Sunday, July 31, 2011

Little Money Secrets

Little things can make a difference in money matters. Just as small adjustments to a swing can change a golfer's game or a batter's average, paying attention to a few details can make you better off financially speaking.

Calculate your net worth. This is the most basic thing you can do. At least every three months, figure out where you stand. If you don't keep score, you won't know how well you're doing and whether or not you're making progress. You can't do any financial planning without knowing your net worth.

Reinvest dividends and interest. Rolling your investment income into new investments allows you to compound your earnings. The leverage from compounding over time is astonishing (see If you reinvest your investment income, you'll have a more reliable source of growth in your wealth than stocks, gold, oil or any other asset class.

Sweep excess income into savings. Let's say, near the end of the month, you've been true to your budget and have some excess income from your last paycheck. Sweep the excess income into a savings vehicle. The savings vehicle can be a savings or money market account at a bank, or a money market fund account. As funds build up in the savings vehicle, you can transfer them to a mutual fund or other longer term investment, if you like. But the point is to get them out of your checking account, where they may be viewed as immediately spendable, and into the category of savings. Resist the urge to view excess income as mad money. Sweeping even small amounts adds up. If you sweep $50 a month, on average, after one year you'll have $600. After ten years, you'll have $6,000, plus investment returns. After twenty years, the total will be $12,000. With investment returns, it might have grown to $20,000. After thirty years, you've swept $18,000, and investment returns may have made the total $30,000 to $40,000. Remember that this is in addition to your 401(k), IRA and other retirement accounts. Little crumbs can be made into crumb cake.

Focus on saving. Too much time and energy are devoted to searching for the ideal investment strategies, and not enough to saving as much as possible. There is no way to pick the optimal investment strategy for the next five years, let alone the next thirty, forty or fifty, because no one can predict the future with certainty. Look at the past five years if you think otherwise. People who save more have more capital to invest and diversify among different asset classes. People who save only modest amounts may find themselves taking big risks in order to ensure a comfortable retirement. The Great Recession has taught us that taking large risks doesn't always yield high returns, or any returns at all. Saving more, and moderating risk, is a smarter long term strategy.

Avoid debt. This is the biggest secret of all, because, judging from the growth of consumer debt in recent decades, so few people seem to understand it. Since most people borrow money to consume, they get no financial return from it. It's a pure cost item, with the repayment of principal and interest coming out of future income. Of course, most people need to borrow to buy large items, like a house, an education, or a car. But borrow only when you must and when there is an important reason. You have a finite lifetime income, and the more of your finite income you devote to debt repayment, the less you'll have for everything else. Why enrich banks? (For more on this point, see

In baseball, most hits are singles, even for Hall of Famers. The same is true for financial planning. Apply these little secrets, and your golden years will likely glow more brightly.

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