A while back, I wrote a well-received post on why it is so important to leverage the power of compound investment returns on your savings.
Here’s what I calculated, to make the case:
“$1 saved in your twenties can be the equivalent of $10 saved in your fifties, if invested over time.
$10.06 to be exact – at an average annual rate of return of 8% on your investments over 30 years. Even if you factor in 2% annual inflation, you’d have 556% of the buying power for every dollar you save today.
Alternatively, if not invested, every dollar you stick under your mattress will still only be worth a dollar (and just $0.55 in buying power).”
At the time, I thought “DAMN!”. I knew compounding was important, but the strength of those numbers surprised even me a little. And if they don’t inspire you to also save as much as you can as early as you can, then I give up.
Unfortunately, on a broader scale, benefiting from compound returns is not happening.
And not only is it not happening, but the opposite is happening. The millennial personal savings rate is -2%. This means that many millennials are not only not saving money, but that they’re actually increasing their interest-bearing debt.
Whereas compound investment returns REALLY work to your benefit, the opposite is true of debt – it REALLY works against you. If it is revolving and you don’t pay it in full, it will compound against you. And with massive McMansion mortgage, $100K English degree, shopping spree credit card, and all-wheel drive loan debt working against you, it’s very possible that you could dig yourself a hole you might never crawl out of, if you’re not careful.
Americans will pay an average of $279,002 in interest payments over their lifetime. To emphasize, that’s not debt payments, that just the interest on top of the debt. The debt number would be much larger. In some states with higher housing costs (i.e. California, D.C., New York) total lifetime interest payments are well north of $300k.
With a median personal income of $31,099, that’s an average of 8.97 full working years just paying off interest on debt. Imagine that, 8.97 of the best years of your life going directly to a bank for the “privilege” of owing them money. And then there’s the lifetime of paying off debt as well.
While, it is true, that debt itself doesn’t compound (unless you are late in payment), every dollar devoted to paying off debt is one less dollar saved that can be leveraged for compounded savings returns. So, even if you keep your interest payments extremely low and pay your debt in full every single month, you’re still robbing your future self.
Here are a few examples on what you’re missing out on, in compound returns (at an 8% annual return):
- The lifetime cost of cable is $2,081,549
- The lifetime cost of a smartphone plan is $4,844,418
- And the lifetime cost of paying for something as trivial as someone temporarily decreasing the length of your hair (aka “a haircut”) is $1,638,314.
Even at a conservative 6% return, it looks like this:
- cable: $1,102,950
- smartphone plan: $2,409,402
- haircuts: $650,731
Just a few examples, but you (should) get the point. Imagine the numbers when you’re talking about the cost of vehicle and home upgrades, versus comfortable necessities. Coming to realizations like this is why:
- I have a basic cable package and lower my bill through negotiation every 6 months (and separately replaced my Comcast modem with my own, saving me an added $13 per month and bought an Ooma for VOIP for $0/month).
- It’s why I’ve opted for a cheap MVNO prepaid plan instead of a monthly contracted plan.
- And it’s why I bought an electric trimmer so that I can cut my own hair for decades for the same cost as 1-2 hair “de-lengthenings”.
- Among hundreds/thousands of other actions I’ve taken.
Everyone has to spend money. But when you do, remember the following:
- Make it count. Ask yourself if this expense is truly worth the present cost. Is it going to make you happier or at least add significant functional value?
- Remember, it’s not just present cost, but also future value.
- If you are going to limit your savings, avoid debt at all costs.
You may not thank yourself today (and you’re probably cussing at me for ruining your day), but you’ll definitely thank yourself later.
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Excellent post GE. I always like to keep my money invested even in my emergency fund account. Compounding can be so powerful and I know my frugalness and eagerness to invest will help me to become more comfortable in life. Thanks for the refresher. Great post.
A negative savings rate. That’s not even a plausible way to live my life. Power of attraction, for the win.
Interesting take. I’ve read similar advice about considering the ‘true cost’ of an item every time you purchase something with a credit card & you don’t intend to pay off the full balance. (Meaning you add in the cost of interest over the months/years to see if you thing that price tag is worth it.)
I also like your positioning – lost savings. It kind of creates a double-whammy for people concerned about saving for retirement to be frugal and spending-sensitive in the present moment.
What I want to know is where the hell are people getting 8% average yearly on their money!?!?! Those kind of rates haven’t been seen for years.
S&P 500 was 13% last year, 32% the previous. Since 08 it’s up 7.75% per year. Don’t let your feelings shield you from the facts.
Also, mortgage interest isn’t just pissing money away like the article seems to say. It serves a purpose because you get an asset that provides a function. Just buy the right amount of house.
That should’ve said INCLUDING 2008
Is this a troll comment? The market is up 154% in the last 6 years and 330% over the last 20 years (and that includes the two huge crashes). That is simply if you had purchased an S&P500 index fund.
That was no troll. 8% annual is aggressive over any long-term span of the US stock market. And that assumes all your chips are invested in it at all times, which should make anyone cringe.
And then, let’s factor in the possibility that you may not survive to enjoy the fruits of your sacrifices… nobody likes that notion.
