IT ALL STARTS WITH SAVING
This is a short, straight-talk book about investing. Our goal is to enhance your financial security by helping you make better investment decisions and putting you on a path toward a lifetime of financial success and, particularly, a comfortable and secure retirement.
Donât let anyone tell you that investing is too complex for regular people. We want to show you that everybody can make sound financial decisions. But it doesnât matter whether you make a return of 2 percent, 5 percent, or even 10 percent on your investments if you have nothing to invest.
So it all starts with saving.
It doesnât matter whether you make a
return of 2 percent, 5 percent, or even 10
percent on your investments if you have
nothing to invest.
I
SAVE
Save. The amount of capital you start with is not nearly as important as organizing your life to save regularly and to start as early as possible. As the sign in one bank read:
Little by little you can safely stock up a small reserve here, but not until you start.
The fast way to affluence is simple: Reduce your expenses well below your incomeâand Shazam!âyou are affluent because your income exceeds your outgo. You have âmoreââmore than enough. It makes no difference whether you are a recent college graduate or a multimillionaire. Weâve all heard stories of the school-teacher who lived modestly, enjoyed life, and left an estate worth over $1 millionâreal affluence after a life of careful spending. And we know one important truth: She was a saver.
But it can also go the other way. A man with an annual income of more than $10 millionâtrue storyâkept running out of money, so he kept going back to the trustees of his familyâs huge trusts for more. Why? Because he had such an expensive lifestyleâprivate plane, several large homes, frequent purchases of paintings, lavish entertaining, and on and on. And this man was miserably unhappy.
In David Copperfield, Charles Dickensâs character Wilkins Micawber pronounced a now-famous law:
Annual income twenty pounds, annual expenditure
nineteen pounds nineteen and six, result
happiness. Annual income twenty pounds,
annual expenditure twenty pounds ought and
six, result misery.
Saving is good for usâfor two reasons. One reason for saving is to prevent having serious regrets later on. As the poet John Greenleaf Whittier wrote: âOf all sad words of tongue and pen, the saddest are âIt might have been.ââ2 âI should haveâ and âI wish I hadâ are two more of historyâs saddest sentences.
Another reason for saving is quite positive: Most of us enjoy the extra comfort and the feeling of accomplishment that comes with both the process of saving and with the resultsâhaving more freedom of choice both now and in the future.
No regrets in the future is important, or will be, to all of us. No regrets in the present is important, too. Being a sensible saver is good for you, but deprivation is not. So donât try to save too much. Youâre looking for ways to save that you can use over and over again by making these new ways your new good habits.3
The real purpose of saving is to empower you to keep your prioritiesânot to make you sacrifice. Your goal in saving is not to âsqueeze orange juice from a turnipâ or to make you feel deprived. Not at all! Your goal is to enable you to feel better and better about your life and the way you are living it by making your own best-for-you choices. Savings can give you an opportunity to take advantage of attractive future opportunities that are important to you. Saving also puts you on the road to a secure retirement. Think of saving as a way to get you more of what you really want, need, and enjoy. Let saving be your helpful friend.
FIRST DO NO HARM
The first step in saving is to stop dissavingâspending more than you earn, especially by running up balances on your credit cards. There are few, if any, absolute rules in saving and investing, but hereâs ours: Never, never, never take on credit card debt. This rule comes as close as any to being an inviolable commandment. Scott Adams, the creator of the Dilbert comic strip, calls credit cards âthe crack cocaine of the financial world. They start out as a no-fee way to get instant gratification, but the next thing you know, youâre freebasing shoes at Nordstrom.â
Credit card debt is greatâbut not for you (or any other individual). Credit card debt is great for the lenders, and only the lenders. Credit cards are a wonderful convenience, but for every good thing there are limits. The limit on credit cards is not your announced âcredit limit.â The only sensible limit on credit card debt is zero.
Credit card debt is seductive. Itâs all too easy to ease onto the slippery slopeâand slide down into overwhelming debts. You neverâwell, almost neverâget asked to pay off your debt. The bank will âgraciouslyâ allow you to make low monthly payments. Easy. Far too easy! Your obligations continue to accumulate and accumulate until you get The Letter, saying you have borrowed too much, your interest rate is being increased, and you are required to switch, somehow, from money going to you to money going from you to the bank. You are not just in debt, you are in trouble. If you donât do what the bank now says you must do, legal action will be taken. Be advised! Never, never, never use credit card debt.
START SAVING EARLY: TIME IS MONEY
The secret of getting rich slowly but surely is the miracle of compound interest. Albert Einstein is said to have described compound interest as the most powerful force in the universe. The concept simply involves earning a return not only on your original savings but also on the accumulated interest that you have earned on your past investment of your savings.
The secret of getting rich slowly, but surely,
is the miracle of compound interest.
Why is compounding so powerful? Letâs use the U.S. stock market as an example. Stocks have rewarded investors with an average return close to 10 percent a year over the past 100 years. Of course, returns do vary from year to year, sometimes by a lot, but to illustrate the concept, suppose they return exactly 10 percent each year. If you started with a $100 investment, your account would be worth $110 at the end of the first yearâthe original $100 plus the $10 that you earned. By leaving the $10 earned in the first year reinvested, you start year two with $110 and earn $11, leaving your stake at the end of the second year at $121. In year three you earn $12.10 and your account is now worth $133.10. Carrying the example out, at the end of 10 years you would have almost $260â$60 more than if you had earned only $10 per year in âsimpleâ interest. Compounding is powerful!
