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Chapter 6

Small Steps, Big Payoffs

“I've spent $40,000 on shoes, and I have no place to live!? I will literally be the old woman who lived in her shoes!”

—Carrie, Sex and the City, “Ring a Ding Ding, What's It All Worth?”

In the last chapter, we looked at seven important components of a financial strategy, but now we want to turn to some principles and practices that have caused a lot of people to say, “Wow! That’s incredible!” When we realize the implications of our decisions, we’ll see that these are small steps that result in surprisingly big payoffs.

For example, a couple of friends try to eat lunch every day (that they aren’t meeting with clients) for less than $2 each. One of them explained, “I certainly don’t need to eat a big lunch every day, and besides that, we can have just as good a conversation over a $1.50 burrito as we can over a $10 trout. I don’t have all the money in the world, and I want my money to go into things I treasure: trips with my wife and kids. If I save $5 a day five days a week for 52 weeks, that’s $1300 I can spend on making memories for all of us. Pretty cool, huh?”

Yes, that’s pretty cool. I’ve noticed that it’s kind of a game to these two guys. They aren’t obsessed with saving money on lunch, but they’re glad to find a good deal!

Here are some insights, principles, and practical suggestions you might want to try.

The Magic of Compound Interest

The impact of compound interest is perhaps the most significant factor in accumulating wealth. It doesn’t take a genius to understand it and use it. For instance, if a 20 year old puts $2000 a year for only 10 years into an IRA at 8% and never puts another dime into it, he’ll have over $1 million when he’s 65. But if his buddy waits until he’s 30 to begin and continues to put $2000 a year into the fund for 35 years until he’s 65, he won’t catch up to his early-bird friend.

In these pages, I’ve mentioned the advantage of starting to invest regularly as early as possible, preferably in your early 20s. No, it’s not convenient, but through the magic of compound interest, it makes a world of difference. And if you’re well past that prime period to start this magic, teach this to your kids so they don’t miss it. Albert Einstein once said that compound interest, not E=mc2, “is the greatest mathematical discovery of all time." As usual, he’s right.

The Rule of 72

You can calculate the number of years it will take to double your money by using “The Rule of 72.” Simply divide the interest rate into 72, and the answer is the number of years for your investment to double. This works, of course, no matter how much money is invested, but it doesn’t take taxes into consideration. For example, if you have an account that is earning 8%, you divide 8 into 72, and you find that it will take 9 years for your money to double.

Risk Early, Not Late

Some people who come to see me are in their 50s, and they are desperate to make as much money in a few years before they hope to retire. They want me to put their money into high risk, and hopefully high yield, investments. A better way to look at it is to realize that higher risks make sense only for the long haul. Historically, the market has trended up over long periods of time, but it reacts with alarming volatility in short time spans. A casual glance at a graph of the Dow, S&P, or NASDAQ indices demonstrates these facts. For that reason, financial planning professionals generally recommend investments with lower risks for shorter time horizons, but if you can keep your money in place for a long time, you can ride out the ups and downs of the market and take advantage of higher risk instruments with higher returns.

A young couple about 26 years old asked for my advice about investing their 403b. We talked about their goals and when they would need the money, and they agreed that they wouldn’t need it until their children (yet unborn, and to their knowledge, unconceived) went to college. I recommended an aggressive growth mutual fund.

A couple in their 50s had a different look in their eyes. Instead of curiosity and confidence, panic filled their faces and voices. “I need to make as much as I can as quickly as I can,” the husband assured me.

“We don’t know what might happen,” his wife agreed.

I explained the principles of risks and time horizons, and reluctantly, they decided to invest in funds with less risk but greater stability. That proved to be a good choice because the market went down about the time she had major surgery and they needed to withdraw some of the funds. Choosing the lower risk investment saved them about $8000.

The Perfect Investment

Well, there may not actually be a “perfect” investment, but matching funds come as close as anything I’ve ever seen. Many companies offer to match money we put into retirement accounts, and that’s free money! It doubles the return on your investment immediately, and it will multiply your savings over time.

Sadly, I’ve known a number of people who didn’t take advantage of this incredible opportunity. If your employer offers it, do whatever you need to do to get the maximum you can get. You might not be able to afford the latest gadget for your computer every time a new one comes along, but you’ll have something far better: peace of mind that your future is looking good!

Don’t Handcuff Your Kids with Handouts

We love our children, and we want to show it. Some of us show it by giving them lots of money, but the effects can be quite the opposite of our intentions. Instead of providing wings for them to fly, those funds handcuff them to the ground.

Not all gifts of money shackle our children. We can use gifts of money to stimulate responsibility. For example, some parents offer to match dollar for dollar the money their children earn toward buying a car. That can have a very positive impact on a young person by teaching the fact that discipline and hard work yield rewards.

