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Resolve to Save Money

One item that will be — or should be — on most peoples' lists of New Year's Resolutions is: save more money. It may be worded in other ways, like "get out of debt" or "pay off my credit cards" or "live within my means", but the idea is widespread. This is why:

Debt Service Payments as % of Disposable Income

That graph has changed quite a bit since the last time I used it. I don't know what's responsible for the differences. Did economagic change the way they're calculating this, or change which series they're using for the underlying data? If you know what happened, I'd very much like to hear.

Using economagic's 09/2003 figures for consumer credit and population, the average amount of non-mortgage debt per person in the United States is $6745.40. Debt is easy and popular to get into, but it's also extremely expensive.

I have a very old-fashioned attitude toward purchasing: If I can't pay for something with money I've already saved, I don't buy it. It's only reasonable to take out a loan for extremely large purchases like a home or car.

I experienced something of a culture shock when I was shopping online for a new laptop a few months ago. When I was customizing components, the price differences were given in full dollar amounts and also by how much they would affect the monthly payment. Monthly payment!? For a computer? Who would pay for a computer on an installment plan? I guess most people don't think that's weird. They must not understand how expensive credit really is.

Let's say you have a $5000 credit card balance at 10%, but your budget is very tight so you only pay the minimum. Unfortunately, little surprises pop up once in a while and you don't have any savings, so you have to put those on the credit card. You're not making any progress paying off the balance, but at least you're not sliding further into debt. If this situation persists for 10 years, you'll have paid $5000 just in interest. At the end of the decade you'll be financially exactly where you started: $5000 in debt with no savings!

If you had $5000 in savings to begin with, you could have paid off your credit card balance immediately. The payments you would have made toward your credit card bill go instead toward replenishing your savings. At the end of the decade you'd have no debt and $5000 in savings. You started with a $5000 debt and $5000 in savings, so you've improved your situation by $5000 over the decade.

The difference between these scenarios is the existence of prior savings. Yes, building up savings means deferring consumption. You must be willing to buy things only when you can truly afford them, instead of as soon as you desire them. It means having a lower standard of living for a while. But in the long run, a commitment to building up savings is one of the best financial attitudes you can have. It's the difference between earning interest and paying interest throughout your life.

When I graduated from college, I lived very cheaply. I didn't even consider buying a new car — my existing one was almost 10 years old, and bought used, but it was still running fine and the insurance was cheap. I didn't buy a new computer, I just kept the one I had in college. I stayed in a relatively cheap apartment. I didn't get a cell phone or subscribe to cable or satellite TV. I rented some low-quality furniture. I went on few vacations and they never cost more than $500. I lived well below my means and built up savings. I did not contribute to any retirement plans because I needed to save cash I could actually use.

Eventually, my landlord decided to raise my rent. I didn't like that idea at all, and responded by moving out and buying a house. This move was only possible because I had made the deliberate decision to live far below my means to save as much money as possible. I had barely enough to cover the down payment and buy furniture, but I was able to do it without carrying a credit card balance.

With the home purchase behind me, I've relaxed my spending somewhat and improved my standard of living, but I'm still saving a lot. What for? I plan to buy a new car in the next year or so, and to start a family within the next several years. Cars and kids are expensive. I plan to afford these things out of savings instead of on credit.

While I'm on the subject of savings, I have to criticize government-sponsored retirement savings plans like IRAs and 401ks. They're very badly structured. The low contribution limits encourage people to save for their retirement steadily during their lives, instead of concentrating retirement savings during the years immediately prior to retirement. That's wrong, it's not how people would choose to save in the absence of government meddling.

People would prefer to save for a house when they're young, save for their children's education as they get older, and save for retirement after their children have become independent. People would naturally save throughout their lives, but the goal of that savings would change over time. By encouraging retirement savings during periods when people would ordinarily save for other purposes, that money and the investment earnings it generates are unavailable for those other purposes. This makes people more likely to go into debt while they're younger to pay for them. It's ridiculous to be in debt and pay interest when you have substantial (retirement) savings — but that's what the government encourages.

Tiny Island