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!

Have you ever given thought to why you get paid for your work? I’m not talking about the specific tasks you do, but rather the purpose of your work in a general sense. At a high level, there are three reasons for any job being created or any service being paid for.

#1 We get paid to solve problems

The purpose of many jobs is to solve problems. We may talk in terms of filling a need, but a need is really a problem. In order to sell product a grocery store faces the problem of needing the shelves stocked. The clerk who stocks the shelves solves the problem and gets paid. It’s important to understand that if you wish to get paid more money then you should learn to solve bigger problems. Stocking the grocery shelves is a minor problem easily solved therefore it earns a modest pay. Contrast that with the problems that a brain surgeon must solve. Obviously if you’re having to see a brain surgeon you have a really big problem. The brain surgeon gets paid really big money to solve it for you.

When I first learned that solving problems equals earning money, suddenly I had a new outlook towards them. I learned to equate solving problems with bringing value. Problems are inevitable. People want to do business with those who are capable of solving them.

Leaders are problem solvers by talent and temperament, and by choice.-Harlan Cleveland

#2 We get paid to avoid problems

A dentist gives his patients routine cleanings to avoid the problem of cavities. A professional accountant is paid to help her client avoid tax problems or bankruptcy. When a house owner pays a company to install an alarm service it is to avoid the problem of being burglarized. For many people, much of their work is proactive activities designed to avoid problems. The bigger the problems avoided the bigger the pay.

The act of avoiding problems is perhaps the most thankless element of work. Yet imagine an amusement park without maintenance men or a new housing development without building inspectors. With most business it is only in the absence of major problems that we can spend our time focusing on opportunity.

#3 We get paid to create growth

Financial advisors make their money by growing their client’s investments. A major part of the business manager’s work is to grow profits. In many industries it is the salespeople who are the highest paid people in the company. The commissioned salesperson’s compensation increases relative to the growth they create through selling her company’s product. Take a look at most companies’ bonus plans and you’ll find they reward the growth of sales and/or profits.

Personally, I feel of the three reasons we get paid for our work, creating growth is the most rewarding. It’s like a payoff for your labor. Create much growth on your job or in your business and you will create much growth for youself in the process.

Don’t wait for extraordinary opportunities. Seize common occasions and make them great. Weak men wait for opportunities; strong men make them.-Orison Swett Marden

If you reflect on your work, you will find that your responsibilities fall under one or more of these categories. Understanding this and considering how you approach your work can go a long way in increasing your reward.

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.

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