THE AMAZING RULE OF 72
Do you know the amazing Rule of 72? If not, learn it now and remember it forever. Itâs easy, and it unlocks the mystery of compounding. Here it is: X Ă Y = 72. That is, X (the number of years it takes to double your money) times Y (the percentage rate of return you earn on your money) equals . . . 72.
Letâs try an example: To double your money in 10 years, what rate of return do you need? The answer: 10 times X = 72, so X = 7.2 percent.
Another way to use the rule is to divide any percentage return into 72 to find how long it takes to double your money. Example: At 8 percent, how long does it take to double your money? Easy: nine years (72 divided by 8 = 9).
Try one more: at 3 percent, how long to double your money? Answer: 24 years (72 divided by 3 = 24).
Now try it the other way: If someone tells you a particular investment should double in four years, what rate of return each year is he promising?
Answer: 18 percent (72 divided by 4 = 18).
For anyone whose attention is attracted by the Rule of 72, the obvious follow-on is surely compelling: If a 10 percent rate of return will double your money in 7.2 years, it will double your money again in the next 7.2 years. In less than 15 years (14.4 years to be exact), youâll have four times your moneyâand sixteen times your money in 28.8 years.
So if youâre 25 and you skip one glass of wine at a fancy restaurant today, you might celebrate with your spouse the benefit of compounding with a full dinner at that same restaurant 30 years from now. The power of compounding is why everyone agrees that saving early in life and investing is good for you. It is great to have the powerful forces of time working for youâ24/7.
Time is indeed money, but as George Bernard Shaw once said, âYouth is wasted on the young.â If only we could all train ourselves at a young age to know what we know now. When money is left to compound for long periods, the resulting accumulations can be awe inspiring. If George Washington had taken just one dollar from his first presidential salary and invested it at 8 percentâthe average rate of return on stocks over the past 200 yearsâhis heirs today would have about $8 million. Think about this every time you see Washington on a U.S. dollar bill.
Benjamin Franklin provides us with an actual rather than a hypothetical case. When Franklin died in 1790, he left a gift of $5,000 to each of his two favorite cities, Boston and Philadelphia. He stipulated that the money was to be invested and could be paid out at two specific dates, the first 100 years and the second 200 years after the date of the gift. After 100 years, each city was allowed to withdraw $500,000 for public works projects. After 200 years, in 1991, they received the balanceâwhich had compounded to approximately $20 million for each city. Franklinâs example teaches all of us, in a dramatic way, the power of compounding. As Franklin himself liked to describe the benefits of compounding, âMoney makes money. And the money that money makes, makes money.â
A modern example involves twin brothers, William and James, who are now 65 years old. Forty-five years ago, when William was 20, he started a retirement account, putting $4,000 in the stock market at the beginning of each year. After 20 years of contributions, totaling $80,000, he stopped making new investments but left the accumulated contributions in his account. The fund earned 10 percent per year, tax free. The second brother, James, started his own retirement account at age 40 (just after William quit) and continued depositing $4,000 per year for the next 25 years for a total investment of $100,000. When both brothers reached the age of 65, which one do you think had the bigger nest egg? The answer is startling:
⢠Williamâs account was worth almost $2.5 million.
⢠Jamesâ account was worth less than $400,000.
Williamâs won the race hands down. Despite having invested less money than James, Williamâs stake was over $2 million greater. The moral is clear; you can accumulate much more money by starting earlier and taking greater advantage of the miracle of compounding.
We could run through dozens of other examples using actual stock market returns. One investor might start early but have the worst possible timing, investing at the peak of the stock market each year. Another investor starts later but is the worldâs luckiest investor, buying at the absolute bottom of the market every year. The first investor, even though she may have invested less money and had the worst possible timing, accumulates more money.
Luck in picking the right time to invest is all well and good, but time is much more important than timing. There is always a good excuse to put off planning for retirement. Donât let it happen to you. Put time on your side. To get rich surely you have to do it wiselyâwhich means slowlyâand you will have to start now.
Like all financial tools, the Rule of 72 needs to be applied wisely. Itâs great when itâs working for you but ghastly when working against you. Thatâs what makes credit card balances so dangerous. With credit card debt, 18 percent is the ânormalâ interest rate charged. And if you donât pay promptly, youâll soon be paying interest on interestâand interest on the interest on the interest.
Credit card debt is the exact opposite of a great investment. Wouldnât you like to have an investment that compounded at such a rapid rate? Of course you would. We all would. At 18 percent, a debt doubles in just four yearsâand then redoubles again in the next four years. Ouch! Thatâs four times as much debt in just eight yearsâand itâs still compounding! That compounding is why banks have distributed credit cards so widely to people they donât even know. And thatâs why you should never ever use any credit card debt.
SAVVY SAVINGS
We can hear the chorus of complaints already: âI know that the only sure road to a comfortabl...