Tuesday, May 12, 2009

Saving Is More Important Than Investing

Tip #137 - Saving Is More Important Than Investing. I hear from many people that they don’t understand anything about investing. And although I have written several posts on basic investing, there are some people who are not willing to undertake more risk to earn more money. And there are other people who are just not interested in investing, and therefore resign themselves to not saving money at all. But being an investor and being a saver are really two different things.

Person A is not a very good saver. He makes $50,000 per year and only saves $1,000 per year, but he makes wise investments. He is not scared to undertake some risk when it’s appropriate and does quite well investing it. In fact, he earns a 12% return on his money. After one year he has $1,120.

Person B, on the other hand, is a good saver. She also makes $50,000 per year and saves $5,000 of it per year, but is uninformed on investing. She is scared to take risk, however, and likes only to save money in FDIC-insured accounts. Her return on investments is only 3%. At the end of the year she has $5,150.

The savings amount and investment rate for each of these people are the same year after year. At the end of 10 years, Person A has about $20,000 in savings with interest (compounded daily), and at the end of 20 years he has $88,000. On the other hand, Person B has $59,000 after 10 years, and at the end of 20 years, she has $139,000.

In fact, for Person A to have as much money as Person B after 20 years, he would need to earn a 15% interest rate per year consistently. Or to look at it another way, it would take Person A almost 27 years for his savings amount to surpass that of Person B because of his abysmal savings rate, even though he is earning a great rate of return.

While I am not in any way advocating not learning about investing or just putting all of your money in FDIC-insured CDs, I am trying to encourage those of you who are too scared to learn about investing or too overwhelmed by all of the investment choices out there to at least bump up the amount you save each year. Because putting money away is more important than what rate you earn on it. And as your savings starts to build up, you can learn more about investing. Or at least hopefully feel comfortable enough to invest a small portion of it in higher risk investments to increase your earnings. If you are new to investing, do not get talked into making investments that you are not comfortable with. Just put the money away where you are comfortable with it, putting the most away that you can.

In Real Life (IRL) – When I was new to saving, I had all of my money in CDs, government bonds, money market accounts, and bank savings accounts. It took me awhile before I became comfortable enough to invest money in mutual funds or stocks. And when I did, I eased into it slowly - gradually increasing my portion in stocks as I became more used to it. And until that point I just kept socking the money away. And truly, that is what has built my savings up today. With the stock market erasing many of the gains I made in the 1990’s, the thing that has saved me is having put so much away.

I have pointed out before in this blog that I tend to be a somewhat conservative investor as far as informed investors go. As I mentioned, I only have 25% of my daughter’s education money in equities (stock mutual funds), while 75% is in fixed income FDIC-insured CDs earning between 4% and 5%. With our retirement money – about 20 years away, I have 1/3 of our money in fixed income – CDs and Government bonds, which is more conservative than most financial advisors would recommend. (Most would probably recommend that I have no more than 20% in fixed income.) But I am an avid saver. We save about 25 percent of our income. So I can afford to get lower returns. I invest the way I do because it is the most risk I am wiling to take at this time.

We each need to take baby steps when it comes to investing – we crawl before we can walk and walk before we can run. Yes, saving a lot and getting the most interest on that savings will get us where we want to go the fastest. But crawling will get us there, too. It will just take a bit longer.

1 comment:

Christian Frugal Mama said...

Hi! I finally got around to writing down your tips and recipe for New York Pizza and might try it tonight. Thanks for letting me know!