The Power of Savings

Whether it is funding a comfortable retirement, helping your children pay for college, or some other important financial goal, starting to save early, aggressively, and consistently is the surest means of achieving it. The message is simple and clear. Spending less than you earn and saving and investing the rest is the most powerful wealth building tool under our control, and is the backbone of any successful financial plan. Let’s take a look at why a savings program is such an important element for achieving financial success.

The future is unpredictable. We have little control over many variables that impact our future finances including investment returns, inflation, employment status, and large unforeseen expenses. One of the things we can control is how much we spend and save today.

The power of compounding. Starting early and saving consistently can produce astounding results. The engine driving this growth is the snowball effect created by compounding that occurs when the earnings on your savings and investments are reinvested and generate earnings themselves. The three components required for compounding to work successfully are savings, time, and investment returns. The more you save and the longer you let it grow, the more remarkable the results. For someone planning to retire at age 65, for every dollar you fail to save at age 25, you’ll need to save two dollars at age 35, four dollars at age 45, and eight dollars at age 55. When you account for the bite taxes and living expenses take from a paycheck, it is difficult, if not impossible, for most 45 year olds to save enough to make up for starting late. The lesson: start saving as early as possible.

Getting started is simple. Start with a cash flow statement so you have a clear picture of how much you earn and spend and how you earn and spend it. Your objective is to generate enough monthly savings to meet your future financial goals. A straightforward approach is to calculate the amount you need to save and then determine how much you need to increase income or reduce spending to achieve that goal. In other words, save first and then base your budget on what’s left. If it helps, put your savings program on automatic pilot by having your savings deducted from your paycheck.

Take advantage of employer matching contributions. If your employer offers matching contributions to your retirement plan at work, make sure you contribute enough to take advantage of the full employer match. This is “free” money that will also grow tax-deferred making it the best deal you’ll find anywhere.

Pay off high interest debt. For most people, the next best use of their monthly excess cash flow is to pay down high interest rate debt. Unpaid interest and finance charges are continuously added to your balance causing the power of compounding to work against you, creating a snowball effect that becomes more and more difficult to stop over time. An item originally costing $5,000 might end up costing you $6,000, $7,000, or more when you factor in the interest and finance charges. Paying off high interest rate debt will provide you a great return on your investment and peace of mind. So, in most cases it makes sense to tackle that before you start building up your reserves. Once this debt is paid down, you can redirect your monthly savings toward your other financial goals.

Conclusion. The most sensible spending and savings program is one that allows you to strike a balance between enjoying your life now and reaching your most important future goals. I believe most people would agree that making small sacrifices today to make tomorrow’s dreams a reality is well worth it.

This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.