The Truth About Money
When Is the Best Time to Invest?
Given $100,000 to invest, should you slowly invest that money over a period of time or simply invest all at once as one lump sum?
To understand the answer, realize that dollar cost averaging (Chapter 46) is intended for the accumulation of assets, not the distribution of assets already accumulated. Studies have shown that the investor who invests all at once makes more money than investors who DCA their way into the market.
This should be no surprise to you; after all, the entire benefit of averaging means that by default, you are guaranteed not to receive the lowest cost available, which in turn means you will not receive the highest returns, either. Since stock prices historically have an upward bias, the sooner you invest, the more money you will make, and dollar cost averaging delays that effort.
People who try to DCA large sums into the market soon learn why their strategy doesn't work: By investing $100,000 over a one-year period, they invest just $8,333 in the first month. That means they didn't invest $91,667. What will they do with that block of cash in the meantime?
It sits in cash, earning 1% interest -- hence the problem. Although you lower your risk by dollar cost averaging, you also lower your return. Therefore, the best time to invest is when you have the money! (After all, if you don't have any money, it's a pretty lousy time to invest, eh?)
This also means you should invest as soon as you do have the money. People sometimes tell me they're saving $25 per month in a bank account. "As soon as it grows to $5,000, I'll buy a mutual fund," they say. If your money is sitting in a bank at only 1% per year, do you realize how long it will take $25/month to grow to $5,000? Don't wait: Invest your money effectively now.
Though all this sounds fine, you're probably unconvinced, because you know that with your luck, the stock market will crash the day after you invest your life savings.
So please don't misunderstand me. I said to invest all your money at once, not invest all your money into stocks at once. The proper way to invest a lump sum is to invest it all at once -- but into a highly diversified portfolio. Revisit Chapter 44.
Four Ways to Create Savings
Maybe you're finding it hard to save. That's not uncommon, for even those who are free of debt sometimes find it difficult to save money. Many people spend all their money each month, and they can't (or won't) change their spending. If that describes you, the following strategies will help.
Savings Creator #1: Pay Yourself First
Let's begin by accepting two facts. Fact One: You spend all your money every month, and have nothing left to save. Fact Two: You can't change Fact One.
Fine. I won't argue with you.
Instead, let's just make a subtle change in how you pay your bills. Currently, you deposit your paycheck into your checking account, and then you start writing checks. If you're like most, you pay the mortgage first, then car payments and other loans, followed by the phone bill and utilities. You save the credit cards (if any) for last, because the amount you pay to them is directly related to how much is left in your checkbook after all the other bills are paid.
So, you send minimal amounts to each credit card company and by the time you're done, your checkbook balance is at or near zero. And while you promised yourself that you'd save some money this month (like you promise yourself every month), you now discover (as always) that there's nothing left to save. In fact, you barely had enough to pay the bills themselves.
Without realizing it, you are treating yourself as a creditor -- albeit a benign creditor. You want to pay this fellow named Yourself, but you know Yourself will never hassle you for the money, so it's okay to miss a few payments -- or ignore Yourself altogether. Thus, you pay Yourself last each month, which all too often translates into not paying him at all.
To fix this, you must pay Yourself first -- before you pay any other bills. By writing a check to Yourself for $25 or $50 (or whatever), you are certain that you will have paid Yourself -- before your checkbook runs out of money.
And if you're concerned that you will run out of money, don't fret -- because you're going to run out of money anyway (you always do, right?). At least, this way, you'll run out of money after you've paid Yourself. And that's the point.
Savings Creator #2: Your Future in a Peanut Can
Try using a trick my big brother Brad taught me when I was eight years old: Stop spending coins; spend only paper currency.
It's easy: Just put the change you collect each day into a piggy bank (I still use the Planters Peanuts can that Brad gave me) and you'll save $20 a month or more -- and double the savings if your spouse does likewise, even more if you get the kids involved. Then deposit the money into your mutual fund account.
Who Says Saving Money Is Hard?
Savings Creator #3: Spend Your Way to Wealth
Many people fail to save because they simply don't want to stop spending. Fine. Keep spending. In fact, I want you to.
