One of the greatest mathematical discoveries of all time — according to Einstein — is the “miracle” of compound interest. It will either be one of your greatest financial friends or one of your worst financial foes. Let me show you what I mean with two examples.
Early and Steady Make All the Difference
Let’s consider how compound interest rewards those who save early and consistently by reviewing the following example of two couples. Paul and Ann save $2,000 per year for ten years, starting when they’re 25. While they stop making additional contributions after the first ten years, they let the investment balance continue to grow at 10 percent until they are 65 years old. John and Carol, on the other hand, don’t start saving until they’re 35. They contribute $2,000 per year for 30 years, yet never catch up to Paul and Ann! This is the power of compound interest. Paul and Ann contributed $20,000, but did so early, and it grew to $677,000. John and Carol contributed $60,000, but since they started late, it only had time to grow to $377,000. Which couple would you rather be?
Now let’s consider another example. According to the US Census Bureau, the real median household income for 2004 was about $43,000. We previously saw that the average household carries $8,000 in credit card debt. Assuming an interest rate of 20 percent, households are paying about $1,600 per year — or between three and four percent of their income — in interest on just their credit cards. It’s little wonder that the savings rate in America is so low. We’re paying credit card companies and banks the money we used to save! What would happen if you eliminated the credit card debt and invested the $1,600 with a 10 percent annual return over 40 years? You would have a balance of $843,000, rather than having paid the bank $64,000!
Saving and investing early and consistently over an extended period of time will revolutionize your financial life and help you reach the goals you have for yourself and your family. One of the keys to succeeding is to not allow your savings to be swallowed up with payments on credit cards.
Fail to Plan and You Plan to Fail
Let me give you another important hint when it comes to saving. You’ll need to make your savings preplanned, just like your giving, otherwise it won’t happen. Again, you’ll find that your money grows legs and walks away. By planning your saving as part of your budget, you set a lifestyle below your means today so you’ll have resources for tomorrow’s needs. This is called delayed gratification and it’s the only way you’ll reach financial freedom.
Generally speaking, a good rule of thumb is to save between 10 to 15 percent of your gross income. Once you’ve budgeted for savings, use direct deposit as the way to make sure it gets into the savings account. You won’t miss the funds and it makes your saving automatic. Think of the peace you’ll have when you can pay cash for the next “emergency” or your next car, or help your child obtain a college education, and then retire secure with the knowledge that you have the resources you’ll need during your later years.
Your first savings priority is setting aside emergency funds. Your initial goal is to set aside $2,000, because until you do, you’ll never be able to break free from the habit of paying for “emergencies” by using credit cards. After you’ve saved your $2,000, you’ll want to eliminate any credit card debt. Once your credit card debts are eliminated, you’ll want to set up a rainy-day fund until six months’ living expenses are safely set aside.
Your next step is to save up for major purchases, such as a down payment on a home or cash for your next automobile. Money you put away for your emergency fund and for major purchases are short-term savings and should not be commingled with your long-term investments. You will be expecting to need these funds within five years. As a result, you’ll want to place them in accessible places. You can keep three months' savings in a money-market type account that has check-writing privileges with a bank or brokerage house, and place the remainder in a three month Certificate of Deposit in order to enhance your overall return.
No Retirement from the Christian Life
The need to save for retirement should be obvious. There will come a day for most of us when we’re no longer able to earn a salary. Therefore, it’s important during our earning years to plan for ongoing financial needs during that time.
There has been a lot of talk about Social Security over the last several years. It should be no surprise that Social Security will be providing less in benefits to future retirees than it does today. There just aren’t enough young people entering the workforce to make up for all the baby boomers entering their retirement years. The message to take home is that you need to develop an appropriate savings strategy to fund your own retirement needs.
While your circumstances will be unique, a typical rule of thumb is that you will need 80 percent of your pre-retirement income to meet your retirement needs. Some of your expenses, like housing and transportation, should decline substantially, but those are often largely offset by increasing medical and long-term care costs.
I’d like to make another point about retirement beyond the need to save for it. The broader culture seems to set a goal of “early and rich” retirement for people. You’ve seen the advertisements that show a carefree lifestyle on the beach. This attitude fails to recognize that work is a gift from God, and that how we go about doing the work God has called us to plays a substantial role in our sanctification. You know the saying, “All work and no play makes Jack a dull boy.” The reverse is also true, in that all play and no work can make for an empty life.
One of the benefits of reaching true financial freedom is the ability it gives you to be more directly involved with God’s work. Whether it’s teaching in an inner-city school, building housing for the poor, working with the handicapped, becoming a deacon, or volunteering as a catechist at your parish, these all become options when you’ve saved for the future and avoided debt. So rather than retiring “early and rich,” focus on how you can use the talents the Lord has given you in ways that glorify Him and help make the world a better place. Give meaning to your life by investing in the lives of others.
Visit www.veritasfinancialministries.com and use the retirement calculator to consider various scenarios for your own circumstances.
People who are blessed financially have been given a tremendous obligation. Once your needs have been met, this includes growing in generosity beyond the principle of the tithe. This is why it’s so important to set a lifestyle that’s reasonable in light of Christian teaching. We read in 2 Corinthians 8:13–15, “I do not mean that others should be eased and you burdened, but that as a matter of equality your abundance at the present time should supply their want, so that their abundance may supply your want, that there may be equality.”
I remember the story about the founder of one of the companies I worked for. Shortly after World War II, he and his wife had been successful at starting a business that manufactured small trailers for people to live in. The initial success led them to seek capital for growth through a public stock offering. At the same time, the founder and his wife attended a small church that worshipped in temporary facilities. There were plans to build a church, but those plans would have to wait for the necessary funds. The stock offering was a success and the couple called the pastor to let him know they wanted to fund the building of the church. Over the years, this man and his wife continued to give very generously for a variety of needs. I remember hearing him once say that deciding where their donations should go was consistently one of the most difficult financial decisions he and his wife had to make. Wouldn’t it be great if everyone took their call to generosity so seriously?
We have been given so much in America — opportunities that most of the world can only dream of. Think of giving as a privilege rather than a duty. You can make a big difference in the lives of those not so blessed and leave a legacy that will serve as an example for others to emulate. Isn’t this an inheritance that should be considered as well as leaving an estate to your family?
Phil Lenahan is President of Veritas Financial Ministries. If you have questions you would like Phil to address, please email them to [email protected].
