The Principles Of Saving Money

Principles of Saving Money

Have you ever wondered why there are people who were born into a well-to-do family, got the best education on Earth and given the best tools to achieve anything he/she wants, yet end up broke? Meanwhile, there are people who were born into a poor family who can barely afford food, let alone anything else, yet able to later soar into financial greatness?

Have you also wondered why studies found that lotto winners – or anyone who wins during a gamble – lose all their money and become financially worse then before they won the money, 5 years after their win?

The reason, I think, is one group of these people understand the principles of saving money, while the other group doesn’t. What are the principles of saving money?

Opportunity Cost

The first principle is called “opportunity costs”. Opportunity cost is the cost of what you missed out on if you take a particular path. Let’s use an example.

Let’s say you decide to buy a car that costs you $10,000. What could you have achieved with that $10,000 if you didn’t buy a car? You could have put it in a savings account and conservatively earn 6% p.a. on it. So the true cost of owning that car is actually $10,000 plus the amount of interest lost to you.

If buying a car saves you transportation cost, how does that saving compare to the interest you could have earned? By looking into opportunity costs, you’re looking into the real cost of the decisions you make.

Sunk Cost

The second principle is called “sunk cost”. A sunk cost is a cost that you can no longer recover. Unfortunately, most people based their decisions on sunk cost instead of what is best for the future.

For example, if you invested $2000 into a company stock and that stock dropped to $1500 in the next month, should you sell your stocks and lose $500 or should you hold it? Most people took that lost $500 into account when making that kind of decision and decided to stay because they don’t want to lose that $500.

What should be done instead, is to consider the future of the stock without taking the lost $500 into account. That $500 is what economists call an irrecoverable “sunk cost”. Your financial decisions must always be made in regards to what’s best for the future, and not based on what happened in the past.

Consistency

Have you ever made a new year resolution, only to break it 10 days into the new year?

People tend to get all excited when they make a budget, but never seem to stick to it because they don’t understand that consistency is crucial to a successful financial plan. Instead of a high yield, quick hit, like “flipping” a stock, go for a more stable investment like property.

Studies have shown that if you invested in stocks for a year and pulled out, on average, you’d have lost money. But if you’ve invested for 10 years, on average, you’d have made money.

But this kind of approach is rare in the market. Financial planners and consumers alike try to “time” the market, buying when the market dropped and hope that the market would rise again right after the purchase. The plan is to then sell it and make the difference.

You may be able to get lucky once in a while but history shows people who take part in such risky investment techniques tend to fail. Warren Buffett, arguably the most successful investor alive, for example, is famous for investing in the long term. Some of the companies in his portfolio he has held for more than 30 years!

The same principle applies to saving money. Do not assume you’re going to give up coffee, movies, snacks, concerts, etc, just to save money! These kind of decisions are usually made in the excitement of a new years but are never stuck to for more than 10 days because they are unsustainable.

Instead, budget for activities that you find fun. Save a little less each month, but at least you’ll be consistent about it. Instead of your original goal of buying a house in 5 years (but you probably can never stick to), you now will buy a house in 7 years (but you probably can reach it).

Automation

Every time you make a decision of whether of save or not, there’s a risk you won’t stick to your budget – and therefore detract you from you goal. A better approach would be to automate your savings so you can be 100% sure that you’re always moving towards your goal.

No more agonizing decisions whether or not to save money.

Ubank, for example, has an “automatic contributions” option you can set. Make sure you do not automate too big a proportion of your income to go into savings. Remember, consistency is key. If you often have to go in and withdraw your savings, it will soon become a habit and drawing from your savings account become “no big deal”.

Compounding

As you automate your savings and your consistently let it add up, another principle of saving money kicks in: compounding interest. Did you know that when the British first landed on America they bought Manhattan from the natives?

If the natives took that money and saved it for 10% interest – and let that interest compound – they could have bought the whole Manhattan back from the Americans today. And that’s before the property crash of 2008. When you save your money, automate compounding interest, something most savings account have.

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3. Famous Money Quotes – What They Teach Us About Saving Money
4. Saving Money for Australians
5. Top Tips For Money Saving
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