Thursday, May 11, 2017

Your Pennies Do Count


There are many opinions about what is the best method to save money, and maybe even more ideas on what we can do to reap the benefits of long term savings.
Some believe that frugality, being economical with our resources, primarily money; is the path.  Having 25 pairs of  shoes, a closet full of dresses, suits and jeans is quite an unnecessary waste of money.  


Many use David Bach’s Latte Factor, how saving just a few dollars a day rather than spending it on small, seemingly harmless purchases do make a difference.  The Latte Factor is not just about that morning coffee. Your “factor” may be the bottled water at the gas station or the magazine you pick up at  the checkout line. Harmless they are not.


Many take this to the extreme and live on a steady diet of peanut butter and jelly sandwiches and noodles to save a couple dollars.  That is not  frugal, it's just cheap and rather unhealthy.


Other extreme measures include buying two-ply toilet paper and splitting each roll into two,  or cutting off the bottom of the toothpaste tube to get one more use out of it.  


One blog post with almost 1,000 shares suggested that we patch-up our clothing, air dry our laundry and get rid or cable, internet and the smartphone.


Enough people go the extreme frugality route so there must be something there.  Not for me.  I will be buying clothes as needed and while  I fondly remember my grandma looking out the window, checking on the sun to see if it would be a good day to do the laundry, I rather toss them into the dryer.  


Those that sit on the opposite end of the table, and do not subscribe to the theory, like Ramit Sethi say that you should focus on the bigger gains and suggest that you simply earn more by getting a higher paying job or aiming for the big bonus.  By focusing on the small savings you forget about the big picture.


He is a New York Times best selling author who has probably forgotten more about finance than I will ever learn,  but I think he goes on too far and even ridicules the concept.
He adds that saving small amounts add nothing to your bottom line and If you want to spend your money on that super special cup of coffee that makes you infinitely happier, you should go ahead and buy it.  That we cannot over-analyze small purchases because money is to be spent on things we love.  That depriving ourselves of that latte is a depressing an unnecessary exercise in futility.   


In reality, this situation is nothing more than the need for instant gratification. We are not children anymore and should be able to control that “I need it now mentality”.  Not buying that latte is not going to ruin your life!


While I agree that big wins are much better, for many, getting a better paying job may not be an option; and would saving $100 a month while earning minimum wage be considered a big win? That is $1,200 per year. Not a life changing amount by itself, but eliminating that daily latte and contributing the savings into an IRA, can equal almost $395,000 in retirement.  Best part of this is only contributed a total of $55,200.  


This total does not include any future raises, promotions or contribution increases of any kind, and only takes into account a $1,200 annual contribution from the ages of 19 to 65 at a 7% rate of return.  


A $125 contribution changes that total to more than $492,000 with a lifetime total contribution of only $69,000.  Proving that in the long run, the pennies do count.


Why not subscribe to both methods?   Do not ignore  either one. There is a proven track record for both.  So why not utilize all that will work for you?


What can we do with the money we save?  Do not sock it away in a regular savings account.  What little interest you earn can not even keep up with inflation. There are better options available. I will mention some and attempt to briefly explain the basics.


Employer sponsored retirement accounts frequently have an employer match, that is free money-take it.  The maximum allowed contribution  currently stands at $18,000.  If you can not max out, you need to contribute enough to get the company match.


Contributions to these accounts are usually made with pre-tax dollars meaning your taxable income is lowered and taxes will be deferred until the monies are withdrawn in retirement when in theory your income will be lower.


The IRA, individual retirement account is probably the most common option for investing for retirement. Contributions can be made with pre-tax and/or post tax dollars.  The post tax account is known as the Roth IRA and has become quite popular because your money will grow tax free.  Contribution for both are currently capped at $5,500.


Many in the FI (financial independence) community have converted their retirement savings into Roth IRAs because your deposit can be withdrawn tax and penalty free after five years.


This transaction can prove costly if done incorrectly.  Seek the advice of a professional before you attempt any such conversion.


There are different types of 401Ks and IRAs to suit specific needs.  They also have age based catch-up contribution allowances.  These are worth looking to maximize growth.  Does not matter if you started late or if you simply want your nest egg to grow faster...use it if at all possible.


The “new” kid on the block is the robo-advisor.  They must be registered as investment advisors and are regulated by the Securities & Exchange Commission same as brick and mortar institutions. These offer portfolio management with almost no human interaction and charge a lower management fee when compared to traditional brokers.


Robo-advisors utilize algorithms to optimize and allocate your funds.  Lower fees and minimums are the trademarks thus allowing for a broader audience.  I opened an account with an initial $25 deposit and simply add a monthly deposit of $25.


One of Ramit’s “pillars” is to automate your savings and that can be done in a multitude of manners.    Use all that you can.  You only need to do it once and adjust as raises and promotions allow.


Whether your goal is financial independence or a more traditional retirement; there are lots of tools available to get there. You now have no excuse to get started,  all it takes is $25.  Spend a little of your time and find what is best for you and get started.  It is never too late to start unless you never actually do get started.

I have no connection to either authors, but as a fan of both thought it worthwhile to share their knowledge from a different point of view.

I am not a financial advisor.  I hold no fancy degree and as such this is not financial advice.  Seek the advice of  a professional.