How To Save Money When The World Says Spend It!

The Importance of Saving For Your Future Financial Freedom And Security

Most of the time, as long as inflation is not so high that saving money looks like wasting money because you can’t possibly keep up, I think most people would agree that saving something towards your future financial freedom would be a really good idea. I think we would all like to retire in some degree of luxury, or at worst, security, and yet for most of us saving is something that just never seems to happen. Or, if it does, it is too little, too late, and probably not done in the right ways to secure our future properly. Why is this?

I’m not going to talk much about the practicalities of saving money here: I covered the general strategies in Here I’m going to talk about the obstacles to saving and especially the obstacles to getting started. In fact, in my experience there are two main obstacles: a) our spendthrift culture; and b) our lack of understanding of just how to even think about saving, especially when many of us don’t have much - or any - spare cash to stash anyway. What can we do?

Our Spendthrift Culture

Probably one of the biggest enemies of the saver is advertising. Advertising as such is not a bad thing, of  course: companies need to let you know what’s available, and you need to know too. But companies have learned how to show us plush lifestyles that we can’t possibly afford and make us feel like we deserve them, and that we are failures if we don’t achieve them. They show us such lifestyles in adverts, in TV series about rich people, or even supposedly ‘ordinary’ people who in fact live lifestyles where money is not a serious issue. We see all this, and of course we want it. We want it now. We can’t afford it now though, but at worst, we want to keep up with the Joneses next door or at work. So... we spend on holidays, on more and more clothes, shoes, cosmetics, jewellery, chocolate, ornaments, bags, computer games, giant TV’s for every room, coffees every day, eating out, drinking and socializing, a new car every three years, and more and more, in a never-ending race to keep up or to show how rich and successful we are. And we even get into debt to do this. And so do the Joneses, who are trying to keep up with you - or with the Hamptons set... it’s a vicious circle.

To get out of this vicious circle, we need to be aware of two things: 1) we don’t need to keep up with anybody or prove to anybody, including ourselves, how successful or otherwise we are; 2) watch the adverts closely and really see how they’re teasing you with the idea that these lifestyles are what equals “success” and that spending money is the “normal” way to live. In truth, it isn’t! From the point of view of the money saver, these adverts are nothing more than a subtle form of robbery, brainwashing helpless people into handing over their money in exchange for unnecessary rubbish. Really watch the adverts closely: look at the lovely happy carefree people showing you how you’re “supposed” to live, and you’ll soon understand what they’re trying to do to you. They’re not your friends. They’re trying to take your money. If you really want to do the exercise well, add up the cost over a year of all the junk you’ve bought that you didn’t need. Even just add up that coffee you buy on the way to work each day: take a flask instead. For most of us, the money wasted is all of our disposable income (after essential bills) and often a little bit more... Instead of being prudent and always living well below our means, we are encouraged to always live well beyond our means. It is no wonder the whole country is in hock to the banks these days.

Some adverts about saving money are especially insidious. They suggest you save up - for a new car, for a holiday, for this and for that... in other words, the whole point of saving, they secretly suggest to you, is so that you can spend it on something.


How To Think About Saving Money

The whole point of saving money is to develop financial security first, and financial freedom second. You do not spend it! Ever! Every penny you throw away now is taken from your future wellbeing forever.

You might be thinking, if I’m not to spend that money, what’s the good of it? Well, of course, in a real emergency, it is available for you to spend: that is financial security. Also, when you’ve saved up enough, the interest on your savings can provide you with an income so that you never have to work again: that is financial freedom. Once the pot is big enough, you can spend some of the interest, but you never touch the capital unless you really, really have to.

How to begin building up such a huge capital amount is discussed in the article linked to earlier, but it must be obvious to you by now that step one is to stop spending on junk and never mind what the neighbors think about you. They’re probably broke or deeply in debt anyway. Step zero (it comes before step one) is to understand what you’re doing - that’s what this article is all about! And it doesn’t matter if all you can save at first is pennies. Do it anyway. Starting is always the toughest part of it. Continuing is the second-toughest part but don’t let that stop you either. Nobody else is going to be looking after your welfare when the chips are down, or that of your family. Experience shows that pennies saved soon add up to a more secure future, in exactly the same way that money wasted on junk soon adds up to debt. And debt, in the end, adds up to slavery, in effect.

If you are paying interest charges on debt, other than a mortgage or something of that sort, use your surplus cash to pay down the debt first, rather than saving it. This is because the cost of the interest on the debt is going to be higher that you are likely to be able to earn by saving, so you need to eliminate that cost as quickly as possible. You’ll be able to save much faster afterwards. Figure out which debt is easiest or most prudent to pay off: either the one charging you the highest interest rate, or the smallest debt so you get a quick reward out of it. The choice of strategy depends on your psychological needs and preferences. But do something.

