Bon Jovi might have said it right with his song when he sang about the hard times and the inability to make a living. With so many monthly financial obligations such as rent, food, and utilities many people probably feel like they need a prayer to get answered just to get by (As evidenced by this Toronto Star article link). Unfortunately, in real life, love isn’t going to pay your rent. If you think these obligations are harder, then think of how much harder it would be if your weren’t making a regular income and retired. Certainly, many working people don’t think of the day they retire, but nonetheless, it’s important to think of one’s future and plan early. As I mentioned in my last post about Compound Interest, the earlier the better.
The importance of saving should not be limited to just the fact that you need money to retire, but also as a means to supplement any current income that you may be making at your employment. I like to take the approach of “Living on Interest”, instead of “Living On A Prayer”. Most people don’t understand the point made here. Most people don’t even save. For the rest that do save, the meagre interest provided by the bank in a savings account is barely enough to buy a Happy Meal at McDonald’s every month.
So what does it take to “Live on Interest”, if keeping your money in a savings account won’t do? Let’s learn from the professionals. If you live in Canada, it is well known that every working individual contributes to a defined Canadian Pension Plan while they are working. The pension plan was designed to provide monies to people when they reach the age of retirement. What most Canadians don’t know is that this form of “tax” is really a savings vehicle for ordinary Canadians so that they will get some form of money to live on in retirement. It’s something a lot of people don’t do, so the government does it for you so that they act responsibly on your behalf.
If the people at the pension plan just put the money away in a savings account it would never last. So how do they generate money to give to it’s citizens? They invest it of course! The pension plan is responsible for managing a well diversified portfolio that will continually grow and allow them to make payments to its citizens when they retire. The fact is, the best money managers are brought to the pension plan. They can’t afford to lose everyone’s money, because then the purpose of the pension plan would be lost. So there is a bit of integrity and logic that is necessary when they invest.
Apply the same methodology to your own investments and savings. If you are putting money away into a savings account making 1% at the bank … stop! The meagre interest being collected and then the taxation that would apply to your interest will leave you with virtually nothing. The only one making money is the bank. Create a balanced, risk adverse portfolio instead that will yield you over 5% interest on a per annual basis. This way the 5% gives you a passive income on which you can put back to make it grow (compound interest), or use it for your day to day expenses.
I like to break apart my investments into two separate accounts. One earmarked for retirement and one that is considered “fun” money. My “fun” account that I invest with allows me to purchase the luxuries in life, without having to take money from my regular paycheck. Imagine the feeling you get when the money that you saved is helping you pay off your credit card bills, or your cell phone bills. It’s an amazing feeling! The first $1000 might not feel like a lot, because $50 interest in a year doesn’t go a long way, but save till it’s $10 000 and then you’re getting almost $50 a month. That’s a cell phone bill right there!
Remember that everything starts small. It takes patience to create a portfolio that will continually build wealth for you. Don’t forget the concept of compound interest. The first few years may be slow, but once the snowball gets rolling, that’s when the real wealth gets built. Start saving, start early. Stop trying to keep up with the Jones’ because it’s a race that you will lose every time.