Early Momentum

It’s that time of year again when people all across America are anxiously awaiting their tax refunds. Some people are so impatient for it they’re willing to pay a large chunk of it just to get it sooner!

Next to being shot at and missed, nothing is really quite as satisfying as an income tax refund.  ~F.J. Raymond

According to IRS.gov, in 2008 the average individual refund amount was $2,902. That’s a good chunk of change by anybody’s standards. For many, as soon as they receive it they begin thinking of all the fun they can have or the things they can buy. But may I suggest before you spend it without much thought (possibly before it’s even in your hands) that you think twice about the best way to use your windfall from Uncle Sam.

Consider the 50-50 rule of newfound money

This philosophy is for those of us who wish to balance planning for future financial freedom while at the same time enjoying today. Whenever you receive a bonus, monetary gift, a raise or even a tax refund, you have in your hands new money that you previously were not spending. At this point you can’t even use the excuse of needing it to cover your current standard of living (well, you could, but if that’s the case there are bigger problems at hand than what to do with your tax refund) . With this money in hand, decide to use 50% to invest or pay down debt and spend the other 50% as you wish.

Now if you’re in dire straits in regards to debt, you may find it prudent to use even more of your tax return to pay down debt (yes, discipline is key). If that is the case (and I’ve been there), let that spur you on to a new way of thinking so that future income needn’t be lost to lenders.

Perhaps today you are financially sound. You could just as easily invest a larger portion if not all of your tax return. Remember, a dollar spent today is just that, a dollar. A dollar invested for the future is multiplied.

The reality of your tax return

Talk to a financially wise person and he will likely tell you that a large tax refund is not necessarily a good thing. In reality, the money you received in the form of a tax refund is money you overpaid in taxes during the prior year. The government merely held on to your money in their bank account collecting interest for their benefit. That’s why it’s called a tax refund, not a bonus!

Wealth conscious people prefer to get no refund. Why is this? Because they understand that by not overpaying in taxes their money will have been in their own bank account all year long collecting interest for themselves.

Collecting more taxes than is absolutely necessary is legalized robbery.  ~Calvin Coolidge

For future planning, consider consulting a tax advisor to determine exactly how much taxes you should set up to come out of your paycheck.

So, when you receive that wonderful tax refund check this year, ask “how can I use at least half of this to improve my financial health?’ But . . . have some fun too!

When looking to create personal wealth and a great financial future, one of the most important things to consider in every single purchasing decision is cost per use. Doing so causes us to use better judgment in how we spend our money and making our hard-earned dollars go further. To determine the cost per use of any given thing, simply divide its purchase price by the number of times it gets used.

One Way To Enjoy A Boat

For the sake of illustration, let’s say you wanted to purchase a new boat. A recent online check tells us that the average cost of a new 2009 Bayliner boat is$47,053. Unless you’re going to pay cash, there will be financing costs to add on top of that. Then there will be ongoing costs like outfitting the boat, fuel, maintenance and upkeep, storage, a boat trailer and insurance. Let’s estimate a conservative $13,000 for this over 10 years time. We are now at $60,000. Now for someone who’s passionate about getting a boat, at the time of purchase, they have every intention of going out on the water “every weekend.” Of course between work, family and needed down time it never quite works out that way. Assuming 12 trips a year for 10 years, the cost per use in this example is $500!

A Better Way To Enjoy A Boat

Last summer my family and I with a few friends went to a beautiful lake and rented a great boat. We drove down to the boat launch and parked the car. We walked down to the dock were somebody from the boat rental company backed the boat into the water for us. They even provided tubing equipment. We stepped into the boat and were on our way for a full day of fun in the sun. When we were about to come in, we called the boat company and right about the time we got to the dock they were there to hook up the boat and take it away. All fun, no drudgery. The cost to rent the boat for the entire day was $180. We split the cost four ways so it ended up being $45. Assuming we did that 12 times a year for 10 years, it would amount to $5,400. A savings of $54,600 over buying a new boat! Even if you were to rent the boat as in this example without splitting the costs, over 10 years you’d spend $21,600 for a savings of $38,400.

Wealthy Is As Wealthy Does

This technique is used consciously by the majority of wealthy people. It’s one of the reasons they’re wealthy. In fact, many financially successful people adhere to the motto of “never buy when you can rent, never rent when you can borrow!”

How Can You Apply It?

I used an extreme example earlier of a boat. On a daily basis, it is in our small and seemingly insignificant purchases that understanding cost per use benefits us. Take a look at your possessions. How many DVDs have you purchased for $15-$20 in which you only watched one time? Would it make more sense to rent a movie so that the cost per use is $3 instead of $15 to $20? Do you own a set of expensive skis that you have used only a few times? Could you have rented skis and all the corresponding gear for a weekend at a ski resort for a fraction of the cost? Parents, can you think of a $50 toy you bought for your child that they only used a few times? At $16 per use would you make the same decision or perhaps invested in a college fund?

Here are some ideas for reducing cost per use.

• choose the library over Amazon.com
• choose Netflix over new DVDs
• purchase your favorite songs individually on iTunes versus entire CDs
• consider a gym membership over expensive home equipment
• buy used instead of new

Wether your motivation is to have more money to invest in your financial future or to enjoy more of your favorite things today, understanding cost per use will go a long ways in your achieving both of these goals.

This is part two of a series of posts on the subject of making the most of your money. Part one is The power of compound interest. Stay tuned for the next post of this series.

