Save, save and save some more

Published 11:00 pm Wednesday, March 27, 2013

Whenever people discover that I’m an economist, the next thing to usually pop out of their mouths is the following: “Do you have any stock tips?” Few people understand that economics is a social science focused on all areas of human behavior. Moreover, if academic economists like myself were smart enough to know where the stock market was headed or what specific stocks to buy, I suspect they wouldn’t be academics for too long!

Since I have no crystal ball helping me predict the future, I punt on issues of where the market is headed or what specific stocks to buy. I instead try to turn the conversation into one of personal finance, and here are some of the most basic (and most important) ideas of personal finance:

Put more money away: Getting rich involves discipline and investing now for a far better future. If I were to save just $1 per day every day – $365 per year – for my infant daughter from now until she is age 65 (and I’m age 100!) and returns average 10 percent, she’ll have $2 million at age 65. Being rich is a choice and requires discipline, but it’ll never be easier than if a person starts saving now – to think my daughter could be a multi-millionaire for just $1 per day now doesn’t even seem like too much discipline!

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Since none of my readers are infants, we all need to save more than $1 per day. How much more? A good goal is to try saving 10 percent of one’s take-home income. This rate should be automatic, and done no matter what. And, it should be treated as savings independent of Social Security and any possible employer withdrawals for pension plans. (As a state employee, for example, my gross income is automatically knocked down 7.5 percent by the Retirement System of Alabama.) 10 percent is, perhaps, ambitious for a lot of people, so start smaller if needed.

Diversify: Stock selection is one of the least important things in a person’s success. Far more important is to build a diversified portfolio with low costs and exposure to many sectors. Diversified portfolios should include a lot of international and emerging market investments. The best mutual funds in the business are, perhaps, the index funds and other low-cost funds offered by Vanguard.

Don’t trade often: If my advice above about selecting low-cost mutual funds is not followed, people should at least do themselves the favor of not making the mistake of trading actively. Passive investors – people who buy and hold stocks for the long-run – outperform active investors who churn through their portfolios with high-frequency. In addition to eating up a lot of time, commissions eat into the returns of active traders.

Don’t time the market; just get invested: Many people talk about pulling out of the market and waiting for it to “cool off” before getting back in; others talk about pouring cash in when the market sells off. Market timers often miss out on really big days in the market, and they’ve been shown to experience lower returns than people who just stayed the course for the long-run. Market timers, of course, could have foreseen the 2008 crisis and left before the market meltdown. But, would they have had the foresight to get back in ahead of the recent bull run? Timing the market requires a knowledge none of us possess, so it’s almost always better to instead get the money working, compounding, and let your time be focused elsewhere.

Invest first; repay debt later (in most cases): Unless you’re carrying credit card debt with high interest rates, investing – especially in tax sheltered retirement accounts – is the better place to be putting your money relative to paying down student loan debt or mortgage debt (assuming, once more, you borrowed at low interest rates). The crucial factors in making the call are ultimately the interest rate on debt and your expected return in the market, but too many people focus on living debt free-regardless of the interest rates on the debt. They do so at the expense of getting their money to work sooner, which is one of the crucial conditions for happily ever after.

As I said at the beginning, the longer a person waits to invest, the harder the climb to prosperity will be. So, the time is now; it’ll never be better. Get saving!

Scott Beaulier is Director of the Manuel H. Johnson Center for Political Economy at Troy University