Saving: The Best Kind Of Investing

Photo By: Jeff Belmonte

Benjamin Franklin once famously said “A penny saved is a penny earned.” But Ben was seriously undervaluing the value of savings. A penny saved is usually worth considerably more than a penny earned, and this is something you should always consider in your daily life.

Why is the saved penny better?

You may wonder how a penny saved can be more valuable than a penny earned, but it’s very simple if you think about it. Imagine for a moment that you purchase an $80 DVD player. In this theoretical situation, you make $10 per hour and work an eight hour day, earning $80. The difference between the $80 you spent on the DVD player and the $80 you made at work is: you have to pay taxes on the $80 from work. So, even though you’ve earned $80 and spent $80, you’re actually behind where you started.

The United States didn’t have income tax in Ben Franklin’s time, so his thinking is understandable.1 His advocacy of saving, however, is even more true today than it was in his time. Many people pay income tax of 33% or more. To pay for a $100 item at that income tax rate, you have to make $150. In other words, you have to earn 50% more than you spend on something to break even. At those levels, a penny saved is worth 50% more than a penny earned.

What about lower tax brackets?

Credible estimates suggest that 38% of “families” pay no income tax.2 Even these families, however, usually pay Social Security taxes and, of course, sales taxes on their purchases. Usually these are often the families who are most in need of some added security, and quite probably having the most trouble creating any savings. While the penalty for purchasing may be lower for these families, due to increased difficulting creating secure savings, unnecessary purchases should still be avoided.

Advantages of Saving

Saving is a good habit to develop. Here are some benefits to keep in mind when you are having trouble deciding whether you’d rather have that DVD player or the money in the bank:

• The freedom that comes with financial stability will usually last longer than a DVD player.
• Purchases tend to go down in value, savings tend to increase (although not always at the rate of inflation).
• While you may think you can afford something right now, an emergency can change your financial situation very quickly.
• People more often have buyer’s remorse than non-buyer’s remorse.

Ultimately, finding ways to motivate yourself about saving is a pivotal step in financial freedom. Until you see saving as a joy instead of a chore, you will struggle to have the security enjoyed by those who do save.

1. Library of Congress: History of the US Income Tax [↩]
2. FactCheck.org: Do 40 percent of Americans pay no taxes? [↩]

Getting Debt Under Control

Photo by: Corica

Always Have Some Cash

As the economic meltdown ensued, financial institutions argued that they were not having a crisis of solvency, they were having a crisis of liquidity. 1 While it very likely was a crisis of both, it points out the importance of having your value in liquid assets as well as the inherent danger of leverage.

So how are we a mini-version of the larger economy? The average person in America has the exact same problems as these huge banks. Their assets have diminished in value, and they’ve leveraged themselves (debt financing, credit, etc.) to get those assets in the first place. Unfortunately, most of us are not expecting much of a bailout, so what should this tell us?

When times are good, we all extrapolate our current success and live accordingly. We imagine that our well-paying job will last, so, of course, we can buy that big house; it’s just going to increase in value anyway. We can put all our investments in stocks, because they’re rising meteorically. Cash seems boring and unrewarding in such a market, but as those who have cash now can attest, it certainly is nice when things go the other way.

Advice For Saving

One simple rule can give you a method for ensuring you don’t find yourself in this situation again:

Live Below Your Means

This one rule will help you make rational decisions in your life. It’s a subjective goal, but it can make every decision the safest one. Unfortunately, much like the banks, while we should have adopted that policy before, it’s very hard to adopt now. If we’ve lost our jobs and are in severe debt, it’s very hard to live below those means. So for this time of crisis I think the rule can be re-summarized as follows:

Assume The Worst

Many of us are expecting a strong rebound, but are we sure it’s coming? If we continue expecting, we may find ourselves in a very precarious position if the recovery doesn’t come quickly. Instead of thinking “I can keep cable TV as long as things turn around soon,” consider thinking “Cable is not a necessity, and for the time being, non-necessities do not get favor.” While this may turn out to be an unnecessary cut, it may also turn out to be the first step in helping you live below your means.

1. Times Online: Loss of liquidity, not insolvency, caused credit crunch [↩]