02. How saving can multiply your investments
In another post we have talked about why before undertaking any investment it is necessary to have money saved. Now we want to tell you more about the power of saving: the potential effects of doing something as simple as spending a little less .
Imagine the life of a blue-collar American worker. Let’s say it’s a gas station attendant. Our protagonist is also a mechanic and, after 25 years between vehicles, he becomes a janitor in a department store until his retirement in 1997. A meritorious life of which we would know nothing if it were not for the fact that, upon his death in 2014, he was the subject of front pages all over the world.
As it turns out, Ronald Read, as he is called, is known today for his philanthropy. Read wanted to do his part in the development of Brattleboro, the Vermont town where he lived. So he chose two representative institutions and left them a part of his inheritance. Thus, the Brooks Memorial Library received $1.2 million from Read. Brattleboro Memorial Hospital was awarded $4.8 million.
What did Read do to amass such a fortune? As Morgan Housel recounts in The Psychology of Money, “There was no secret. He had neither won the lottery nor received an inheritance. Read saved what little he could and invested it in safe securities. Then he waited, over several decades, while a small nest egg grew to more than eight million dollars.
Saving is financial freedom
It is easy to underestimate the power of savings. After all, spending less money is a plan that sounds anything but fun. However, most of us like the sense of accomplishment we feel after saving. In essence, saving increases our present and future freedom of choice, as Burton Malkiel and Charles Ellis explain in The Elements of Investing.
The best thing about saving is that its benefits are applicable to everyone. If you reduce your expenses to a level well below your income, you will achieve a form of wealth. You will have more – more than enough. And this is just as true for a multimillionaire as it is for a guy as humble as Ronald Read.
We know that time is money thanks to the miracle of compound interest. The money you keep, for example, in a savings account will generate (small) interest periodically without the need for you to make any investment. This interest is applied on a growing amount, so the rate of growth is increasing. That’s why you have to start early, as Ronald did.
There is nothing wrong with saving to achieve a goal: buying a house, changing a car. But it is necessary to save for the sake of saving. As Morgan Housel warns, “saving exclusively for a specific goal makes sense in a predictable world. But ours is not. Saving is a hedge against life’s inevitable ability to surprise you with the unwritten at the worst possible moment”. But how to achieve this?
The first tip we have already seen here: cancel debts. Especially those with high interest rates and short terms. Malkiel and Ellis point to credit card debt, which they describe as “great, but not for you, or anyone else.” This type of financing usually accrues interest at a rate of at least 18% in the United States. A ratio that, as we know from compound interest, can multiply our debts in a short time. Roughly speaking, monthly debts should never be more than 40% of income.
But there are many adjustments, large and small, that we can make in our day-to-day financial life to increase our savings and, with it, our present and future peace of mind. Here are some tips.
Automate your savings
Saving deliberately can be difficult if you don’t have a plan. Therefore, it is useful to set goals. The best are those that do not require our continuous intervention. For example, if you have a savings account -if you have not done so, it is a good first step-, you can transfer to it at the beginning of each month an amount of money that you decide. As if it were the first expense of each month.
Other ways to save systematically have to do with rules. For example, save one euro more each week than the week before; or raise your savings by one euro from month to month. These are small gestures that, at the end of the year, translate into savings of more than 1,000 euros…
Check what you are going to buy
We’ve all heard them: making a shopping list avoids distractions as you stroll past suggestive supermarket shelves. In this sense, many recommend shopping online, as it forces you to select what you had in mind and leaves less room for improvisation.
If it comes to clothing, you can subject every purchase to what Malkiel and Ellis call double positive: don’t buy anything unless your partner, friend, companion and you both agree that it’s a good idea. Morgan Housel recommends avoiding purchases intended to show off or to keeping up with your neighbors/colleagues/friends…: “People who enjoy lasting personal financial success, who are not necessarily those with the highest incomes, tend to be prone to not give a damn about what others think of them.”
Reduce your expectations
Somewhat along the same lines, but applied to major expenses, Malkiel and Ellis talk about buying pre-owned cars instead of brand new ones or choosing term life insurance instead of conventional insurance. More controversial is the recommendation of living in a home you own, which the authors advocate because it allows young families to have a nice place to live while their children are growing up; mortgage loans are far more manageable than other types of financing; and because housing is a reasonable hedge against inflation.
It is also advisable to compare utility bills -and lower the thermostat a couple of degrees in winter-. Reviewing expenses every month or two helps to determine if we are really spending money on what brings us value. And, if you are able, another powerful measure is to reduce your expenses to the level they were two or three years ago.
Invest in low-cost products
When it comes to investing, it is important to take into account not only profitability, but also costs, taxes and inflation . There is no point in obtaining good nominal returns if the associated costs and inflation cancel out most of them. It is therefore advisable to invest in instruments with low costs, such as index funds. As we know, these funds do not require a manager to select the stocks and charge for his good judgment, but invest in whole indexes -with better results and much lower cost-.
Another option that combines a stable industry and very low costs – zero, in fact, for investors – is real estate crowdfunding . You can try Urbanitae from only 500 euros…