Just change what you spend your money on:
- Instead of buying a bottle of ketchup, buy Heinz stock.
- Instead of buying a gallon of gas, buy stock in Exxon.
- Instead of a six-pack of soda, buy shares of Coca-Cola.
- That new lawnmower? Try stock in John Deere instead.
So go ahead and spend your money. Spend as much as you want. But instead of buying things that later will have no value (like an empty ketchup bottle or a vacation), or virtually no value (like costume jewelry, clothing, or furniture), make sure the things you buy will retain and even grow in value. Remember: Life is a series of choices. I'm not telling you to stop spending money, merely to choose how you spend it.
Once you get into this habit, you'll develop as much excitement buying investments as you currently do buying clothes. The reason that this is a foreign concept for you is that you have never bought anything that has retained its value -- except maybe your house.
But once you start to buy things that rise in value, you'll never look back. If you think shopping is fun, wait until you start shopping for things that make money for you. Now, that's shopping!
Savings Creator #4: The Right Way to Use Supermarket Coupons
If you're like most people, you clip coupons. And you redeem them at your local supermarket.
And if you're like most people, you're doing it wrong.
Think about it: The coupon in your pocket says SAVE ONE DOLLAR.
Well? Did you?
I mean, did you save that dollar? Or did you merely spend that dollar on something else?
Maybe you don't get my point. Say you're headed to the grocery store to buy $50 worth of food and household goods. You have $50 in your pocket or purse, along with a "dollar off" coupon that you can redeem against an item you need to buy. When you leave the store, you will have either:
- fifty dollars' worth of items, and one dollar in your pocket or
- $51 worth of stuff, and no money left because you spent it all!
Although the former is how you're supposed to handle coupons, the latter is more likely how you are handling them. If you're smart, you'll spend $49 and SAVE ONE DOLLAR by placing it into your peanut can before you even leave for the store! (See Savings Creator #1.)
How to Get Out of Debt
I'm going to show you how to get out of debt and increase your ability to save. But first, let's see how people get themselves into debt in the first place.
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Don't Spend Tomorrow's Income Today
Nobody intends to become debt-ridden, but at some point in your life you may turn around and say, "Gee, how did I accumulate all this debt?" It starts very innocently.
You see, none of us are born in debt. We start life with a clean slate. But then we make bad decisions, or we fall into traps, and the most common trap people fall into is committing themselves to a future lifestyle that is based on their current income.
Here's a great example. Debbie is 23 and lives with her parents. She earns $23,000 a year. Her parents cover her basic living expenses, although Debbie chips in $500 every month.
Recently, Debbie's old clunker died and she needed a new car to get to work. She intended to buy a Ford Escort for about $14,000, but the salesman talked her into buying a hot new Mustang for $28,000. Well, we can't really blame the salesman -- Debbie loved sitting behind that wheel. And considering her income and expenses, as the salesman showed her, Debbie easily was able to afford the 'stang. So she bought it, financing $20,000. Her payment is $445 a month for five years.
By committing herself to this payment for the next five years, she will not be able to move out of her parent's house. Consider the figures: Her after-tax income is about $17,000, or $1,400 per month. From this, Debbie has obligated herself to $445 for the car payment, plus another $150 per month for insurance, gas, and maintenance -- a total of 43% of her income! That leaves her with only $805, and that's not enough to rent an apartment and pay for food, clothes, furniture, and utilities -- plus entertainment expenses.
Today, Debbie doesn't mind. But what about three years from now? She has made a decision today that commits her income for the next five years. This not only means she must continue to earn at least as much in the future as she earns today, she must actually increase her earnings if she wants to improve her lifestyle.
And since she has already committed $595 per month toward her automobile expenses for the next five years, and another $500 to her parents in lieu of rent, her discretionary income is reduced to just $305 per month. So guess what happens when she decides to rent a house at the beach for a week with her girlfriends next summer? Debbie runs out of money -- not because she doesn't have any money, but because she has already committed the money she has.
So, to get by, Debbie starts to pay for gasoline with a credit card. When it is time for fall clothes and Christmas shopping, she uses the credit card some more. Soon, she discovers that she's built up thousands of dollars in credit card charges. When the bill arrives each month, she finds herself unable to pay it off because her money already has been spent.
