A Contributory Tale
A Contributory Tale
This is a tale about developing the proper mindset. When it comes to money, sometimes the best thing you can do to develop proper habits is to trick yourself. Here is a trick I recommend for people first entering the work force, although any time is a good time. It is the tale about Johnny Instant and Billy Delayed. They both go to work for the same company, they earn the same amount, they get the same raises throughout their careers, etc. The only difference is their mindset. Here’s the trick. The trick is simple, take the very first raise you ever get in your career and invest it. Pretend you didn’t get the raise until your second raise. Repeat this mindset until you stop working. The first raise is the most important.
What I just described is a powerful trick. If you work somewhere that rewards performance on an annual basis, if you delay gratification just 1 year, the savings pile up. Furthermore, your partner Uncle Sam encourages this type of behavior as does your employer by offering company retirement plans. It is essential to understand the benefits your employer offers so take the time to learn. But it isn’t enough. The mindset and this trick is how you should think. Let’s look at our two characters to see what happens.
Billy Delayed understands the concept of delayed gratification and how money today invested in appreciating assets becomes more valuable tomorrow than money today spent on depreciating assets.
As I said at the beginning of this tale, Johnny Instant and Billy Delayed are identical in every way except Billy Delayed has the proper mindset because he knows the trick and practices it. Rest assured, Johnny knows the trick as well but he didn’t get his name because he can delay gratification. He wants it now. So, at the end of their first year at the company they each get a 6% raise or $3,000 and their salary increases from $50,000 to $53,000. Billy Delayed follows the trick and pretends he is still making $50,000 per year and invests his $3,000 raise. Johnny Instant goes shopping. At the end of the second year they once again get a 6% raise which in this case is $3,180 and their salary increases from $53,000 to $56,180. Billy Delayed pretends he is still making $53,000 per year and invests his $3,180 raise but is now free to spend his previous raise of $3,000. Once again, Johnny Instant goes shopping. This process is repeated every year. Let’s see what happens after a few years.
By now you are probably thinking, everyone preaches saving money but Johnny Instant is having a great life and poor Billy Delayed is living like Scrooge. This couldn’t be further from the truth. Billy Delayed is just 1 year behind. So if Johnny Instant spent his first raise on a television, Billy Delayed did the same but one year later. If Johnny Instant spent his second raise on travel, Billy Delayed did the same but one year later. If Johnny Instant spent his third raise on a better car, Billy Delayed did the same but one year later. You see, Billy Delayed wants the same things as Johnny Instant. He can just wait one year.
Let’s see what Billy Delayed gets out of this whole thing and remember that Uncle Sam as well as his employer encourages savings and delayed gratification. Uncle Sam encourages or incents people to save for retirement by giving them an instant tax break when they save money in an approved plan, which they call a qualified plan and includes things such as an IRAs, 401(k) or 403(b). Employers typically encourage or incent people to save for retirement by matching either all or part of what you save or contribute to a qualified plan at work. What this means to Billy Delayed is in the first year he contributed $3,000 to his retirement plan and the company matched it by contributing an additional $3,000. This is an instant 100% return on your money because employers won’t reward Johnny Instant. If he doesn’t save, they don’t match because there is nothing to match. In addition, Uncle Sam chipped in by giving Billy Delayed a tax break of approximately $750. So you see, Billy wasn’t even delaying his $3,000 raise, it was actually only $2,250 due to Uncle Sam’s generosity.
Let’s fast forward 10 years and see what happens. Billy Delayed met a wonderful woman that shared his proclivities for delayed gratification. Johnny Instant did the same. His soul mate wanted everything now as well. But now, 10 years later, they each wanted to buy an identical $500,000 house. But there was a problem. Neither Billy Delayed nor Johnny Instant had saved any money outside of their retirement plans. While Billy Delayed had saved money in his retirement plan, he had spent just as freely as Johnny after that first year. What can they do? In the case of Johnny, because he has no money for a down payment, it will be difficult to qualify for a mortgage and even if he does, his mortgage will be on the full $500,000 purchase price. But what about Billy Delayed and his wife, Betty Delayed? They have an option. It is a very obscure and not well known option but it is available nevertheless. They can borrow money from themselves against the money they have saved in their company retirement plan.
Let’s do a little math. If we assume a 6% rate of return on the money invested in the retirement plans, both Billy and Betty Delayed will have a bit over $100,000 each in their retirement plans. Of course Johnny and his wife have nothing in theirs. So, if both Billy and Betty Delayed borrow $50,000 from themselves they can take out a combined $100,000 to put as a down payment on the new house and should easily qualify for a loan. Johnny Instant and his wife, even if they can qualify for a loan, will have a substantially higher monthly mortgage payment when it is all said and done. But hey, Johnny Instant is a resourceful guy and gets what he wants and so he too gets the house. If we assume they each get a 30 year mortgage at 5% interest this means Johnny and his bride, Jenny Instant, pay an additional $5,000 per year than Billy and Betty Delayed.
Now we have some decisions to make for our two characters. Should Billy and Betty Delayed invest the $5,000 savings or should they spend it? It’s great to have choices. They decide to invest it and make 6% per year on it for the entire 30 year period while making their mortgage payment. At the end of 30 years, they own their house, have money in their company retirement account and have built up a considerable nest egg from the $5,000 per year they saved on their lower monthly mortgage payment. Let’s look at our two couples 30 years from the day they buy their house.
Johnny and Jenny Instant own their house and it might be worth as much as $1 million dollars by then. But they have no money in their retirement account, and no savings. Billy and Betty Delayed, also own their house and it is worth whatever Johnny and Jenny’s house is worth because it was an identical house. But, here is the difference. They also have a retirement account as well as a savings account. How much do you think their retirement accounts are worth? How much do you think their savings account is worth? Remember, the only thing they did different is to save their first raise and delay gratification just one year.
If you answered that Billy’s retirement account is worth a little under $2.4 million and Betty’s is as well you would be correct. Furthermore, the savings account they funded from their mortgage savings is now worth a little bit over $400,000.
What happens next? At some point both couples reach the age where they want to retire or are forced to retire. Which couple is better off? Which one has more options? Which couple would you rather be? What did it take? Just one year. Learn this trick and remember it’s not too late to start. As George Allen, one of my boyhood heroes and Hall of Fame football coach would say, “the future is now.”
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