old and gray - that is now a foolish proposition.
For young people today, the idea of retirement is different than for almost all past generations. For the first time in history, neither (1) the familial/community structure that effectively provided retirement benefits for the old nor (2) the retirement benefits provided by welfare systems like Social Security is likely to be around when today's young men and women reach retirement age.
So, we're now in a world where the old family and community structure have long since been almost totally wiped out and where the retirement safety net that came in to replace that old structure is itself in peril. We are facing a troubling and dark world when it comes to retirement - we have neither one nor the other, we only have ourselves at this point. Although a fix might occur and things might turn out well, in the end, any prudent person who is under the age of 40 should discount Social Security and only rely on himself/herself to provide in old age and retirement. This requires changes - it requires a discipline that might not have existed in the last century for most of the population in term of saving. Young people must be diligent and disciplined savers and investors if they are going to be able to amass a nest egg large enough to support them through what could be decades of retirement.
This means that saving 5% or 6% in your 401k to get your employer match, putting $5000 a year into an Investment Retirement Account (IRA), or simply having a nice cash cushion in the bank is not even close to enough. Saving rates must far exceed 10% and should approach 25% if young people today are going to be able to comfortably retire. Additionally, effort and energy must be put in to invest the savings in a smart way - saving cash will not be sufficient as growth is going to be needed over time in order to build up a nest egg.
Compound interest is something we all know about, but not something we fully grasp. Sure, most people in the developed world in 2017 know what compound interest is and what that it's a pretty powerful thing, but few know exactly how powerful it is. There's a rumor that Einstein said something to the effect of "compound interest is the greatest force in the universe." If that's true, he was a smart man.
So, how can we approach a better understanding of compound interest? There seem to be two possible approaches here:
It seems that both are important, bu that the examples always are better in getting the ball rolling. Some examples are so astonishing that students of finance and financial theory are in awe both at the power of compound interest nad the previous disrespect for it. Here is one such example for your entertainment and pleasure.
Let's imagine 3 scenarios:
So, we've got 3 scenarios here, with each person separated by two main differences:
So, we know what's different, but what is the same? We have a few things that are the same for the people in all 3 scenarios:
So, we now have what we need - we have 3 babies born on the same day in the same hospital to different families. Let's take a look at how things turn out for them over the course of their lives.
We first notice that the baby in the Ideal scenario starts accumulating wealth - although not very much. In the first year, $1200 is saved. By Year 10, however, almost $20,00 has been accumulated thanks to the 10% growth. Another 10 years goes by and by Year 20 the Ideal baby has accumulated almost $69,000 - a very significant sum especially given the fact that the parents have only saved/invested $24,000 over the course of those 20 years.
Now, let's move to Year 25 - the Optimistic baby is now and adult and is joining the pack here. Unlike the Ideal adult who now has a lot of cash at Year 25 (about $118,000), the Optimistic baby has nothing. However, the Optimistic baby is saving 10x what the Ideal baby is saving - that's $1200 a year vs. $12,000 a year!
So, let's observe these two over time. At Year 30, the Ideal adult has roughly double the amount the Optimistic adult has (that's about $197,000 vs. $93,000). This might seem not astounding unless you realize that the Ideal adult has only saved/invested $36,000 over the course of his or her life while the Optimistic baby has already (over the course of just 5 years) invested $60,000.
Continuing through to Year 50, where the Typical adult finally joins us, we see an interesting situation - the Ideal and Optimistic adults have roughly caught up with each other. Each has about $1.3 million, BUT the astounding part is only revealed when we think about how much each has saved/invested over the course of their lives:
Now, we've got everyone in the game - the Ideal, the Optimistic, and the Typical adults. Let's follow through until 65 - they have 15 more years to save and growth their wealth.
Catching up with all of them at 65, what do we see? We see a few interesting things, but first, let's start with the numbers:
BUT, let's again sit in awe of the power of compounding by taking a look at how much each saved/invested:
So, we see that they're all very wealthy, but they've achieved their wealth in very different ways. While the Ideal person barely saved anything throughout their life, the Typical person saved a ton. Digging deeper, we can see that the Ideal person actually saved less in their entire 65 years than the Typical person saved in one single year. This is truly astounding and provides excellent evidence at the amazing power of compounding.
We can see that time matters a lot. In fact, this example clearly shows that in many cases, time matters more than money. The one who started first finished ahead of everyone and barely had to save anything. The Idel person could have earned $40,000 their entire lives with no raises at all but would still have more money at 65 than the Typical person who had to earn enough from 50 to 65 to be able to put away $120,000 per year (that's very hard considering that savings comes after expenses and after-tax for the most part). The Typical person would probably have to earn at least $400,000 per year to be able to reasonably save that much money - even at that level of income saving $120,000 per year would feel like an incredible sacrifice.
