This blog is written weekly by Dock David Treece, a registered investment advisor with Treece Investment Advisory Corp. It is meant to share insight of investment professionals, including Dock David and his father, Dock, and brother, Ben, with the public at large. The hope is that the knowledge shared will help individuals to better navigate the investment world.

Sunday, July 5, 2009

Living beyond means

Recently released numbers from the U.S. Bureau of Economic Analysis show that the US once again has an increasing personal savings rate. Unfortunately, this rate has been declining for decades as Americans began living increasingly beyond their means.

On more than one occasion the savings rate even dipped into negative territory, meaning that America’s population in aggregate was borrowing more than it was saving. This high consumption rate in turn has led to excessive borrowing, which was the ultimate cause of the financial crisis that occurred last year.

Generation Y, my generation, seems to have particular difficulty saving money. First off, we’re still relatively young, and young people in general are less inclined to think long term. However, young adults today are worse than previous generations in that they see disposable income and no need to save a portion.

This inability to save is partially the fault of parents. Many simply never taught their kids to save. Mine was the generation of the allowance. Parents thought they were teaching us a lesson and that by giving us a defined amount for any given period, we would learn to budget. Instead, kids got their allowance and viewed every cent as spending money.

To people who never think about the benefits of saving, allow me to introduce the 8th Wonder of the World: Compound Interest. Consider the following examples:

1. Let’s say that at age 25 a person had accumulated $10,000 to invest. If they can earn, say 10% per year for round numbers, on average, how much will he have at age 60, assuming he never contributes another dollar?

2. What if that same person waited until age 30? How much would they have at 60 then?

3. And if they waited until age 35, what’s there at 60?

The answers can be found at the end of the blog. Keep in mind that those results reflect growth with no additional savings. To see even more phenomenal results, consider the following:

4. Let’s say I have a friend who’s 25 years old and has little or no savings to date. Realizing the predicament he may face in the future, he has decided to adjust his spending habits to start saving $100 per week. While this is no large sum, let’s say he continues this pattern of saving for the next 35 years. Assuming 52 weeks per year and an average annual return of 10%, how much will my friend have when he’s 60?

The real concept here is to let your money work for you. For continued reading on the subject, we strongly recommend Rich Dad, Poor Dad by Robert Kiyosaki, which explains accounting and saving in terms that are much easier to understand than textbooks.

The lesson here is simple: Save early. By putting money back early on, you allow it to accumulate over an extended period of time with little or no extra work. The reality is that the young adulthood comprises some of the prime saving years. It’s the time before we start our own families and have kids, while living expenses are relatively lower. This is the time before diapers, toys, babysitters, Disney World, and, if they’re lucky enough, kid’s college tuition, room and board, etc.

The bottom line is to save early so you can afford to live better later on. And, perhaps most importantly, when you do have kids, pass the lesson on. Don’t make them learn the hard way.

Answers: 1. $ 281,024 2. $174,494 3. $108,347 4. $1,550,259

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