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While most financial advice is heavily focused on maximizing returns while minimizing fees (and this is perhaps one of the reasons so many people fail long-term in their financial plan) I will take time today to introduce a concept which is by no means new, but one of those golden little nuggets that can dramatically change the way you look at financial matters through the lens of your personal self-worth.
Since SOPA and PIPA went down in a bullet, I̵7;m posting the following image to illustrate what today’s post will be about. Not, of course, before acknowledging that it’s not my original work and noting that you can buy it directly from despair.com (I haven’t started selling advertising space; I’m not getting paid for this, FYI)
Now that you’re all depressed and thinking about all the things you probably won’t accomplish, let’s have an uplifting conversation about all the money you piss away every year. We’ll start from the very simple building blocks on this one. It will seem almost childish, but believe me, as an artist’s sketch, this will be better in the end.
We’ll start with a hypothetical guy (I was going to say guy or girl, but decided not to because I’d be writing “him/her” a lot, sorry ladies, I’ll remember to use a hypothetical woman next time, promise) who makes $100,000/year and has 30 years left before he turns it in and heads south to become a professional shuffleboard player. If this person could save every dollar earned over the next 30 years, he would have $3 million in his possession. Graphically (and I have a lot this time) it looks like this:
Now let’s add an example to our model where our friend now gets a raise. He’s a newly minted young professional with a 5%/year raise, total savings jumping to just under $7M:
Now let’s take a look at what happens when we withdraw income, get a raise and invest it at some hypothetical rate of interest. I assume 8% because everyone else does.
There you have it, about $35 million that our friend has the potential to collect. If you’re sitting here thinking “I make half what he makes”, divide everything by two, and if you make double… well, if you can’t figure out what to do, I wonder how you managed to get there you are. But what happens when we introduce reality. We know that no one gets to save every dollar they earn, if only to pay taxes, there are expenses that must be internalized, and this is what it looks like:
And now our $35 million fortune has dwindled to not much more than a pathetic half a million dollars. It is very scary red. But most people motor through life without even thinking about it. Largely because they cannot see the red, or rather it is masked by utility derived from the conspicuous consumption of bigger houses, faster cars, shiny do-dads/gadgets, etc. This red part is real and it represents what you have given up as a consequence of your decisions. What’s worse is that traditional financial planners and investment advisors have no plan of attack to address this issue. Instead, they live and die by the sword of yield. They call you in with the promise of smarter, more complete investment advice that will increase your returns. But what does a 2 percent increase in yield get us? That gives us this:
All that stress with higher risk exposure for about an extra $300,000 or about 0.009% of your total wealth building potential. And we already know that a 10% return (call annual growth rate) is pretty unlikely.
So what to do? Sit back and complain that the system is against you. No. Time to be a little more strategic. A little more financially oriented. A little more grown up perhaps and realizes that the math behind this concept is quite far reaching and everything you do has consequences. Time to internalize the true cost of all those Venti Frappaccinos and choose the 528i over the 328i. But maybe it’s time to realize that when I say that you can accumulate money in whole life insurance and then access it while still making money, you have a way to prevent yourself from giving up all this potential wealth.
Since you will never be in control of the return, it is not wise to spend significant amounts of time worrying about it. Remember the old rule, assuming less is more, if I guess 5 and get 8 I’m in awesome territory, if I guess 8 and get 5 I’m screwed. Instead, build a plan that puts more focus on what you have control over, how much money you actually save. Remember, there is a financial tool that allows you to save money, spend the money, and then put the money back, and the money continues to grow even as you spend it. How about turning red bars into blue bars? So kicking up the savings doesn’t mean you absolutely have to give up your conspicuous consumption problem (thought it would probably help if you cut back a bit) it just means you have to shake up the timeline a bit. What happens when we focus on savings, here’s a description of a good starting point:
I got here by doubling my savings rate from the live situation. Now, you don’t come here with a financial guy worried about being a good stock picker. Those calls are fun for a weekend outing, and by all means a little pretend money on the side to see if you can pop Jim Cramer is certainly not something we frown upon. But the true path to this point is a cautious approach to using your resources. Choosing the wrong mortgage, letting a car dealer beat you up, putting all your faith in tax-deductible qualified plans, not being able to say no when you walk by the store window and the item of your dreams is displayed neatly in all its glory, giving the U.S. Treasury a large portion of your money to hold onto until spring while paying absolutely no interest on it… I could go on about this all day but won’t.
Hopefully I have now made you think about the limited nature of your resources and who you are. You can blow the money, or you can try to hang on to every dollar. Keep this question in mind: How many paychecks do you have left before you retire? If you’ve never thought about this, now would be a good time to start. Because it is these remaining paychecks that you will create your retirement and your overall legacy.