This is Part 2 of a 9-part blog series called “The Founding Four”, about the four most important things you need to do to begin down the path to financial independence. You can read Part 1, in which we lay out the basics of all four, here.
As we discussed last week, there are four key principles you need to work on if you have any chance of being financially independent. If you haven’t read that primer, take a minute and do it now.
This week, we’re tackling the first of the Founding Four: Saving.
Why do we save?
We save money simply to spend it later. Whether that’s for needed expenses like food, shelter, taxes, medical expenses, or even burial, saving money we make today, for the needs of tomorrow, is a fundamental concept of sound financial management (and what you can’t realistically save for, you insure against – we’ll get there in Part 6).
The more you have saved up, the less likely you are to be dependent on (indebted to) other people.
Having a sum saved provides more than actual financial security. It provides emotional security, physical security, and can even elevate you in terms of social status.
Let’s face it; you’re reading this blog right now because you want to be better off financially someday. You’re willing to work on self-improvement and make sacrifices to do exactly that. And the first sacrifice you need to make is to accept that you absolutely, unequivocally must save some of what you earn for a later date and a future need.
It’s not a question of “if”. It’s just a question of “how”.
If you’ve left the safe confines of your parent’s home for any length of time, you know how important it is to have an income. You also know how quickly that income can be spent on both necessary and frivolous things. Saving money means denying yourself something you could have today, for something you will likely need tomorrow. It’s a mark of a disciplined person (or family or business) to have sizeable savings. It means that you have self-control; you can choose to tell the little kid in you, who wants what he or she wants and wants it NOW, “No.”
The concept of saving our surplus for times of deficit is as old as human civilization. It’s what prompted us to settle and farm instead of following herds in tents. It’s what created the barter system, and later in Turkey, the beginnings of currency transactions. Indeed, even as far back as 3,000 years ago in the Bible, saving was a critical skill of survival.
During the time of Joseph, who was first sold into slavery by his jealous brothers but many years later promoted to become a governor of Pharoh’s entire treasury, a famine was prophesied in Egypt. Joseph interpreted Pharoh’s dream of the coming famine as a call to save for the impending emergency.
The solution was simple: if we have more than enough now, save it for when there won’t be enough.
So Joseph created a plan to save Egypt from the coming disaster. This was how he described his plan to Pharoh:
Genesis 41:34-36 Let Pharaoh appoint commissioners over the land to take a fifth of the harvest of Egypt during the seven years of abundance. They should collect all the food of these good years that are coming and store up the grain under the authority of Pharaoh, to be kept in the cities for food. This food should be held in reserve for the country, to be used during the seven years of famine that will come upon Egypt, so that the country may not be ruined by the famine.
(As a quick aside, did you know that the Bible actually says more about money and financial stewardship than it does about Heaven, Hell, and Salvation? Must be an important subject!)
Joseph’s interpretation of Pharoh’s dream was that Egypt was to take 20% – a fifth – of each year’s harvest for the next 7 years, and store it, because a famine of 7 years was to follow right behind. If you read the rest of this story, the prophecy was correct, and Egypt was the only country in the region to have food in abundance when the famine came.
A simple concept saved an entire civilization.
You need to save
Like the people of Egypt, and every human being who ever lived since, we live in periods of feast and famine in life. Life is rarely fair, and it’s never a constant. I’ve had (and I’m sure you have, too) times of great gain, and times of staggering losses. In fact, learning how to smooth out that rough ride is exactly why I became a financial advisor.
So the first step on your road to financial freedom – the first leg of your chair – the first of your personal Founding Four, is to save money.
How much do we save?
Like Joseph’s example, I want you to, eventually but hopefully within a year, get used to living on only 80% of your “harvest”. As the ancient Egyptians did, living on 80%, even for just 7 years, provided 100% of what they needed for another 7 years (plus the ability to sell some surplus). If your savings are properly invested and earning interest (more on that later in this post), it can do the same.
Saving 20% annually gives you a 100% payout in retirement, year-for-year.
So you’ll not be spending 20% of your income. Suck it up and get used to it. And go make some more money if you think that’ll be too tight.
10% should go to charity or a church tithe of some sort (I’ll explain the logic of that in a future post, but for now, suffice it to say that tithing 10% strips away any kind of poverty/scarcity mindset you may still carry with you that Rich Guys simply do not have). The other 10% will be saved for you, but for a future you.
Saving vs. Investing
Let me quickly describe the difference between saving and investing. Or watch the video below:
Saving is the accumulation of money for an imminent but unforeseeable circumstance. It’s the “rainy day” fund, the vacation fund, the holiday fund, the emergency fund.
Investing is the growth of money by putting it to work in the larger economy and taking ownership risk. When you invest, you are placing trust in the future prosperity of an idea, company, or project.
Investing is a positive, optimistic, forward-looking activity.
Saving is a pessimistic, “prepare for a problem”, any-day-now activity.
As you can see, there is a universe of difference between saving and investing. Today, we’re talking about saving.
What should I save for, and what should I invest for?
Using my definitions above, saving should be a defensive strategy based on short-term needs, where investing should be a long-term, optimistic, goal-based endeavor.
We save for those things that we couldn’t endure well otherwise (or have to bring on debt to get through). These are things like:
- Holidays and vacations in the next year or two.
- Shorter-term goals that would make investing for them difficult. For example, if we want to ensure we have enough money in 5 years for a second home, we’d save for it rather than invest it, because we cannot predict the future accurately for investments. To reach that 5-year goal with certainty, we’d need a vehicle that had little to no daily volatility, to make sure the amount we needed was there when we needed it.
- Unexpected emergencies like insurance deductibles, capital losses, loss of income, etc.
Note that we never save for longer-term goals like college and retirement. If they’re further away than 5 years, we’d likely invest for them instead of saving for them.
The other reason we invest for long-term goals and save for short-term goals is a concept called inflation. Inflation is the increasing number of dollars circulating in our economy as a result of borrowing from banks. Every year, more and more dollars are created, literally out of thin air, by companies and individuals borrowing from their local bank. With a growing amount of money each year, it means that the prices of things in our economy rise. This increase in cost (or decrease in buying power of each dollar) is called inflation.
Goals like retirement or a summer home in 20 years need to be invested because invested money generally grows faster than inflation, where savings accounts, CDs, and government savings bonds do not.
Where do I save?
Most savings can be done at your local bank or credit union, though be sure to see if they are both:
- Safe- all US banks and credit unions, and nearly every investment account are insured against loss in the case of failure of the bank or institution. But make sure.
- Paying you interest on your money, because those institutions will use your money while it’s just sitting there, either by investing it themselves *and making a profit), or lending it out to someone to buy a home, car, or business (again, making a profit). Your savings should be earning at least some interest.
There’s a Rich Guy Mantra you must always remember if you’re going to achieve financial independence, and we cover it a lot:
Money that isn’t earning money is worthless.
Make sure your savings are earning a healthy interest because the bank most definitely is making money by re-using yours. If you need to know some great places to save that I personally recommend, see Part 3 of this series, where I point out 5 places you can earn above-market rates on your simple savings (and open the accounts online.)
In part 3 of this series, we’ll finish the first leg of our “Founding Four”, and show you what to save for, how to do it, and maybe most importantly, where to save it. Stay tuned!