It has been said that most Americans are just one paycheck away from bankruptcy – Basically, if they miss one month’s salary, they would be unable to recover. The problem is that most people have a mortgage to pay, several credit cards and many small loans. Add in the day to day-to-day expenses of living and you’ll see why there is a problem.
The Light at the End of the Tunnel
It’s not all doom and gloom, however. As long as you understand why the situation can end up getting this bad, you can avoid getting yourself into the same sort of trouble.
In fact, if everyone used this mantra more often, “Save not Spend,” there would be a lot more financially secure people in the world. That’s not to say that you have to become a miser – after all, you work hard for your money, you are entitled to benefit from it – you just don’t want to end up in a few years feeling as though you only work to pay off your debt. By getting ahead of the problem, you’ll be putting yourself in a much better position, as you’ll see in a second.
Compound it All!
To understand why it is so important to start saving money as soon as you are able, it is important to understand the concept of compound interest.
When it comes to simple interest, the interest that you receive is based only on the amount of capital that you originally invest. If that interest is then reinvested with your capital amount, you earn interest on both the capital and the interest added in and the interest is said to be compounded.
Compound interest is easiest to explain in a table – for this exercise, let’s assume that Julie and Sarah are two 25 year olds. Julie contributed $5,000 per year and earned 8% interest per year. She invested for just 10 years, until she was 35 years old. Then, she sat back, relaxed, and let her money do the work for her for the next 30 years while she spent her money on other things.
Sarah waited 10 years to start saving, but to make up for it, invested for the next 30 years, with the same $5,000/year contribution and 8% annual interest. In the end, Sarah contributed a whopping $150,000 while Julie contributed just $50,000. So who had more money at the end of 40 years?
It sounds crazy, but Julie actually outsaved Sarah by a significant margin, despite only investing just a third of what Sarah contributed. The important lesson here? Saving early is even better than saving often! Check out this table to see what happened.
What to Take Away from This
The lesson here is to start saving now – make saving a priority for you. If you do have credit card debt, repay that first as the interest rates charged are a lot higher than the rate that you’d likely receive from investing. Once that is done, your aim should be to get to a point where you are saving around about 10% of your salary. Retirement funding can help you to qualify for tax breaks, allowing you to sock away even more of your money for the future.
Once you get into the habit of saving your money, it will become easier and easier and you won’t miss it. Forget about just having 3 months salary saved, carry on saving for as long as you can so that you can truly start to build wealth, or, at the very least, avoid being forced to work until well after you would like to retire. Do your best to invest as early as you can. You can try and make up for it later by investing more or investing longer, but there’s no replacement for time!