Take a look at the table below for a rundown of all the numbers. You'll see the age of our group on the left along with the savings rates and rates of returns at the top.
If you cannot save money, the seeds of greatness are not in you.
To become an excellent saver over the long term you must get some sort of mental reward from saving - if saving is a difficult process (like resisting eating food when dieting), you might be able to do it for a little while but over time you'll fail because we all only have limited amounts of willpower and energy. The real secret to being an amazing saver is to love saving - the secret is to have saving be a very enjoyable thing.
For some people saving money is very easy - they were either born with a mind or a disposition that rewards them when saving or they developed such a mind or disposition over time. Rarely will you see a really excellent saver who has to consistently battle himself or herself to put money away for the future or to resist spending in order to save - it's just too hard to do over the long term.
Other people, however, just can't seem to save. They spend all of their incomes (and sometimes even more) and they don't seem to feel any reward by putting money away - it feels like a chore to resist spending all of their money or putting some money aside. They won't become wealthy unless they strike it rich through luck or unless they have extremely high incomes. For most people who can't seem to enjoy saving money, they will need to change their mind a bit in order to be able to become truly excellent savers capable of building real lasting wealth overthe long term.
How can you change your mind? That's the hard part. You'll need to force or will yourself to start saving at first despite any internal resistance you have to it. When you do save some money, take the time to sit down and think about what you just did:
Reward yourself with a nice dinner, a nice movie on Netflix, or anything else you enjoy. Let the pleasure sink in and try to associate the pleasure with the act of saving money. Do this consistently and over time saving will seem more pleasurable and easier.
Here are some other tips to help you become an excellent saving:
Now, it's possible that not everyone can be an excellent saver - as much as we want it to be true, it seems like some people either don't have the personality or the internal energy to become excellent savers. That's a sad proposition. However, if you're reading this post, you're very likely not one of those people - you've already shown excellent initiative and you're already ahead of the game in your search for high-quality information. Go out and practice the tips above with vigor and intensity until you saving feels amazing for you also.
Living below your means is absolutely required if you are to build wealth, gain financial independence, and live a life of dignity. However, too many people fail to live below their means even though they intuitively know that they should do so. Are you one of them? Below are 3 powerful tips that will help you live below your means and set you up on the path to financial prosperity and wealth.
1. Make Saving and Investing Automatic
One of the most effective ways to live below your means and save more money is to put your savings and investments on autopilot - have your saving program and investing program draw money from your transactional account (usually your checking account) before you can get to the money.
So, for a typical example, let’s take a look at an hourly or salaried employee who obtains all of his or her income from his or her job. Let’s say they get their pay via direct deposit into their checking account every 2 weeks (this is the most typical payment timeframe). They should set up a system so that it automatically withdraws money from their checking account either every two weeks or once a month. Such a system is very easy to set up on most online savings accounts and online brokerages - once your accounts are open, it usually will take you less than 20 minutes to set something like this up.
Automatic withdrawals into a savings or a checking account almost always beat manual withdrawals into those accounts because of issues presented in the field behavioral finance. Humans are prone to procrastination, forgetting, getting lazy, or getting distracted - the algorithm or computer program that will be in charge of executing your automatic withdrawals will not be prone to such things (although it could be prone to computer bugs). You might think you’ll be able to consistently save and invest every month, but if you look at what people really do in the world, you’ll see that too many people fail themselves and their financial plans at some point in time. Usually, it doesn’t take very long for them to fail and not make the monthly or weekly transfer or stock purchase they committed to making. With an automatic investing and savings plan, however, you’ll turn your human faults into advantages - the same procrastination and laziness which would prevent you from saving and investing money will also help to prevent you from going into your online savings account or online brokerage to change or remove your automatic savings and investment plans.
2. Understand that Many Significant Expenses Don’t Occur Monthly
We’ve written about this a bit already on Pennies and Pounds, but it is worth restating often. Only a portion of all of your expenses are monthly expenses - other expenses occur once a year, once every few years, once every five years, once every decade, or once in a lifetime. These expenses are not financial emergencies because we can predict them (eg. you know you’ll have to pay your child’s college tuition or you know you’ll have to pay for a wedding).
Click here for more on non-monthly expenses and an extremely in-depth explanation on why you must save a lot of money and build up a pile of cash!
Since we know that many expenses (especially the big and important ones) occur very rarely (but predictably), we must save for them if we are to be prudent adults. Anyone who is serious about building wealth and attaining financial independence cannot ignore this important fact about our current financial reality - that not all of our expenses are monthly. Ignoring this fact will cause you unnecessary stress and anxiety down the road and might cause you to have to either dip into your emergency fund or your investments for something that you should have (and could have) planned for.
