Reaching your goals doesn’t have to be about depressing denial. By deferring spending now, you’ll enjoy rewards you can look forward to for many years to come.
Stop for a moment and think about how much you have earned in your working life. It’s probably a fair chunk of money. What do you have to show for it?
Don’t despair if the answer is, not much. The problem may be nothing more than a lack of “future focus”.
Here’s the “eureka” moment you need – anything you are able to save now, you will be able to spend later. This means there will be something left to spend later, when you are no longer working and still playing. It’s about deferred spending rather than depressing denial. And you’ll enjoy rewards you look forward to more anyway. Delicious anticipation! But, as I always say, you need strong motivation to resist instant gratification. Shiny, yummy, consumer temptations come at us every day and if we are to walk blithely on by, most of us need a very good reason.
Before we get into that, it’s vital you realise the damage you could be doing with seemingly innocent spending. A dollar here, a fiver there … they’re called micropayments, but before you know it, they can add up to major spending. Indeed, these could be what’s breaking the bank – and derailing your future.
Previous generations had it right when they coined the phrase “take care of the pennies and the pounds will take care of themselves”. Today the average person can easily spend $1,200 on coffee a year, perhaps $700 on a snack to go with it, a possible $500 more on, say, impulse buys at the register and another $500 or so on movie rentals, song downloads, apps and games. That gives us a grand, scary total of nearly $3,000. But you probably have no concept of how much this is actually setting you back. Here’s what that money could do for you instead.
If you saved just the money you might spend on coffee – $100 a month – in an account earning six per cent interest (a long-term average), in 25 years you would have close to $70,000. Better still, only $30,000 will have come from you; the rest will be courtesy of the bank. But wait 10 years before you start and, to reach that same balance, you’ll need to save $240 a month – so you have to cut out far more than just coffee. You’ll have to scrounge $43,000 of your eventual $70,000 yourself. Delay another decade and you’ll need to find an eye-watering $1,000 a month to stash away $60,000 of your $70,000 cash.
This is your new best friend, compounding – the sheer magic of earning interest on interest – in action. It means the sooner you start squirrelling away money, even small amounts, the easier it is to amass a lot! Also, it means you will need to rely less on big returns and the extra risks they demand.
While micropayments are doing nothing but holding you back, micro-deposits significantly advance your progress towards your hopes and dreams. So in the immortal words of the Spice Girls, tell me what you want, what you really, really want. You’ll need very clear short, medium and long-term goals to overcome the temptation to simply spend what you earn when you earn it.
And whatever the timeframe, repaying debt puts you in the realm of financial geniuses. When you’re in the red and paying interest, compounding is working against you. Ditching debt gives you a risk-free, tax-free effective return equal to your interest rate (more about that in a moment).
Here are some ideas to get your big life goals underway:
In the short term:
Think fun! A holiday in Thailand next year … or a more expensive, longer sojourn the following year. A new couch. Maybe even a new kitchen. These are the sorts of goals you should focus on in this period – the relatively instant pay-offs. These are beautiful money targets, because they make you feel like you are really achieving something. (Whatever you do, never use credit for something experiential, for which you’ll have nothing to show afterwards but photos.) Also, cast your mind towards the future: pay off a credit card without forking out a fortune in interest, or clear that car loan years early.
In the medium term:
In this period your car might need replacing. Plan this far ahead and – rather than automatically borrowing for what is one of the worst investments – you could pay cash. Put aside $140 a fortnight and in five years with a top savings account, you’ll have $20,000 to buy a car. The alternative is buying a car up-front, then paying about $27,000 including interest for it over five years, or $205 a fortnight. In this timeframe you might also like a new kitchen. Same deal.
In the longer term:
The ultimate goal for all of us should be to retire with no personal, or non-investment, debt. The other holy grail of retirement is a big-enough asset base – super, a separate share portfolio or property for example – to generate an income adequate to replace your salary (or the recommended two-thirds of it).
Let’s talk a little more about your potential debt freedom. Make this a priority and you will be laughing all the way to the bank (or usually the far cheaper home lender, the non-bank).
If you have the average $350,000 mortgage debt at a five per cent interest rate and stick to the banks’ 25-year repayment schedule, interest means you’ll fork out an extra $264,000. But if you can manage to throw just $100 more a month at your mortgage, you will save more than $26,000 and clear your debt three years early. If you are able to repay an additional $500 a month, the savings leap to $93,000 and nine years.
It’s also possible to make these same savings free. Those non-bank lenders I mentioned earlier typically offer mortgage interest rates at least one percentage point cheaper than the big guys. By simply switching your loan to them and keeping your repayments the same, you slash your interest bill twice: through under-cutting and over-paying.
All of a sudden, you’re putting in nearly $200 more a month and it’s not costing you a cent above what you’re used to paying. This pain-free strategy slashes your interest bill by almost $100,000 and brings your debt-freedom date forward by five years. You can find your own potential time and money savings on my free Mortgage Freedom Date calculator here.
Beyond all these savings, when your mortgage is repaid you will also have possibly $2,000 extra each and every month with which to achieve everything else that you want.
“Hang on,” I hear you say. “Isn’t super supposed to be taking care of my retirement for me?”
It’s crucial you realise that mandatory 9.5 per cent super contributions are unlikely to sustain you for the whole of your sunset years. The industry body that calculates these things, the Association of Superannuation Funds of Australia (ASFA), says a couple needs an annual income of $59,000 to fund a “comfortable” retirement. Comfortable is defined as including some leisure and recreational activities, occasional clothes and other shopping, private health insurance and a bit of travel. It’s far from lavish. ASFA also assumes in its calculations that you own your own home.
Debate is raging about what kind of super stockpile you need to generate this kind of money. A million dollars is a figure often bandied about, although some pundits are disputing whether this is enough at current rock-bottom rates. Certainly, you’d need an annual investment return of six per cent for $1 million to yield the ASFA income estimate. But that assumes you never touch your fund itself and simply live off the income, so in reality you could get by with far less.
My advice is to be alert but not alarmed – and simply target your biggest possible balance. There’s a great calculator by the regulator that lets you project your super balance and the huge benefit of additional before and after-tax contributions. Again, it’s all about compounding, so start early. And watch like a hawk that your fund’s returns are high and its fees low. You want to make this as easy as possible on yourself.
Now you’re in the know, be sure to include repaying your mortgage and building a nice little nest egg in the list of your personal money goals (right). Write beside each one the date you’d like to achieve it. Then put an estimate of what the goal will cost and how many pays until your target date (so if the target date is five years away and you are paid fortnightly, multiply five x 26). The moment of reckoning is to divide the cost by this number of pays to find the amount to put aside from each one.