This short synopsis is from “The Truth About Money” by Ric Edelman.
As you begin trying to accumulate wealth, you’ll encounter four major obstacles. The first is the most deadly, but if you think it’s the economy or taxes, you’re wrong. Your biggest enemy, as I can attest from having worked with thousands of people just like you, is yourself. Without question, procrastination is the most common cause of financial failure.
To understand this, consider the story of Jack and Jill. You know Jack fell down the hill, but you didn’t know that he suffered head injuries. As a result, Jack decided not to go to college. Instead, at age 18, he got a job, enabling him to contribute $4,000 to his IRA each year. After eight years, he stopped, having invested a total of $32,000.
Meanwhile, his sister Jill, inspired by Jack’s accident, went to medical school. At age 26, she began her practice and started contributing $4,000 to her IRA. And she did so for 40 years, from age 26 to 65. She invested a total of $160,000 and she put her money into the same investment as her brother Jack. Thus, Jill started investing the same year Jack stopped, and she saved for 40 years compared to just eight years for her brother.
By age 65, whose IRA account do you think was worth more money?
Assuming Jack and Jill each earned a 10% return, Jill accumulated $1,327,778 but Jack collected $1,552,739 — $224,961 more than his sister!
While Jack had invested only $32,000 to Jill’s $160,000, his money earned interest for eight years longer than his sister.
It wasn’t the money that made him successful — it was the time value of money. Jack didn’t procrastinate, and by investing sooner than Jill, his account grew larger.
I have heard the complaint that procrastination does not belong at the top of my “Enemies of Money” list. There must be other, more serious causes for financial failure, right?
Wrong!
Obstacle #1: Procrastination
I cannot stress enough the need for you to get started right now. Procrastination says you’ll do it tomorrow. It’s easy to see why you put planning off until later: After all, who has time? You’ve got lots of deadlines and you don’t need another one. You’ve got to get to work on time, get your kid to soccer practice and prepare for out-of-towners who will be visiting you this weekend. With today’s deadlines, you don’t have time to work on something whose effects will not be felt for 20 years. But that’s okay because you’re young and you’ll still have plenty of time later! Right?
Wrong!
Maybe this is why so few of my firm’s clients are under 30. It just seems that young people don’t want to talk about something 40 years away: They’re more concerned about this weekend’s party!
In fact, I’ve heard all the excuses: If you’re in your 20s, you figure you’ve got 40 years to deal with it, so you’ll put it off until you are in your 30s…
…but by then, you’ve got a new house, new spouse, and new kids — and you’re spending money like never before. Who can think about saving at a time like this? You’ll deal with it later, after things settle down in your 40s…
…when indeed you’re making more money than ever, but now you find that your older children are entering college. On top of that, your income growth isn’t as rapid as it used to be. No problem, you say, because by the time you hit your 50s, you think your major expenses will be behind you…
…only to discover that your younger kids are entering college and the older ones are starting to get married (with you footing all these bills) and maybe the graduates need help buying a house, too.
Your parents probably need some help as well, because they’re getting up in years. And you can’t remember the last time you got a promotion; after all, you’ve moved up so high in the company that the only way you’ll get promoted is for somebody to retire or die. You’re also finding that the cost of living has never been higher, so planning for retirement will just have to wait a bit longer…
…and when you hit 65, you lament your anemic savings and wish you had started 40 years ago.
I see this all the time.
If there is only one thing in this entire book that you need to take on faith, it’s this: There is never an ideal time for planning, and while you can always find a reason to put it off, don’t. Do it now. Procrastination will cause you financial ruin more effectively, more completely, than the worst advice a crooked broker could ever give you.
The Cost of Procrastination
There is, in fact, a specific cost to procrastination. If you are 20 years old and you want to raise $100,000 by age 65, you need to invest only $1,372 today (ignoring taxes for the moment and assuming a 10% annual return).
But a 50-year-old would need to invest nearly $24,000 to obtain that same $100,000. This is the cost of procrastination. As you can see, it’s not money that makes people financially successful, it’s time.
The cost of procrastination can be shown just as easily for those who save monthly: Our 20-year-old would need to save less than $10 a month, but the 50-year-old would need to save $239 a month. You tell me: Who has an easier task?
Why $1,200 = $37,125
A lot of folks reading this will concede that starting young has its advantages. But I’m plenty young, you might be thinking, so I’ll just start next year. After all, next year, I’ll still be young enough, but I’ll be making more money, and it’ll be easier for me to start. After all, what difference can one year make?
A big difference.
If a 30-year-old saves $100 a month until age 65, earning 10% per year, the resulting account would be worth $379,664.
But if this person waited just one year, beginning her savings at 31 instead of 30, her account at age 65 would be worth only $342,539.
While presenting this in a seminar, an elderly gentleman rose to object to my comments. “Excuse me,” he said, “but I can’t to do that.”
“Why not?” I asked. “Don’t you have a hundred bucks?”
