How Savings Builds Wealth -- Why Save? Part 2
Several reasons exist to answer the question of why save.?These three remain at the top of my list:
Hopefully, this series on savings is the start of an informational and inspirational understanding of the time-tested truth of long-term savings. Look for future installments on the next few Fridays, based on my book, Baker's Dozen -- 13 Effective Principles for Financial Success.
SAVINGS ETHIC
What about developing a savings ethic? Let's look more closely at savings. We know income only comes from a combination of man at work and money at work. Just as a business strives to create a profit, the residual after paying fixed and variable expenses, your profit measures the amount you can save after everyone gets paid, including the mortgage holder or the landlord, the utility company, the supermarket, your entertainment choices, etc. In addition to these expenses, there are always other necessary expenditures. It is a fundamental fact of life that our savings account is the last "person" to get paid. What are the obstacles to successful savings which we must all overcome? Here are some I have identified:
LACK OF KNOWLEDGE CAUSES LOSS OF CAPITAL
Let's be frank. People are unsuccessful in establishing savings habits because of their spending habits. We can talk about taxes and inflation all day, but without a significant effort to control spending, the "wants" will always exceed the "needs." As a result, there is nothing left to save. The story is always the same—a new couple starts their lives together and ultimately finds out their "needs" are overwhelming. They buy what they "need" on credit and spend everything they make on other necessities. Eventually, the credit card costs become overwhelming, and they are choked financially by the debt. The longer this goes on, the deeper in debt they become. The credit card interest rate absorbs any extra money. The sad thing is, if they would only plan their expenditures better, they could meet their financial objectives while still purchasing those "necessities." We'll look at the budgeting process more closely in the next chapter. Here is the typical wealth accumulation model.
SAVINGS MODEL
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Assuming the distribution of all income to its highest and most economical use, people would first pay
TAXES
Then, after taxes, most people would pay the expenses they can't avoid, i.e., house payments, food, etc., namely the
FIXED EXPENSES
The next expenditures are typically for those things which we call lifestyle choices, i.e., TV, clothes, trips, etc. In other words, the
VARIABLE EXPENSES
The remainder goes to other discretionary purchases or savings if there is a surplus. Assuming some will go to savings, let's see why a plan is crucial to financial success.
TWO TYPES OF SAVINGS
There are only two types of savings plans. First is what I will call your "long-term" savings account. These are precious dollars that you purpose to keep saved forever. Most of us use a passbook for this account. Let's take a minute and look at this popular method and see why it does not complement the savings ethic. Most savings plans work like this: You get a tax refund and put the money in the bank, thinking you will save it forever. Then oops! Things happen to make you take the money out of the account—new tires, appliance repair, a new roof, etc. Then you might get some additional cash, a surprise bonus that you put in. But then, your car breaks down, and you must take money out to fix it. Sound familiar? You put it in! Then you take it out! You put it in, and you take it out. Appropriately named, this savings is called a PUT' N' TAKE machine.
An actual "long-term" savings plan is an entirely different proposition, designed to keep your surplus money saved regardless of your needs. How do you accomplish this? First, you must set a savings goal by identifying a primary goal and then systematically increasing it once you achieve your initial objective. This approach may sound simple, but I have seen from experience that it takes work to maintain discipline. Here's the rule:?You must refrain from spending the money in your long-term savings pot. That's a commitment! The secret ingredient to all financial success is the chain of compound interest.
(Watch for next week's article when we will discuss the secret of compound interest.)