How to Really Save Money ..It's Actually the Big Things...
Every personal finance guru has a column that gives you advice on how to save money. Tell me if you haven't heard this one before. Give up your daily coffee and change your life! It seems like a broken record with TV snippets of Suzie Orman look alikes telling you the key to financial security is as easy as giving up a small indulgence.
The reasoning goes like this. You purchase five coffees from Starbucks every week for a total of $25 a week, which adds up to $1300 a year, and if you invest this money at 7% for forty years you will have a six figure sum for retirement. Florida beaches here I come with my black socks and sandals!
What they don't say is that your life is made up of tons of small things, and if they want you to give up your daily coffee, what else will be falling to the cutting room floor? How about eating out once in a while? How about that weekend get away? How about a few drinks with friends? How about going to the movies once a month? If you cannot justify indulging in the small things that you enjoy, what kind of life is that? Do you really want to spend the first 60 years of your life depriving yourself of all the small pleasures in the hopes you save all those pennies and retire in style? If you enjoy coffee, you can cut back but by all means indulge once in awhile!
I will make the case here that it is not the small things in life that make a difference, but rather the big decisions that you make that will determine your financial security.
What term do you have for your mortgage?
Let's start with your home, which is most likely the largest purchase you will make. On a 30 year mortgage with average finance rates an individual will almost match the purchase price in interest payments. Purchasing a home that costs a bit less and taking out a 15 year mortgage instead will save you tens of thousands of dollars. Lets start with a $200,000 mortgage @ 5% for 30 years, after all is said and done you will pay $186,511.57 in interest. Purchase the same home with a 15 year mortgage at 4.75% (15 year loan rates are generally lower), and you will end up paying $80,019.49 in interest. That is a savings of $106,492.08, or approximately 21,298 coffees, which is one a day for 58 years. The higher the interest rates the more that amount is exaggerated. For a 30 year mortgage at 6% verses a 15 year at 5.75% you would save $132,728.75.
How about being diligent about watching interest rates and refinancing your mortgage when rates drop? A one percentage drop in rates on that 30 year 5% mortgage refinanced down would save you $42,772.56 near the beginning of the term. Do you watch close enough to know when it is advantageous to refinance? Would you be more likely to watch rates if you realized it could mean that much in your pocket?
It has been said that financially, the worst investment you can make is in a car. It depreciates until it is worth little to nothing, and at that point you start over with a new one. Because of this, the decisions you make can be a huge factor in your long term financial health.
First, what type of vehicle will you purchase? Are you practical with a model that gives you what you need in functionality and safety? Do you go for the $20,000 Jeep Patriot or the loaded Jeep Grand Cherokee at $32,000? If you are financing the vehicle at 6% for five years that extra $12,000 actually becomes an extra $13,919.62.
Second, do you need a new car or can it be gently used? You have probably heard that the minute you drive your car off the lot it loses value. Did you realize that the average car is worth 20% less after it's first birthday? and 30% less after it's second? In 2013 the average cost paid for a new car was $31,252 according to TrueCar.com. Wait a year or two and purchase the same vehicle with the remaining warranty , and you can save $9375.
How often do you purchase a new car?
Third, how long will you finance the vehicle for? In years past it was unheard of to take out a loan of over five years on a car. In an effort to sell more expensive cars to more consumers dealers now will offer loan terms of six or seven years, and sometimes longer! Take that $31,252 car and finance it at three years at 6% and you will pay $2974.87 in interest. Finance it out for seven years and you will pay $7097.81, or $4,122.94 more.
Fourth, how long do you keep the car? Do you sell it and get another one every five years? In years past this may have been wise due to the general age limits of a vehicle and the repairs that would inevitably come with age. In Today's world it is not the case and many vehicles will easily last over 10 years and 200,000 miles (one of my cars has reached it's 12th birthday with about 250,000 miles on it). Not having a car payment is a wonderful feeling and by doubling the time you keep your car you can save tens of thousands of dollars over time. Added up over a lifetime assuming you get one car a decade from age 20 to 60 at $31,252 and that would save you $156,260 over a lifetime. Of course, there is the trade-in value factor. A car on average will depreciate 60% after five years as a general rule. Even at that rate and if you get the full trade in value your savings would be $93,756 !
Fifth, do you take into account your gas and insurance costs? I will not delve that deeply into this factor but the savings can be significant over time. It is worth looking into all facets when making these purchases.
How about your retirement accounts? Are you one of those individuals who puts your money into managed funds? It has been proven over time that a majority of fund managers cannot beat the market in general. Why? One of the reasons is that a managed fund has higher fees than an index fund. There is a premium you pay for having someone study individual stocks and try to achieve a better return than the market in general. Also, the additional buys and sells cost money that must be recovered in yearly fees. Many times this amounts to about a percentage point each year. Doesn't sound like much does it?
Lets try a basic calculation. Let's say you are lucky and have $100,000 saved by the time you are 35 and and invest it in a mutual fund that has a 1.2% expense fee. At the end of 30 years if you calculate the total without any fees you would have $761,225 assuming an average annual return of 7%. How much does that 1.2% yearly expense fee cost you? You would only have $563,078, or over 26% less. Now imagine how much this amounts to with regular contributions.
In general, investing in ETF's (Exchange Traded Funds) is cheaper than investing in Mutual Funds, even if indexed. Vanguard and Fidelity are two companies that are known to have very low fees and are worth researching.
Looking back at three big decisions you will make in your life, your home, your vehicles,and your investments, you will find that by being smarter with these decisions you will make far far greater of a difference than trying to nickel and dime your budget by giving up those little pleasures. Enjoy life AND be responsible with your future at the same time.