How about NO cable. I live close enough to a major metropolitan area that antenna TV works just fine for me. Basic cable package didn’t offer anything that I wanted to watch that I couldn’t get over the air.
While I agree with the sentiment, you also have to take into account a person’s utility curve. Not everyone looks good with a buzz or a “high & tight” ;)
Hot Damn that is a lot of interest for the average person to pay ($279K).
This is exactly why I have planned to pay my 30 year mortgage off in 7 years. I did the math and over the course of 30 years I would pay almost $230K in interest if I kept the loan to term. And that is assuming rates stay the same, if you consider that I have a 5/5 adjustable rate mortgage than that interest expense could climb to as much as $445K if it were to reset to the max every 5 year adjustment period.
Instead of 7 years we will only pay $62K in interest. And if we meet our stretch goal of 5 years it will be even less.
I would much rather earn interest than pay it.
Cheers!
GE, how do you feel about paying off mortgages early? I hate the idea of debt, but with my mortgage about to refinance to 3.6% I can’t imagine I would be coming out ahead by taking money I could be putting into an index fund and paying down my house ….
Not to mention, if push came to shove (ie, my e fund was gone) I could take money out of my investments. A house? Not so much.
With interest rates this low, it’s not a bad strategy to keep funds invested versus paying off your house.
A lot of people buy too much house, and lesser house could result in more savings being invested and less debt/interest payments. I think that’s a more important question.
The Millennial Personal Savings Rate of -2% quoted in this article, is the ‘best’ savings rate of any generation in post WW2 American history. It is absolutely normal and expected that one increases debt when in their ‘growth’ phase in life (i.e. buying real assets, like a home). That is the true purpose/function of debt – to fund your personal gap between asset/net worth growth and income.
This article, like so many in the personal finance blogs space, assumes all debt is created equal and that all people are using debt to purchase “upgrades” versus “comfortable necessities”. A millennial, purchasing their first home, their first car, etc. is in their growth phase of their life and would be wise to accumulate assets and net worth with today’s cheap money at ridiculously low interest rates. Money is one of the cheapest things you can buy today (comparatively to other ‘things’ and historically to the cost of money in the past) and to not take advantage of that will really set you back in later life as your peers will far outgrow you in wealth when inflation returns. There’s a reason why so many older people living in high cost areas say they could not afford today’s homes but are glad they bought when they did. To not grasp this point – is missing the point.
The author’s point about paying for a cheaper version of a smartphone or a tv are valid – and they will get you slightly ahead but the key is to focus on the big issues of today – the abundance of cheap money and the HUGE opportunity cost of NOT acting on this money and the impact this has on your potential net worth in the future. If the opportunity cost passes you by, you will be stuck in a frugal lifestyle complaining about how expensive everything is and remembering the good old days of when you probably could have afforded a home but never acted because you were brainwashed into thinking all debt is bad and giving my money to a bank to lend out (i.e. savings account) was sound financial advice from the 20somethingfinance blogs of the time…
G.E. Miller in this article does a pretty good job of highlighting the importance of opportunity costs by using examples of himself saving money (i.e. cable, phone) – let’s hope he uses those savings in combination with CHEAP debt to accumulate assets and grow his net worth in order to achieve financial independence.
“The Millennial Personal Savings Rate of -2% quoted in this article, is the ‘best’ savings rate of any generation in post WW2 American history.”
– Do you have a link to this research? I’d love to check it out.
I don’t agree with your general “debt is good” sentiment for a number of reasons. Other than real estate, most asset purchases that result in debt depreciate with time. It’s a quick way to the poor house.
As far as real estate (that you live in) goes, it’s proven to be a horrible investment over time compared to stocks/bonds: https://20somethingfinance.com/a-home-is-not-an-investment/
Inflation adjusted housing prices are just 1.35X what they were (in 2013 dollars) in 1890. That means only 35% growth above inflation in 125 years (or 0.28% average growth per year)! And growth exceeding inflation has been approximately 0% over the last 60 years. And that does not include all of the costs that go in to owning and maintaining a home.
So… go out and buy more home – for what? Miniscule returns over investment? It’s akin to recommending buying gold. The market is a much better investment, and saving so that you can invest more is what I am advocating in this article.
Now, you could make the case for leveraging debt to become a landlord many times over – and I would agree with you. However, very few readers have the kind of assets and credit available to them to make this a legit strategy.
For most, avoiding paying interest on debt, vehicles, too much home, and too much education – and using the savings for long-term investing, is a better strategy to start with, in my opinion.
What you fail to observe here is the RISK that is taken on when leveraging in this way. Yes, purchasing assets that appreciate (i.e. real estate) can be an important component of your net worth. But really, buying a $200k house does not increase your net worth by $200k. The BANK owns the vast majority of the house. You only own what you’ve paid down. If crisis happens, you lose. I’m certainly in favor of home ownership. I’m certainly in favor of owning a car. But this assumption that you must leverage as much debt as possible in order to do that is just bogus. Do you need to buy a 25k car? No. Buying an 8k car cash will do just fine. SAVING (in the right places of course) is what makes people rich over time far more than leverage.