It's very easy to fall into this trap, and newlyweds are caught all the time. My clients Darren and Barbara asked me if they could afford to buy a $225,000 house, and after reviewing their situation I told them they could, but only if they were willing to become "house poor." They'd have to use all their current savings and investments to get into the house, and then, even after considering both incomes, they'd be stretched each month to pay for the mortgage and related costs. Thus, I told them, they could afford the house if they both continued to work and if their future expenses and income both remained unchanged.
Because I didn't say "no" outright, they were excited. "But," I was quick to remind them, "you don't have children yet."
Too often, I have seen couples experience radical changes when a baby comes. But by purchasing such an expensive home -- by committing such a large amount of their income to maintaining that home -- they essentially were making decisions today that would affect (haunt?) them in the years to come.
Therefore, I advised them to buy a less expensive home, one that did not place such financial restrictions on them for the next 30 years. I cautioned that by doing it their way, in the best case they'd be house poor and in the worst case they'd lose their home. They rejected my advice. Six years later, after two children, they lost the house and divorced. (For more on the notion of working while raising young children, see Chapter 54.)
Expenses Should Be Adjustable Over Time
If you want to avoid the debt trap, keep your fixed expenses as low as possible. Don't obligate yourself to long-term expenses, such as "buy now, pay later" deals. That way, if your income or lifestyle changes, you will be able to handle the change financially. Debbie and Darren & Barbara failed to do this.
But let's say you have succeeded on this point. Let's say you haven't made commitments for income you haven't yet earned. Thus, when your expenses go up or your income goes down, your lifestyle can change accordingly. Congratulations -- but don't skip the rest of this chapter yet.
There's still one more trap awaiting you: You must be willing to make that lifestyle change when the time comes. Being unwilling to change is as deadly as being unable to change.
The best example I can offer is Lon and Gretta. When they married, Lon was 42 and Gretta was 39, and she became (rather unexpectedly) pregnant at 41.
From the time she was 18 until her marriage, Gretta had been on her own. She owned a condo, and enjoyed an excellent career. She earned $60,000 and, with no family, was able to live quite comfortably.
Lon was in research, with an income not as high as Gretta's. He too owned a home, and after the wedding, they sold their houses and together bought a bigger, more expensive home. Still, not much changed for them financially. Their joint income allowed them to live pretty much as before.
Then they had the baby, and six months later, Lon was let go after his firm lost a big grant. This forced the family to rely solely on Gretta's income for a time. Soon, Lon was back at work, although at a lower salary. Although things should have worked out, by the time they came to my office, Lon and Gretta owed $30,000 to credit cards.
Although they had not fallen into the trap of spending money they hadn't yet earned, they had fallen victim to the second trap: They each continued to spend as they always had, without regard for their new and different circumstances.
Indeed, they acted as though they were still "single and free." Gretta would think nothing of spending Saturday at the mall. Lon, too, regularly indulged himself. A car buff, he was forever under the hood, installing some new gizmo or other he bought at the local speed shop.
Yet they never adjusted their spending to reflect their new family obligations. So while they incurred new expenses with the house and the baby, they still maintained their previous spending habits. And while they easily could have paid for their new lifestyle or their old one, they couldn't afford both simultaneously.
Thus, Lon and Gretta continued to use their credit cards as each had done for the past 20 years. But now, instead of being able to pay them off each month as they'd always been able to do, balances started accumulating. At thirty thousand, it occurred to them that something was wrong. But they weren't sure what. After all, they hadn't been doing anything new or different. They had always spent money, and their incomes had always been enough to cover it. So spending couldn't be the problem. What, then, could it be?
This is the trap many people get into. We are so used to supporting only ourselves that we become used to instant gratification. We don't have to worry about feeding or clothing others, and since we earn our own money, we don't have to ask others for permission before we spend it. We've got ready access to cash that we're not afraid to spend. And since all our friends are just like us, it seems both easy and right.
Then one day you find yourself in your mid-40s with a spouse, a house, and kids -- and lots of debts. Make sure you don't commit tomorrow's income today, and when your life changes, make sure your spending habits change with it.
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