Saving money
may seem an obvious thing to do, but many people still don't prepare for a "rainy
day." Jeffrey Strain turns his attention to long-term investment.
I received my first lesson on the importance
of compound interest and long-term savings from a pair of training shoes I bought in high
school. To emphasize the point that training a little bit every day could create vast
improvements over time, the training manual used an example of the Native American Indians
and pilgrims in the US.
In the early 1600s, the American Indians sold an island, now called Manhattan in New York,
for beads and trinkets worth about $16. Since Manhattan real estate is now some of the
most expensive in the world, it would seem at first glance that the American Indians made
a terrible deal. However, had the American Indians sold their beads and trinkets and
invested the $16 in a bank with 8 percent compounded annual interest, not only would they
have enough money to buy back all the real estate in Manhattan, they would still have
several hundred million dollars left over.
Most financial experts recommend saving at least 10 percent of your monthly income for
long-term investing. This may initially seem like a lot of money and impossible to do. In
reality it isn't too difficult to accomplish, especially if you consider that 33 percent
of your income would be deducted from your pay check each month for taxes if you lived in
the US. For many people, the key to saving money is to begin a "pay yourself first
program."
Have you ever considered why tax authorities collect a person's estimated taxes from each
month's paycheck instead of waiting until the end of the year to collect all the taxes?
Tax authorities do this for a simple and specific reason. They know that if they attempted
to collect a years worth of taxes at the end of the year, most people wouldn't have it.
Governments know that people tend to spend the amount of money they have available to
them, so they take their share up front.
A pay yourself first program works in a similar way. Most people try to save money on
their own by putting away the extra money they have left over at the end of the month. In
theory, this seems practical, but in reality there rarely is a whole lot left over at the
end of each month.
A pay yourself program is a system where you decide to pay yourself money before you pay
any bills, go to any bars or restaurants or make any other payments.
Paying yourself first becomes quite easy once you've done it a few months. Getting
started, however, is a different story. It takes self-discipline to put the money away and
not dip into it during the month. Therefore, the people who are most successful utilizing
this saving plan put their money somewhere where they can't easily gain access to it.
Those who immediately send the money to their home country or have it automatically
deducted from their bank account and sent into a limited access savings instrument will
have better success than someone who puts the money into a separate bank savings account
which can easily be accessed.
The reason tax authorities are able to collect as much as they do is because they take out
the estimated taxes a person will owe before he or she has had the opportunity to spend
the money. A pay yourself first program works in a similar way. Instead of saving the
amount you have left over at the end of the month, which usually isn't a whole lot, the
very first payment you make each month is to yourself and your long-term savings.
Here's how the plan works. If you earn JY300,000 a month, before you spend any money, even
pay your rent, you must put JY30,000 into your long-term investment account. Long-term
usually refers to five or more years. By paying this money to yourself first and
considering this long-term investment money "untouchable" for short-term
expenses, you guarantee that you will have money saved for your retirement. If a person
invested JY30,000 every month from age 25, he or she would have well over JY100,000,000 by
age 65, and this is assuming they never receive a pay rise during their lifetime.
Even those who are older can save a large amount of money for their retirement, although
they will have to use more discipline.
For example, if you are 40 years old and haven't saved a single yen for retirement, you
can still retire at age 65 with over JY100,000,000. Assuming your monthly income is
JY500,000, by saving 20 percent of your monthly salary, you would easily reach this goal.
The above situations include the important assumption that you will receive an 8-10
percent yearly compounded interest on your long-term investments. For those who have their
entire savings in a Japanese bank account, this assumption will be impossible to achieve.
However, an 8-10 percent yearly return is not an unrealistic assumption. The US stock
market has realized an average of 11.4 percent return over the last 60 years. Even if you
don't want to take the risks involved with investing money in a stock market, you can
still earn five percent or more by simply converting your yen into another major currency.
That is far better than the below one percent your Japanese bank is currently paying you.
The biggest problem facing those trying to save is adjusting to having less money to spend
during the month. This is especially true with those on tight budgets, or older people
trying to save larger amounts while raising kids. However, those who strictly stick to the
savings plan the first few months usually figure out how to get by without the invested
money.
There are a wide variety of options for those wishing to maximize the interest they earn
on their long-term savings depending on the amount of risk they are willing to endure. It
is therefore advisable to talk with a financial planner who can create a financial
portfolio for you and your family that meets your specific needs and goals. The important
thing to remember is that the earlier you begin a pay yourself first program and begin
long-term investing, the more likely you'll retire financially secure.
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