“I have the hundred dollars,” he replied. “But I don’t have the 30 years!
Thus, the cost of not saving $100 a month for just one year is $37,125. Can you really afford to blow thirty-seven grand?
Don’t procrastinate. Start now.
Obstacle #2: Spending Habits
Again, the problem is you, not the economy or world politics!
To see what I mean, look at the Newmans, married, with a combined annual income of $60,000. They felt they didn’t spend extravagantly, but they were nonetheless concerned that they couldn’t seem to save any money. “We don’t drive fancy cars or take big vacations and our kids don’t have the latest Reeboks,” they told me. “But we can’t seem to get ahead.”
Needless to say, the Newmans didn’t know where their money was going, so my firm helped them figure it out. The Newmans commuted to work separately and here’s what we found:
When they each got to the office, each would buy a newspaper for fifty cents, coffee ($1.25), and a doughnut ($1.00). In a mid-afternoon break, they’d buy a candy bar ($.75). Without knowing the other was also doing this, each was spending $3.50 a day, for a daily total of $7.00.
With 20 working days per month, they were spending $140 per month, or $1,680 a year.
And guess what happens to the money you earn before you receive it? It gets taxed. In other words, the Newmans had to earn $2,400 in order to net the $1,680 that they frittered away on candy and soda. Then they came to us saying, “We can’t seem to save any money.” Where Does My Money Go?
Have you ever withdrawn $50 from an automatic teller machine, yet find your wallet or purse empty just a few days later?
Have you ever asked yourself, “Where does all my money go?” Like the Newmans, you probably are piddling it away. You have no idea you’re doing it, because if you did know, you would stop instantly, for there isn’t a rational human being in the world who would tolerate such nonsense.
But we all piddle money away because we don’t pay attention. The Newmans were spending 3% of their annual income on… nothing! To avoid this problem, you’ve got to look at your spending habits, for that’s where you’ll find the key to your financial future.
Obstacle #3: Inflation
The most onerous of money’s enemies, inflation is perhaps the best illustration of how The Rules of Money Have Changed.
Over the past 25 years, inflation averaged 4.4% per year, according to Ibbotson Associates. At that rate, a 50-year-old earning $50,000 a year, who plans to retire at 65 on that same income, will need a net worth of $1.7 million — and his income in his first year of retirement needs to be $95,000.
Indeed, to look into the future, you need not 20/20 vision but an inflation-adjusted 50/50 vision!
In fact, 4.4% annual inflation means $1,000 will be worth less than two-thirds as much in 10 years. Put another way, you’ll need $1,538 in 10 years to buy what $1,000 buys today. Are you old enough to remember when President Nixon announced a 90-day wage and price freeze? Inflation was rampant and nobody could stop it — not Congress, the Federal Reserve Board, the President’s Council of Economic Advisors, the banks, or Wall Street.
Nixon and the nation panicked. Convinced that inflation was going to cause an economic calamity worse than the Great Depression, the President stopped inflation artificially. For 90 days, nobody was permitted to raise salaries or prices. And the strategy worked — until the 91st day, anyway.
When President Nixon established his freeze in 1971, the inflation rate was just four percent. If that were the case 10 years later, Jimmy Carter would have been re-elected! By the time Jimmy left office in 1980, inflation was 13% and banks were offering 15% CDs.
But you didn’t buy those CDs, because you were convinced that next month, CD rates would be 16% and you didn’t want to be stuck with “only” 15%! So you kept your money in daily accounts. You rode the interest wave up and right back down again!
Inflation — even very low inflation — once panicked our nation, but no longer. How can that be? The reason is the frog.
Yes, the frog.
The Boiling Frog Syndrome
If you throw a frog into a pot of boiling water, he’ll jump out. But if you place a frog into a pot of lukewarm water and slowly turn up the heat, it will boil to death.
And so it is with inflation. We’ve grown accustomed to inflation over the past 25 years, but that doesn’t mean we don’t continue to be hurt by its effect. We are hurt even at “low” rates of inflation.
Obstacle #4: Taxes
We all love to hate taxes.
According to the Tax Foundation, Tax Freedom Day is April 19, meaning that every dollar you earn for the first four months of the year goes to taxes. Put another way, you work nearly three hours of each workday just to pay taxes. No wonder we find it difficult to save money!
In addition to federal income taxes, you also must contend with state income taxes plus personal property taxes, sales taxes, user taxes, intangibles taxes, excise taxes, capital gains taxes, and estate taxes.
The amazing thing is that everybody thinks taxes are a natural part of life. Have we all forgotten why we revolted against England?
Our federal income tax wasn’t even created until 1913 — and it took a constitutional amendment to do it. And when the tax was established, it was quite low: There was no tax on the first $20,000 of income and only a 1% tax on income between $20,000 and $50,000 — and $20,000 was a lot of income in 1913!
You can guess what the politicians said back then, too. “Don’t worry,” I’ll bet they claimed, “tax rates will never rise!”
It’s the Boiling Frog Syndrome all over again.