The Best Way to Save Money and Build Wealth

My worried clients had needs for the future, but no idea how to get there. I looked them in the eye and told them how they’d get to where they wanted – through a sound discipline of saving money automatically, year after year, religiously.

We set up monthly direct transfers from their bank account to investments, occurring right after they got paid every month. Their paycheck went into a completely separate bank from the one used to pay bills. This assured that the old concept of “pay yourself first” happened.

We also tackled debt with the same relentless system. They are very thankful.

Unfortunately, a lot of people don’t adopt such a strict approach. And that’s to their detriment. Most folks want the result, but don’t know what is involved to attain it.

A few years ago, the television show that captivated Americans was called “Who Wants to Be a Millionaire?” Later, the Indian film Slumdog Millionaire, based on the same show, was an international hit. So the desire to be wealthy clearly has a broad global appeal. But how do you gain wealth? It’s not buying the correct lotto ticket. People often overlook a simple secret to building wealth: the time value of money.

Disciplined saving and investing is the key. Oftentimes that lesson is lost in a consumption-based society that is always seeking the next hot thing, regardless of cost or value. To many people, saving feels like a subtle punishment as though one is “losing” money that could be spent. Really saving is like building an ever-growing gift for yourself.

Ellen Rogin and Lisa Kueng, authors of a recently published book entitled Picture Your Prosperity: Smart Money Moves to Turn Your Vision into Reality. They cite a perceptual difference. Ask people if they can save 20% of their income, the answer may be a resounding “no” – but ask if they can live on 80% of their income, and that may seem reasonable.

Saving money should make everyone feel great. It means effectively “paying yourself” or at least building up cash on hand. A household with a save-first financial approach may find itself making progress toward near-term and long-term money goals.

Chung Sung-Jun/Getty Images

Chung Sung-Jun/Getty Images

So why do some households save more than others? Building household savings may depend not only on cash flow, but also on psychology. With the right outlook, saving becomes a commitment. With a less positive outlook, it becomes a task – and as we recall from our youth, tasks and chores are almost always postponed.

Rogen and Kueng point to a truth that’s been around since the dawn of time, but has only recently received academic study. That is the divergence between expectations and behavior. Since 2001, Gallup has asked Americans a poll question: “Thinking about money for a moment, are you the type of person who more enjoys spending money or more enjoys saving money?”

While more respondents have chosen saving over spending in every year the poll has been conducted, the difference in the responses never exceeded 5 percentage points from 2001-06. It hit 9 points in 2009, and has been 18 points or greater ever since. In 2014, 62% of respondents indicated they preferred to save instead of spend, with only 34% of respondents preferring spending.

So are Americans a nation of good savers? Not to the degree that these poll results might suggest. The most recently available Commerce Department data (January 2015) shows the average personal savings rate at 5.5% – a percentage point higher than two years ago, but subpar historically. During the 1970s, the personal savings rate averaged 11.8%; in the 1990s, it averaged 6.7%.

Economists know full well that a dollar received today is worth more than a dollar received a year from now. Why? Because that dollar could be invested, saved or spent to purchase an asset such as real estate that will appreciate in value. What’s more, inflation slowly but steadily erodes the purchasing power of your money, rendering tomorrow’s dollar less valuable than today’s.

The relationship between time and money provides the foundation for virtually every financial decision you will make. Whether you are saving money for a future event or considering a loan to pay for a current financial need, you will be greatly affected by the time value of money. The following are some tips for making the most of your dollars, today and tomorrow.

That $30,000 luxury car you’ve had your eye on will cost you a whopping $67,872 just two decades from now.

The cost of some financial objectives will grow even faster than this. College costs, for example, have increased by some 9% over five years on average for private institutions, 12% for public. Planning for such cost increases will ensure that your asset accumulation level is sufficient to meet your objectives.

What’s the best time to start preparing for a sound financial future? Twenty years ago, goes the old joke. Failing that, the second-best time is today.

Ways to save more? Automated retirement plan contributions or payroll withdrawals into an investment account can assist the growth of savings, and are a means of paying oneself first.

There is the envelope system, where a household divides its paycheck into figurative (or literal) envelopes, assigning X dollars per month to different packets representing different budget categories. When the envelopes are empty, you can spend no more. The psychology is never to empty the envelopes, of course – leaving a little aside each month that can be saved.

Households take an incremental approach: They start by saving one or two cents of every dollar they make, then gradually increase that percentage, household expenses permitting.

Frugality may help as well. A decision to live on 70% or 80% of household income frees up some dollars for saving. Another route to building a nest egg is to invest (or at least save) the accumulated consumer savings you realize at the mall, the supermarket, the recycling center – even pocket change amassed over time.

How many households budget like businesses? Perhaps more should. A business owner, manager or executive may realize savings through this approach. Take it line item by line item: spending $20 less each week at the supermarket translates to $1,040 saved annually.

Working with financial professionals may encourage greater savings. A study on workplace retirement plan participation from Natixis Global Asset Management had a couple of details affirming this. While employees who chose to go without input from a financial professional contributed an average of 7.8% of their incomes to their retirement plan accounts, employees who sought such input contributed an average of 9.5%.

The study also found that 74% of the employees who had turned to financial professionals understood how much money their accounts needed to amass for retirement, compared to 54% of employees not seeking such help.

Follow AdviceIQ on Twitter at @adviceiq.

Walid L. Petiri, AAMS, RFC, is chief strategist at Financial Management Strategies LLC in Baltimore.

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