Why Should I Save?

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I got asked the question recently by a colleague “why should I even save money? It doesn’t seem to make a difference.” It might feel that way to many Canadians since the Bank of Canada’s interest rate has been stuck at 0.25% for as long as I can remember and the banks have followed suit by giving out a measly 2.0% interest on a high interest savings account.

In the latter parts of the 1980’s and early 1990’s the savings rate for Canadians was up past 10%. In the last two decades, the savings rate has cratered to less than 5%. During that same time period, the debt-to-income ratio has risen from under 100% to over 165%. So it seems like there is a strong correlation between savings and debt levels as interest rates have fallen.

With cheap money floating around, it seems individuals would rather borrow money now to spend rather than saving up for purchases. That isn’t that much of a surprise, who doesn’t want instant gratification?

Road To Financial Independence

No one said that gaining financial independence would be easy. We all want to reach that point where our assets are able to generate enough cash flow to meet our needs and wants. Without savings; however, financial independence would never be achievable.

It’s important to realize that savings, no matter how small, is necessary to help build up an investment portfolio that is capable of generating positive cash flow. One of the key concepts to recognize about money is not what it can purchase, or how much it would take to retire on, but the how much free cash flow it can generate.

One of the biggest misconceptions that people have of reaching financial independence is figuring out how much you need in order to retire so that you won’t deplete all your savings. That is the wrong approach. No matter how much we work, how hard we try to conserve money, it is inevitable that we probably won’t be able to accumulate enough money to retire on without investing it.

As the human lifespan extends further and further, our financial requirements get greater and greater. That’s why it’s important to learn about financial investments because it’s the only way to generate enough cash flow to retire.

Compounding Early

It doesn’t matter if the salary of your first job is $30k or $50k. All that matters is that you start saving early. Why’s that? It’s simple. We can always earn money, but we can’t earn more time. Time is necessary because it allows our savings to grow through compound interest.

The difference between saving $50k by age 30 versus having saved $50k at age 40 can be quite staggering. If we compare both individuals and assume an average return of 7% annually on their portfolio, the person that saved $50k by 30 years of age would have $533,829 by age 65. The person that started at age 40 would have only $271,371 by age 65. The difference is almost double!

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If you have ever read the Wealthy Barber by David Chilton, you should already know that you should always begin by saving 10% of your gross income. That’s before tax income. If you have a $30k salary then save $250 a month. If yo have a $50k salary then save $415 a month. Just remember that you should always pay yourself first.

Delaying gratification earlier in life will lead to less money problems in the future. However small you save will go a long way once the compounding effect takes place. If you are just beginning your career, you will no doubt feel the struggles of trying to just make it by. On the positive side, as your career progresses and your income increases, the amount of money at your disposal will grow and you will also be able to save more with your 10%. The key is to start getting into the habit of saving, no matter how small it is.

Think Investments

Saving is just one half the of the equation, but the real reason why we should be saving is so that we have funds to invest. To reach financial independence, our savings needs to generate enough cash flow to cover our costs. That includes, food, shelter, other essential and discretionary spending.

A first thought it might seem far fetched that this could ever happen, but as your savings grow the amount of cash flow that it generates will also increase. At the beginning it may seem almost inconsequential when all you get is a few dollars in interest, but after a decade of saving and investing the results could become substantial enough to cover your insurance bills, or maybe your cell phone bills or if you’re lucky even your rent or mortgage.

Of course this can’t be accomplished if your money is sitting in a savings account or a GIC at the bank. You need to take risks, but calculated risks. This is why every novice investor shouldn’t be going out and trying to find the next big home run investment. It’s not gambling that we’re talking about, but long term investing. A well balanced, diversified portfolio of index funds and ETFs is what every beginner investor should be striving to create.

The key is to not focus on the short term results, but what you can get out of your investments in the long run. Realistically, a well balanced portfolio should average anywhere between 5-8% in returns annually. This is what the expectation should be, not 100% gains over the small period of a few weeks.

Don’t Delay

wall-clockNo matter how small the amount that you can afford to save, you shouldn’t delay. Let time be on your side. Remember that even the smallest amount can one day grow to become something substantial given the patience and persistence.

Most important of all don’t get discouraged. If you can save only 10% of your gross income, you’re already doing better than the average Canadian. Don’t compare yourself to other people where their crazy lifestyles are being funded by debt. You’ll be thankful in your latter years when your own personal portfolio is capable of paying your necessities and wants while other’s struggle to pay off their large credit card loans and mortgages.

 

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