Into September already! It's hard to believe that summer 2017 is pretty much done. Here in Edmonton the first leaves are starting to die on the trees and nights are definitely getting cooler.
For most of us that means getting back into routine as well: school, 5-day work weeks, no more vacations until winter break, and an opportunity to catch up on summer spending.
Saving Is Important
Particularly in the earlier days of this blog, I talked about saving a lot. In recent months investing has been the major topic. However, investing—even phenomenal investing—cannot outperform saving.
I can't emphasize this point enough.
I've had a few quick discussions with people who read this blog about investment performance. Particularly the fact that, from January through July, I achieved nearly a +20% return on my investing. Who needs to save when you achieve this kind of ROI?
While +20% in seven months might be great, it's far from a certainty. I'm not counting on that going forward. While my investing strategy has worked well the first half of this year, it may not do so well for the next half. I don't know.
Why is saving so important even with high returns? Because you need money to work with in order to achieve good returns.
- 20% of nothing is nothing
- More complex strategies don't work with small accounts
- Saving + consistent returns + time = high net worth
Months back, I suggested that every individual under 30 years of age should be saving a minimum of $562 a month—or $6,750 per year—to have a comfortable retirement at 65 years old. That's a solid chunk of change, but is manageable when you consider some tax breaks with RRSP contributions. Maybe you're lucky and your employer will match your savings as well.
I used a 6% real return over 30 years to get an account worth $800,000 (in today's dollars) after 35 years of saving and investing. This should be enough to cover expenses for a decent retirement with CPP/OAS top-ups.
What if you decide you only can invest $200 a month and make up the rest with good investing?
Well, you would need to have an average real investment return of 10.25% to get to that same $800,000 number. That's a gross return of 12.5%.
Achieving 12.5% return is just about impossible over the long haul. The Canadian stock market has returned under 4% over the last decade. The U.S. stock market did just under 7%. Bonds returned under 5%. By the time you add it all up, you're basically demanding the market gives you 2x the average return of a mixed portfolio.
When you save, you should count on low and realistic returns. If you do better than that, great! Counting on high returns so you can save less is not a good strategy. That's how people end up working the door at Walmart. You're essentially playing roulette against the house. It's fun to play and you might win every now and then, but in the long run you will lose every time.
A Real Problem of Low Savings Rates
Low savings replaced with high investment return dreams has a problem—the compound interest curve.
While you might get to that magic $800,000 at the end of the day, twenty years into saving and investing, your account is worth just $155,000 (using the $200 a month @ 10.25% example). That's less than one-quarter of your required amount more than halfway through your journey.
After 30 years, you're still at just $475,000 (60% of your required total) with just five years to go. The smallest mistakes near the end of your journey can strike wine tours and European vacations right off your retirement dream list.
With high investment return expectations, you are banking on your whole retirement being achieved in the final few years of your journey. The risks are enormous.
All it takes is an untimely market correction, a job loss, a health issue, or whatever else life may throw at you and your likely to be in a world of financial hurt.
Common Sense and Caution
If your target goal is $800,000 and you use the 6% real return number, chances are you'll be successful if you save at least $562 per month. If the market doesn't quite return what you thought it would, a slight bump in savings in the last decade can easily make up for it.
If you're left with just $750,000 instead of $800,000 because of a miscalculation here or there, no big deal. We're talking an effect on your spending of a couple hundred bucks a month or less.
When you bank on a realistic, lowish return, chances are that upside surprises are more likely. If you save a bit more, or investment returns are a bit higher, you might have enough to retire early or increase your retirement spending. An extra vacation or two, an early move to part-time work, higher charitable donations, and other interests become a real possibility.
Planning Your Lifestyle Around Saving
Life is full of choices, make the difficult ones count.
I'm a huge advocate of achieving wealth at a young age. But it's not without sacrifice and that's why it is so difficult and rare.
Without a doubt, there are substantially more people who exit their 20s with a negative or close to zero net worth than those who enter their 30s with a net worth over $100,000. It's not because we can't save $100,000 by age 30, it's because we choose not to make difficult choices.
Anyone can finish high school, take some job training for a year or two, and be working at age 20 making $20 per hour. A lot of entry level trades jobs, manager jobs, sales roles, or even admin jobs pay $20 per hour.
If you work just 2,000 hours a year (should be the minimum effort!), you will earn $40,000 a year before taxes. Estimate $10,000 for taxes and payroll deductions and you're left with $30,000 to spend or save.
Considering most millennials live at home until they're in their late 20s, let's for argument's sake say you move out at 27. This means most middle class 20-somethings have no shelter or food costs for the first seven years of work.
What's left? Vehicle, gas, phone, clothing, and entertainment. A cheap vehicle can be run with fuel and maintenance for under $500 a month. $60 for a phone. $100 for clothes (consignment stores are great!). Now we're down to $1,800 for savings and entertainment.
Did you know just saving and investing $1,000 of that every month for those seven years will get you over $100,000?
That first $100,000 is critical. If you have $100k and can wisely forgo the ridiculous housing debt-spiral, you can use this $100,000 to propel yourself through the rest of your lives.
That $100,000 at age 27 will swell into more than $800,000 by age 65 with no additional monthly contributions.
But it will mean $1,000 less to spend each month on bars, vacations, closets full of clothes and shoes, motorcycles, mountain bikes, booze, or wherever else money disappears when you're in your 20s.
Wealth might be realized in age, but it is definitely started young. If you have no debt, money in the bank, and a solid understanding of smart investing when you are 30, you are all but guaranteed to become very well off as time goes on.
On the other hand, if you're in debt and spending as much or more than you earn when you are 30, it is nearly impossible to turn this cycle around.
This is why the working poor stay poor and the working rich get richer. It's not an earning problem as most would believe, rather it's a spending and entitlement problem that no one wants to come to terms with.
Taking the First Steps for Wealth
If you're approaching 30, or already past it, with a negative or zero net worth, it's important to make big changes to make sure you're not on the wrong side of 30.
- Get rid of debt. Debt is a huge problem because it results from overspending and consumerism issues. Debt can easily suck up a large portion of your income in interest costs and debt repayment. Income that you could otherwise put to savings.
- Cut spending big time. This means making serious sacrifices and it sucks at first. Eating out, clothes, consumer items, entertainment, and recurring bills are great areas to cut quickly. Then tackle vehicle spending and finally your house. Many people are poor because they want to "own" a house and it siphons off way too much of their income. Renting is likely to be a better option for most Canadians.
- Use all excess cash flow to cut down your debt until you only have a mortgage and car loan. These can be dealt with later once you've convinced your partner that you don't need to fool your neighbours into believing you're rich by driving nice cars and living in an oversized money sucking house. Get rid of credit cards, lines of credit, personal loans, furniture payment plans, etc. as fast as you possibly can.
- Start investing after the high interest debt is gone. Make this a habit; it should be part of your mandatory "spending". A 6% return might not seem worth the the hassle at the start, but compounding year after year it adds up a lot!
It's much easier to "live poor" while fueling a fat investment account when you're under 30 than to be poor with options running out when you're 70. Slinging coffees at Tim's is not in anyone's retirement plan.
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