Pay Yourself First

I just don't understand people. In 1985 the average American saved 10.1% of disposable income. Disposable income is defined as all aftertax employment income minus all basic needs. Some might argue with that definition but it is hard to wrap your arms around this term because of the nuances you can create from playing with expenses. Some simply see it as "money I can spend or save after my bills are paid". Well, people today are doing a lot more spending rather than saving. The percentage of disposable income saved this year? Negative one-half of one percent! That's right. We've finally hit the point where folks are spending more than they're making. How? By racking up huge credit card debt and paying for other high priced items in installments. Look, some people just aren't going to save money - it's that easy - but others who want to don't know how. The first thing they should do is read "The Automatic Millionaire". The book goes into great discussion about "The Latte Factor". People in the author's class said they didn't have money to save. He had each person make a list of all their cash expenses for the entire week. He noted how much was spent on frivolous items and noted that if $5 per day ($150 monthly) could be saved and invested at 10% (the historical average of the stock market), over 30 years if left untouched it would grow to roughly $300,000. He called it the latte factor because of the number of designer beverages on everyone's cash expenditures.
Here's where the usage of "disposable" gets sticky to me. Car payments are included in monthly expenses. I'm not saying everyone should be driving around in the cheapest car on the market - but is your car costing you tens of thousands of dollars in retirement? Or better yet, is your car choice going to cause you great pain when it comes time to send little Johnny to college? Let's take a look. Let's assume your family needs 2 cars to survive. Let's also assume you just had a baby and you have 18 years to save for college. Even if you don't intend to pay the entire tuition, you would like to contribute. Who knows where tuition costs will be in 18 years? Would you think I'm crazy if I said the cars you decide to drive over the next 18 years could cost you $120,000 in tuition or retirement money? Let's say you have $700 per month to throw at your cars. I'll try to break these 3 examples down quickly but you can work out the math if you don't believe the numbers. If you choose to spend the full $700 per month every year (either by leasing or trading up/in every time a car is paid off) you will have saved $0 over 18 years. Many people choose to lease these days because you get to rid yourself of the car before problems start, you always have a newer car and it allows you to drive a more expensive car than you probably would have purchased. If instead the same $700 went towards buying 2 lower priced cars so that they could be kept another 2 years after payoff (while banking the $700 per month) and then repeating that cycle twice while little Johnny grows up - the saved money would accrue to roughly $74,000 over 18 years. And that's with not starting to save a dime until year 6 when the first set of cars are paid off. It's $33,600 of your money with your good friend compounded interest at work. Sure, you would have some repairs to pay for, but you would still come out way ahead. For a real eye-opener, let's say we stick with leasing but instead of leasing 2 $350 cars we lease 2 $250 cars. That will save you $200 per month over 18 years at 10% for a grand total of $120,000. Think about it! That's the difference between leasing a high-end Passat or a Honda Civic. It's the difference between a Lexus and a Ford Taurus. Sure, you can afford to drive a Lexus, anyone can...it's all about priorities. Also, I don't want to sound like I'm begrudging anyone that drives an expensive car. Some people make enough money to live in a nice house in a nice neighborhood, save more than enough money for retirement, save enough money for Johnny's college fund AND drive nice wheels. I'm just saying if you currently don't have enough money to have everything you want - why put the better part of your budget into your car? I used to have a neighbor who drove a brand new Toyota 4Runner and a brand new high-end Acura coupe. Nothing wrong with that...except they had lawn furniture in their house and slept on a mattress on the floor. I'm not kidding. It cracks me up when people try to guess what you make based on what you drive. I'm guessing Bill Gates doesn't tool around in a Hummer, but i bet there are thousands of guys that have $700 a month of disposable income and spend $600 of it leasing a Hummer. The sad part is, by the time you realize you better start saving money - it's usually too late.
You don't make $1 million dollars overnight. Most millionaires make it over the long haul by constantly saving their money. Also, I just used cars as an example. What if you drive a leased car that costs you $450 per month but you never go out to eat. Your neighbor may own a Ford Focus which costs him $225 per month but he spends $300 per month eating out every chance he gets. My thing is that most people would argue what their "real" disposable income is. I pay $80 a month for Direct TV and some people might think that's insane. That same person may smoke 2 packs a day at a cost of $240 a month. What is necessary? Who knows....but if you see what you are missing by not compounding these small monthly amounts - you may change your mind as to what you think is really necessary. When you get to be 50 or so and the kids start college or you want to retire because you're sick to death of your job - think back to all the money you could have saved had you driven that one car for 2 extra years, or not spent $100 a month on Starbucks, or not had the best cable or cell phone package or the 97" plasma TV. Don't feel too good about what you can afford...feel good about what you can save. Minus...point... five..... percent! Think about it. Sheesh.