One of the most important things you can learn in order to help assure your financial success is the concept of consequence costs. With every purchase you ever make, there are consequences attached to it. At the very least the consequence is not being able to use the money you spent on something else. But often, there are additional consequences in the form of time, energy, options and follow-up costs.

The ultimate example of a purchase with many consequence costs is a pet. Now before you consider me a pet hater, let me assure you I’m not. I fully understand the value and companionship a pet can bring someone. In fact my family has a pet cat named Sam that was a birthday present for me, however he turned out to be more of a family gift. I think my birthday was just an excuse to get him.

He started out so adorable. Little did I realize the consequence cost of his developing annoyingly bad habits. 

As great as pets are, many people make a decision to get one on a whim without taking the time to think about the ramifications. Sure they consider the initial price tag and maybe the upfront shots and licenses. They even realize there will be the ongoing purchase of food. But generally they do not really count the costs long-term. For example, a large size dog is estimated to cost $1,500 in the first year and $700 each year thereafter. With an average life of 14 years, that amounts to $10,600. If one were to invest that amount of money for 20 years at 6% interest, they would have $33,995! For the costs involved for other various pets, see this chart.

Now even if the money is a non issue, it’s important to consider the other consequence costs of a pet. Now that I have a cat, there is energy and time costs of additional house cleaning, additional errands to a pet store for quality products (the cat doesn’t settle for the low-class stuff from the grocery store), and every time my family wants to get away we must arrange plans to have Sam taken care of by family or friends or spend the additional money for boarding. For a dog owner, add the needed daily walks of the animal regardless of the weather or how busy they may be.

Before moving on, let me just reiterate that I think pets can be great. Some people love their pets as though they were their children. Just be sure to think it through when you make the decision on whether or not to get a pet. You have to make sure that the value it brings outweighs the costs. Unless it’s a fish. The kids talked me into getting some fish. We picked out two. One died soon after (I think the other fish killed him, if not by intent than by hogging all the food). At first each morning upon waking I’d walk by the fish tank and say “what cool little fish.” Now upon waking I walk by the fish tank and say “oh, you’re still alive.”

While pets are an obvious example of purchases that have consequence costs, it’s important to give thought to the ramifications of every purchase large and small. For every item you ever bring into your home or life, it means you have one more thing to clean, one more thing to store, one more thing to maintain and one more thing to move every time you relocate. This means taking your time and your energy from doing something else. Sometimes people acquire so much stuff that there is the consequence cost of needing to purchase a larger home or a storage facility just to house it.

To paraphrase Jim Rohn, some people miss out on the treasures of life because they’ve blown all their money on the trinkets of life!

Before making a purchase of any kind, take a moment to consider a couple things.

What will be the follow-up costs in money, time or lost options with this purchase?

Is there something I would rather have that will be delayed or canceled If I make this purchase now?

Wealthy people count the costs, both initial and consequential, of every purchase. Developing this habit early will do wonders for moving you towards freedom in both your finances and lifestyle.

Albert Einstein is rumored to have said “the most powerful force in the universe is compound interest.” I say rumored because as much as his quote is used in financial circles, its debated whether he really said it or not. Regardless, it’s a pretty valid statement.

Compound interest arises when interest is added to the principal, so that from that moment on, the interest that has been added also itself earns interest. This addition of interest to the principal is called compounding (i.e. the interest is compounded). A loan, for example, may have its interest compounded every month: in this case, a loan with $100 initial principal and 1% interest per month would have a balance of $101 at the end of the first month, $102.01 at the end of the second month, and so on.                  Wikipedia

Compound interest can be for or against you. It is for you when it is applied to the money you’ve saved. It is against you when it is applied to money you owe (either a loan or credit card debt for example). For now I’ll be talking about how you make it work for you by saving and investing your money.

Now before I get any further, let’s be clear that this subject for most people falls into the category of I wish I knew about this sooner! So I’m hoping you’re getting this sooner than later. If not, than let’s remind ourselves that late is better than never.

Let’s look at some examples of what will happen if you start early verses starting late. For these examples we’ll assume the interest we earn will be 10%. Admittedly this is ambitious in today’s economy, however this has been the traditional long-term return on investments in the stock market, particularly when observing the S&P 500 index.

An 18-year-old named Mike who begins saving only $100 a month ($1,200 per year) and invests it with a 10% return until the age of 65 will have $1,151,006.81! He will be a millionaire.

Now assume the same scenario of $100 per month invested at 10% until the age of 65 except Mike doesn’t begin saving until he’s 28. He will than have only $435,652.12. In order to catch up to where he could have been, if he waits until 28 to start saving he would have to now save $250 a month at the same interest rate.

If Mike waits until 38, at 65 he will have $159,851.92. Or he could catch up by saving about $700 per month.

One more example and then we’ll move on.

If Mike as an 18-year-old begins saving $200 a month ($2,400 per year) at 10% interest until the age of 65 he will have $2,302,013.61!

Depending on your age, the numbers will change. Also, your interest rate will change based on a number of factors. So to figure out where you could be, play around with a compound interest calculator. Run some different scenarios for yourself. What will happen if you start sooner than later? If you invest more per year than less?

It is exciting to see that even with modest savings ($100 a month from the time we start our first job), we see the potential to become a millionaire! If you’re starting  later, it is still possible with a little more discipline. But in any event, the key is to leverage your time and your money through the power of compound interest.

In short:

• Save early as possible
• Save as much as possible