It’s hard to save money when you’re young. If you’re lucky enough to have a job, you’re probably not flush with cash. With a glut of young and talented job seekers, companies have little pressure to offer generous starting salaries.
And let’s not forget educational expenses. Inflation in college tuition has massively outpaced broader consumer price inflation for decades, meaning most college graduates start their careers with large student-loan debts hanging over their heads. A recent poll found that college graduates finish their studies with an average debt load of $35,200. And if you are the ambitious sort who decided to go to graduate school, you might have multiple hundreds of thousands of dollars in student debts.
Still, the savings you manage to sock away while young will have an outsized effect on the lifestyle you’re able to live when in middle age and your golden years.
How to Save: Rich Man, Poor Man
To illustrate, let’s look at Richard Russell’s classic piece, Rich Man, Poor Man. Russell, who has covered the financial markets since 1958, gives an example of two savers.
One opens an IRA at age 19 and sets aside $2,000 per year until the age of 25 and then never invests another penny again. He invests for seven years and then simply lets his existing savings compound. A second saver starts saving at age 26, picking up our first investor stopped. He then continues to add $2,000 per year until age 65, a period of 40 years.
At the age of 65, who would you expect to have more in savings: the first investor, who invested for seven years before quitting; or the second, who got a later start but invested for 40 years?
Assuming annual returns of 10%, Russell found that the early starter had a net worth of $930,641 by age 65 versus $893,704 for the late starter, and this despite the late starter having an additional 33 years of contributions!
This is a hypothetical example, of course. Real-world returns will depend on market valuations. But the critical point stands: Saving early is far more valuable than saving later in your career.
Let’s now look at a few tricks on how to save and put the power of compounding to work.
How to Save: Pay Yourself First
I have a little theory about human spending habits. Just as nature hates a vacuum, we humans are hardwired to expand our spending to absorb any increases in income.
In order to mitigate these impulses, you have to “pay yourself first” by allocating your first dollar of income to savings rather than your last. Figure out a dollar amount that you want to save, and set it aside before you budget your regular monthly expenses.
If your employer offers a 401k plan, this is easy enough to do. Your 401k contributions come out of your paycheck before you have a chance to spend them. Not including the value of employer matching, you can contribute $18,000 of your salary to a 401k plan in 2015.
That might be a tough hurdle to reach on a $50,000 salary. But even contributing $500 per month will get you to $6,000 per year, and most young workers can make do with $500 less per month.
How to Save: Make it Automatic
Very closely related to paying yourself first is making your savings as automated as possible.
Returning to the example of the 401k plan, this accomplishes both. Once you set your contribution limits, your company’s payroll department will take care of the rest. It’s automated, and you don’t have to think about it.
But what if your company doesn’t offer a 401k plan? Or what if you find yourself in that enviable position of maxing out your 401k plan and having additional sums to invest?
There are plenty of other ways to automate your savings process.
Often times, your payroll department will allow you to split your paycheck among two or more accounts. This will allow you to automatically divert whatever sum you can afford away from your primary checking account and into a savings or investment account.
You can also generally instruct your brokerage account or savings account to automatically draw from your checking account on a specified day every month. As a practical example, my kids’ 529 college savings plans automatically pull from my checking account on the first of every month.
The key here is automating the process so as to remove your discretion. If you have a real, bona fide emergency, you can always suspend the automated instructions.
Otherwise, you have made saving part of your monthly routine and made it a lot harder to fritter the money away on something frivolous.
How to Save: Take a Knife to Your Budget
Ok, I’ve given you mechanical recommendations on how to save. But let’s face it, it can be easier said than done when your monthly bills seem to get bigger every month. Here are a few concrete examples of how to save without crimping your lifestyle too badly.
First off, ditch cable TV. Most of the programming you watch is probably available for free over the airwaves or at a very modest cost with Hulu Plus or Netflix (NFLX) after a short delay. And the handful of shows not available probably aren’t worth the $100 per month or more you’ll pay in cable bills.
If you can’t live without Time Warner Inc’s (TWX) HBO, chances are good that one of your buddies has a subscription that you can borrow from time to time. The same goes for Walt Disney Co’s (DIS) ESPN. And if you don’t have a buddy, HBO GO will be available as a stand-alone streaming service next year. And for your ESPN fix, you can always stretch your legs and walk to closest sports bar. The exercise will do you some good.
Also, forgo a new car purchase as long as possible. If you take reasonably good care of your car, it will last you 150,000-200,000 miles. Not only will you save money on a car payment, but the older your car the less insurance coverage you will need. And when you finally do need to replace your wheels, buy a late-model used car rather than a new one.
I know, I know. There is nothing like that new car smell. But you have to balance the joy of owning a new car against the joys of retiring early with the compounded savings from going with a used car instead.
My last recommendation might be the hardest to implement, but I recommend you give it some real thought. Consider cutting your rent and utilities bills in half by having a roommate. Chances are, you did it in college. Why not share an apartment for a few more years?
The average apartment rent is more than $1,000 per month, and it is considerably more in the popular urban cities that attract young people. Cutting that bill in half will make reaching your savings goals a lot easier.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. As of this writing, did not hold a position in any of the aforementioned securities.
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