I once saw a billboard that said something very simple. So simple in fact that it appeared virtually impossible. The billboard said, “Pay Yourself First.” The sign was an ad for a bank yet it gave me an important lesson.
Their statement meant that I was allowed to keep some of my hard earned money. Paying me first was an idea I could live with. I had been given permission to save.
Paying yourself first is easy. Simply designate a small amount of money to begin saving. The amount must be small; try five dollars each paycheck. Anyone can find five dollars a week in their spending to divert to saving; skip one beer at the gay bar. The object is to create a habit. The object is not to build wealth, yet. You only need to save the same amount twenty-one times and you will be on your way. Once your saving habit is established you can rapidly add to the initial amount and include any raises and unexpected income that comes your way.
There are three types of savings and you need a separate account for each. For simplicity I term them operating savings, emergency savings and capital savings. Be certain to understand the difference, it’s crucial to your long term financial success.
Operating savings is money you put away on a regular basis that you intend to use for normal or unusual expenses such as a gay cruise, college, furniture, a car. Operating savings are built though disciplined, regular planned contributions to your savings account. Operating savings are spent for things that you have defined.
Emergency savings is money set aside for an unexpected repair, accident, illness or job loss. A good rule of thumb for the total amount necessary is three months of usual expenses. Not including the latest gay fashions! Once this savings level is achieved no more emergency saving is required, unless you consume some of it.
Capital savings is the most fun because capital savings grow and grow. Like operating savings, capital savings are funded regularly from each paycheck. The difference between operating and emergency savings and capital savings is that you never spend capital savings. Did I say never? If there is any confusion here let me repeat, capital savings is never spent. Never.
So what’s the purpose of capital savings? Capital savings is for the creation of wealth. The money is never used for everyday expenses that you failed to plan for, nor is it used for emergencies. Capital savings is only used to generate income.
Too many people work all their lives and retire dependant on Social Security. Even if you forget all the hype about Social Security going broke in the future, today Social Security benefits do not provide a high level of security. The benefits might keep a roof over you head, or food on the table, but not much else.
That’s the job of your capital savings: to grow throughout your lifetime and provide you income when you chose to no longer work or are unable to work. So the rules are clear, right? Capital savings is never spent. Capital savings is used to earn, not spend.
A house may be purchased using capital savings, or buying stocks and other investments. When you invest in a house, even with a mortgage, you are investing in an asset. In most markets, over most time frames a house is an appreciating asset, appreciating on average at the rate of inflation. You can use your capital savings for the down payment on your house, or better yet for the outright purchase of your house.
Capital savings will grow and grow and are never ever spent. Never.