Welcome to our beginner investor education program. This is the first of a six-part seires.
Lost amid all the chatter about the stock market is a simple truth that many newbie investors fail to grasp: If you want to retire rich, you have to save. In other words, you have to spend less than you make.
Too many investors get it backwards. They think they can take a small pile of money and build it into a fortune by picking the right stocks and cashing out for a big profit. Sure, it can be done; you could also win the lottery or hit the jackpot on the slots.
Learn more about investing from John Heinzl The 2010 Investor Education series for beginner investors:
The 2010 Investor Education series for advanced investors:
Gail Bebee's weekly mentoring for our investor education contest winner:
The truth - and this is one of the most powerful weapons you have as an investor - is that you have to set aside money on a regular basis to invest. The earlier you start, and the more you set aside, the better off you'll be in the long run. For a look at why saving is the key to building wealth, read this eye-opening blog post.
And check out the saving tips at the Investor Education Fund Learning Centre.
In business terminology, you need to build capital (savings) in order to make a return on your money (capital gains, dividends and interest).
Spending less than you make may sound simple, but for people who are seduced by easy credit and who face costs for home mortgages and raising kids, socking away money every month can be a challenge. We all know people who do the reverse: Instead of saving, they draw more on their credit line every month. That's not a way to get rich; it's a way to go broke.
So, how can you find the money to save?
One strategy is budgeting: Figure out how much you plan to spend every month on groceries, clothing, entertainment, housing and other expenses, and do your best to stick to it. Only problem is, many people find it hard to stay within a budget and eventually give up.
This website has six secrets to create a budget you can stick with.
For people who don't like budgeting (that would be me), there's another solution: Track your expenses - right down to the penny.
You can use a software program such as Microsoft Money or Quicken, but we've found that a simple notebook carried around in a shirt pocket works just as well (and it's cheaper!). Whenever you buy something - a coffee and a muffin, a new sweater, an LCD television - jot down the cost.
At the end of the month, tally up all your purchases. Many people have no idea where their money goes, and this is one sure way to find out. The results may surprise you. If you find that one category of expenses is chewing through more money than you had realized, you can cut back.
If carrying around a notebook seems too onerous, you can also track your spending through bank and credit card statements. Even if you track your expenses for a few months, you'll have a much better idea where your money goes.
Once you've figured out how much you're spending, subtract this amount from your total after-tax income, and that's your annual savings. If the number seems small, there are only two ways to make it larger: You have to earn more, or you have to cut back on spending.
Need some motivation? There's a classic book called Your Money or Your Life , which is full of terrific advice about earning, spending and saving. We highly recommend it, and suggest you start your money-saving journey by ordering it from the library instead of buying it. (Then again, this is one book you may want to have on your shelf for inspiration.)
Once you know how much you're saving every month, you can start projecting into the future. This is the fun part, and it's easy to do with online savings calculators. We'll use the one at moneychimp.com.
Say you're 45 years old and you're managing to sock away $200 every month. If you expect to make 5 per cent on your money annually, by the time you turn 65 you'll have $83,326.
Now, let's look at what would happen if you'd started saving earlier, at 35, and managed to sock away $400 monthly. You'd end up with $334,852.
You can see how important it is to start early and maximize your savings. We've deliberately used a conservative growth number; in the past the stock market has delivered returns closer to 8 per cent.
So when planning your financial future, don't put the cart before the horse: You have to save first, and then invest, not the other way around. And the earlier you get going and the more you save every month, the better off you'll be in the long run.