Realizing the above should motivate you to live below your means in order to save. We must all realize that our monthly expenses are just an illusion (they don’t represent the full reality of our expenses over long stretches of time) and we must live below our monthly means in order to save for future expenses. It’s pretty interesting that before even taking investing and wealth building into account, we still must live below our monthly means in order to just break even over the long term - if you spend your entire monthly (or biweekly) income you are actually overspending. For example, multiplying your monthly expenses by 120 would severely underestimate how much you’ll need to spend over 10 years because you won’t be taking account those big expenses that occur once every year, once every five years, or once every decade. If you’re spending your entire monthly income you are doing the equivalent of going into debt except you are borrowing from your future self who will have to struggle and strain to make up for your lack of forethought and planning today.
3. Imagine and Connect With Your Future Self
At Pennies and Pounds, we value research but we also value common sense, good stories, and tradition - we're not religious about research like many people are in today’s modern world because we are aware of the games that can be played with research and the various biases and agendas that can influence studies. We also know about the games that can be played with statistics. Have you heard the following saying?: “There are lies, damn lies, and statistics." We won’t go into it deeper than this in this article, but we wanted to let you know our views on research before we proceeded with the following point.
New research is showing that when people are better able to “connect” with their future selves, they will make better long-term decisions including financial decisions. A piece by the Harvard Business Review on the study can be found below. We encourage you to read HBR’s piece and look at the actual research study if you are so inclined. In very general terms, the research implies that people generally have a disconnect with their future selves - people don’t really understand that their future selves are themselves. This might sound funny, but it’s true in a way. The research showed that people are more willing to commit to things in the future and are also more willing to commit other people’s time. It’s almost as if they view their future selves as a different person.
It’s astonishing in a way, but the disconnect described in the research between your current self and your future self sort of makes sense. Have you ever committed to something in the future only to realize how foolish you were to do so when the time to actually execute on that commitment comes around? Have you ever set an alarm to wake up extra early the following morning only to hit the snooze button and wake up at your normal time (or wake up late) when the time comes around? Have you ever promised yourself to save more money or spend less money only to not follow through when it’s time to actually have the discipline to follow through? The research suggests that this occurs because it’s as if you’re committing another person to something when you’re making a future commitment - it’s easy to commit your future self to a project if it’s a year from now because it is as if you’re not really committing yourself but are instead committing another person. If you had to execute on things immediately, you would be far more cautious about what you promise to other people and to yourself and you would feel the weight of your actions (or inactions) much more.
All of this is to say that if you can better connect with your future self, you are more likely to make better financial decisions - you’re more likely to save money today and live below your means today because you’ll have a better connection with the future you who will one day benefit from your smart decisions today.
In the study, researchers used MRI and sophisticated aging techniques to present participants with photos of their aged selves. This is very expensive and difficult for us to do, but there are other techniques that can help. You can simply sit and imagine yourself in the future or you can write a letter from your future self to your current self. Additionally, there are apps available that can “age” your current photos. Check out one such app below. Your connecting with your future self doesn’t have to be complicated or sophisticated - it just has to help you realize that it’s not some distant other person that will benefit from your positive actions, it’s you who will benefit.
We once again will stress this important point because we believe it cannot be said enough - you cannot be satisfied by living at your means, you must live below them if you are to truly build wealth and become prosperous. As is stated above and in other places on this website, you must live below your means because:
Don't foolishly fall into the trap that derails many financial plans and needlessly taps into people's emergency funds: mistaking a non-emergency for a real financial emergency. A financial emergency is something unexpected, not something that predictably happens every so often.
Read our comprehensive article on emergency funds for more on the randomness of life and how so many things are unpredictable (that's why we have to have an emergency fund)
Here's what unexpected means: that you cannot reasonably anticipate the nature of the financial emergency in advance. You can of course anticipate that a financial emergency will occur based on the nature of our reality and existence, but you cannot reasonably predict what it will be.
Therefore, the following would not properly be considered financial emergencies:
The above are not emergencies because we can anticipate them - we have anticipated them for you and we don't even know you.
Real financial emergencies, however, are things that we think might happen, but things we cannot predict in any reasonable way from where we currently are. We know we might get a flat tire or injure our ankle, but we don't know if that will ever happen, when it could happen, and the financial cost of it.
Do not confuse rare expenses with financial emergencies - you will not be served well by doing so because you will consistently fail to build lasting wealth if you dip into your emergency fund to pay for things that are not at all emergencies.
And now, given the rise of cyrptocurrencies and crypto assets to quasi-mainstream financial assets, we're dedicated to providing quality, relevant, and interesting material on cryptocurrencies and cryptoassets. Articles on Bitcoin, Ethereum, Ripple, Cardano, and many more cryptocurrencies and cryptoassets can be found on Pennies and Pounds - all that in addition to a plethora of information on what cryptoassets are, how the entire crypto industry came to be, blockchain/immutable ledger technology, mining, proof of work, proof of stake, and how to prudently invest in crypto if you are so inclined (based on your risk tolerance and ability to withstand the volatility that will come with a crypto portfolio).