Finding the $
Finding that investable cash

We’ve all heard it before: forgo that daily Starbucks latte or give up those desserts (which has the additional benefit of helping the waistline....but I digress.....).  There are numerous ideas on the internet & elsewhere describing how to budget & save money.  I've only found one technique that has truly worked for me over time to find that sometimes elusive investment money - I pay myself first.

But before I get into this methodology I want to discuss credit card debt.  What does that have to do with saving money, you ask?!  Everything, it turns out.

The credit card industry is a gimongously profitable business.  According to various sources (including a 2010 Federal Reserve Bank of Boston study - search for it, and others, this information is all out there), there are over 600 million credit cards held by US consumers.  Average credit card debt per household is in excess of $14,000.  This amount, no doubt, fluctuates over time.  I would venture to guess that average balances go up during the good times, when people consume more, and down in the dire times when people are concerned about the economy, their job stability, etc.  However, one could easily take the opposite position and believe credit card balances increase during bad economic times because people need the credit in order to pay bills and make ends meet.  Whether the former hypothesis is correct or the latter is doesn't matter - what matters is you should never, ever carry a balance on your credit card.  Why?  Simple mathematics.

The average APR on credit cards is over 14%.  Many cards charge far in excess of this amount.  This is extremely expensive money when one considers the cost of money to banks is currently close to 0%.  They charge this spread because they can.  No other explanation.  But rather than rail against these credit card companies your take-away here should be two-fold:

  1. If the cost of this money is so expensive, I should prioritize paying off my balance....and keeping the balance at 0 every month (i.e., pay it off every month)
  2. If they charge so much they are most likely very profitable.  Therefore, perhaps I should investigate investing in Mastercard, Visa and/or American Express?  This is an important mind-set change that I encourage you to develop over time.  One person's cost is likely to be another's profitable venture.

But back to my point - the cost of borrowing money from your credit card company is greater than the average returns from the stock market over the last 30-40 years.  Warren Buffett, perhaps the greatest investor in our lifetime has achieved 19.7% average annual returns in Berkshire Hathaway, his main investment vehicle, from 1965 to 2012.  The average annual return from the S&P 500 index (which includes the 500 largest publically-traded stocks in the US), including their dividends, was 9.4% over this time period.  Your takeaways?

  • If the cost of credit card debt is higher than the average stock market returns, then this is a bad trade.
  • Unless, of course, you're Warren Buffett - then you can capture a 4-6% spread by borrowing expensive credit card debt and investing this in the stock market!  Woo-hoo - road to riches, right?!  Well, no, as neither you nor I are anywhere close to Uncle Warren in investing prowess.  I can turn this bullet-point into a positive, however.  Every year, Buffett publishes a letter to his shareholders.  I encourage you to read it to learn from the master himself what are his views on the current investment environment and to see what he has his money invested in.   

So, final message to those currently carrying credit card debt.  Please stop reading here...especially the next section because your priority at this stage must be to eliminate your extremely expensive borrowing.  For your own good.

Paying yourself first

Hopefully we should be left with only readers having no credit card debt.  Good.  But the readers will, no doubt, have a wide spectrum of monthly incomes to start with.  This is fine since the methodology I present works, over time, with as little as $25 per month.  Obviously the more you can invest, the larger sums you will have in the future....but the key is to start with as much as you can as early as you can.

So, what does paying yourself first mean?  It means transferring money from, say, a monthly paycheck or an annual bonus or tip jar money to new bank account immediately upon receiving it.  The ‘immediate’ is needed so you don’t spend it.  And the separate bank account is needed to you ‘forget’ you have it.  This new bank account will be the funding vehicle for your regular investing. 

I’ve done this for over 10 years (oh how I wished I had learned about this much, much earlier in my life…) and found it an effective way to ‘trick’ myself into having monthly investable monies that I am not tempted to spend.  I have a certain portion of my salary automatically transfer out of my main bank account to my investing vehicle.  As we will learn later, this investing vehicle will, in turn, fund your stock purchases.  But for now it is sufficient to understand this money needs to ‘disappear’ from your regular bank account before you start paying your monthly bills, rent, etc.  In effect, it forces you to save money as you never see it in the bank account that you use for that thing called life. 

Again, I want to emphasize that the amount in which you start ‘paying yourself’ isn’t nearly as important as starting….now….  Don’t believe me?  Click here for a powerful demonstration on why & how.

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