Your Net Worth

What you are trying to do with saving money is to build up what accountants refer to as your “net worth.” Most people mistakenly think that you are wealthy if you have a high income. For instance, the idea is put about in the media that people who earn a million a year are millionaires. That is actually not correct! If these people earn a million and spend a million and a bit, they are not rich at all: they are on the way to skid row. This is the common fate of unsophisticated high earners like footballers, celebrity basketball players, some movie stars, and so on. They earn lots of money for a while, buy themselves fancy houses and fancy friends, but when it all ends, they are destitute and alone in an instant because they’ve made no provision for their future. They have not built up their “net worth.” Instead, they’ve built up their debts.

So what is this net worth business then? In short, it is a summary of what you’ve set aside for your future. You take your assets, like your savings and any equity you may have on your house if you have one, and you subtract from that your liabilities, like the outstanding amounts on your debts including what’s left to pay on any mortgage you may have. The difference is your net worth.

Really this is a simple calculation for most people, except the equity/mortgage bit: you just take your savings and subtract your debts from them. The idea is to have as large a positive net worth as possible, of course.

For those of you with a property  or mortgage (real estate), the equity part of the calculation is done like this. The equity on your property is how much of its value belongs to you, rather than to the mortgage company. For example, suppose you bought a home worth $100,000 at the time. You put down say $10,000 deposit and borrowed the remaining $90,000, so at the start of this debt you owed say $200,000 (because of the mortgage interest). You’ve paid off $45,000 of that so far. Luckily, the house has increased in value over the years to $195,000. Here is how you calculate your equity. Note that the initial value and your deposit play no part in the calculation: what matters for your net worth is the position right now.

Asset: Value of house:                         $195,000
Liability: Amount owed:                     $155,000 ($200,000 mortgage less $45,000 paid off)

Net equity (Asset less Liability):    +$40,000

It is possible for the equity to be negative, for instance if the value of your home has fallen. In this case, when calculating your net worth, you have to put it in as a liability and not an asset. Suppose in the above calculation, the house’s value had fallen to $80,000 instead of rising.

Asset: Value of house:                         $80,000
Liability: Amount owed:                    $155,000

Net equity:                                            -$35,000 (Value minus Amount owed)

Because the equity is negative, this is a liability, not an asset. These calculations can be complicated by varying interest rates,which can change the amount you owe to the mortgage company. In all cases, you just take the figures as they stand on the day you make the calculation. If you owe more today than yesterday, well, your net worth has gone down.

In these calculations, you might think about other big ticket items you own as well, such as a car. If you include them, make sure you put in only their likely sale value, perhaps biased on the pessimistic side. The same goes for other items like furniture: the second-hand sale value of most stuff really isn’t much. They are assets, but only just. In a fire sale, you couldn’t expect to raise much. Put it all in though if you want the calculation to be complete.

Anyway, a full net worth calculation including savings and equity would look something like this:

    Savings:                                              $5,000
    Car, etc:                                              $5,000
    Equity:                                              $40,000

    Credit Cards                                     $25,000    (pay these off ASAP)
    Mortgage                                         $155,000

Net Worth                                           -$90,000 (Assets minus Liabilities)

With a negative net worth, this person has some way to go to catch up to where they should be, and in these post-Credit-Crunch days, unfortunately a lot of people are going to find themselves in a similar position. In fact, although it looks bad, the position is not necessarily hopeless. As I mentioned earlier, pennies saved (and ultimately invested) can start to add up surprisingly quickly. But, you do have to be prepared to take a long view of the situation. If you aren’t prepared to work the long haul, your position will in fact probably be hopeless. Welcome to the real world.

What Should Your Net Worth Be?

To calculate whether you are doing well or badly on the net worth scale, that is, whether you are well off or badly off compared to others, many accountants use a simple calculation. Good savers who started as soon as they could saving at least $10 for every $100 gross that they earned, develop their net worth like this, at a minimum:

Net Worth Target     =      Age x Annual Income / 10

So, a 40-year-old with a current annual income of $30,000 should have a net worth of:

                                      =     40 x $30,000 / 10
                                      =     $120,000

If they reach this target or better they are relatively well off. Below the target, and they are under-achieving financially, no matter how much money they may be making: if they’re spending it rather than building up their net worth, they are in a bad way financially in the long run. And note that the income shown above is not an especially large income. An ordinary working person or couple who get it right, or who correct their mistakes and start getting it right, can, over time, build up a substantial net worth and at a minimum ensure some degree of financial security for the future. Note that very few people start even close to their target for their age. For example, most 20-year-olds have little or no savings to start with, but a good saver can catch up in only a few years if they are seriously diligent about it. Most exceptional savers put away at least $15 for each $100 they earn before tax.

So, get started now. Good luck!