Too much of a good thing—large gifts without expectations of responsibility—can genuinely harm our kids. In their study of millionaires, Stanley and Danko made a number of observations about parents who give money to their children. In retrospect, these conclusions seem to be obvious, but many wealthy parents don’t realize the negative impact they have by giving too much. Stanley and Danko found that receiving cash gifts produces kids whose lifestyle is characterized by consumption rather than saving and investing, and these kids become emotionally and financially dependent on their parents, often well into adulthood and until their parents die. * [Thomas J. Stanley and William D. Danko, The Millionaire Next Door, (Simon & Schuster, Pocket Books, New York, 1996), pp. 153-159.]

Why do some parents give their kids too much? There are several possible answers. Some parents experienced hardships when they were young, and they simply want to protect their children from those difficulties. Other parents feel guilty that they haven’t been the mothers and fathers they know they should have been, and they try to compensate by giving cash and presents. Similarly, some parents try to buy their children’s love, or they may try to use money and lavish gifts to make their kids happy. The questions we need to ask are:

—Am I giving money or things primarily for them or for me, to make me feel better as a parent because I’ve blown it so badly?

—Will this gift build or destroy my child’s sense of independence and responsibility?

In some cases, parents who have been giving too much to their kids for a long time have developed children with a debilitating, deep-seated dependence. Changing course at this point requires far more courage and communication than would have been necessary if they had changed directions earlier, but it’s still worth it. It’s never too late to wean a dependent child from his parents. The process may be painful, but it simply must be done if you want your children to become emotionally healthy adults.

Ultimately, personal maturity, growth, and wisdom are stunted in young people who receive too much from their parents. Self-absorption ruins relationships, distorts purpose, and crushes drive that leads to achievement. Irresponsible adult children—that’s not a legacy any of us want to leave to our families. Teaching our kids some of these small steps early in life has a huge payoff for them and for us. (We’ll look at a lot more on this topic in Chapter 8.)

Give ‘Em Choices

Since we’re talking about children, Buck and Jeeta are friends who taught their son Todd valuable lessons about money by giving him simple, meaningful choices. When they went out to eat as a family and the waiter asked for their drink order, they asked Todd, “Do you want a Coke, or do you want a dollar?”

Jeeta told me, “Todd’s pretty smart. He picked the dollar every time.”

Buck and Jeeta found a teachable moment, and they used it over and over again to show their son that simple choices make a difference.

The Snowball Effect

When people who are buried in debt decide it’s time to make a change, they often look at their list of debts, wince a time or two, and prioritize from the largest to the smallest. That’s the wrong way to do it. Financial planning professionals recommend that you start with the smallest debt and work toward the largest. When the first one is paid off relatively easily, the sense of accomplishment propels you to the next one, and the next, and the next. They call this “the snowball effect.”

I’ve seen this effect many times with my clients and friends. Those who tried to pay off their biggest debt often became discouraged when it took so long to see any real progress—like no more demand letters from that creditor! In some cases, they simply quit trying. But I’ve also seen plenty of people start with their smallest debt and experience genuine joy when they make their last payment on it. They were highly motivated to take on the next challenge.

If you think this sounds like pop psychology, that’s fine. You probably aren’t in debt and don’t need the adrenaline boost of joy to keep you going as you deal with tons money you owe.

Dress for Success

My wife Connie is a smart shopper. We live on a budget, and part of that budget is her clothes allowance. Long ago, she found a way to beat the system. She realized that many upscale women’s resale shops have clothes she loves for a fraction of the price in department stores. These days, she feels like she’s splurging when she buys a couple of dresses in a month. They cost about $25 each instead of $150 or $200, so she comes out like a bandit!

Two for One

When Connie and I were poor, we sometimes went to nice restaurants and bought two meals. We seldom could eat everything on our plates (well, Connie couldn’t), but that, we were sure, was the price of going out to eat. Somewhere along the way, however, we realized that portions were so big that we could easily split a dinner and save a lot of money. For the past 15 years, we’ve seldom ordered two meals. We always have plenty to eat, and if we’re still hungry, we go wild and get dessert.

Some people think that splitting a dinner somehow shortchanges waiters who have to do the same amount of work for half the tip. We solve that by giving a larger tip, so everybody’s happy.

How much have we saved over the years? My estimate is that Connie and I go out to eat three times a week. (Yes, I know that’s a lot.) If we save an average of $12 on each meal, that’s $36 a week and $1872 a year. Over the 15 years, that comes to over $28,000 (with no interest on the money)! If we had paid that much each time, I’m not sure we’d have gone out to eat as much, or maybe we’d have gone to restaurants with cheaper meals. Even if we didn’t save that much money, we went to nice restaurants, enjoyed fine meals together, and stayed within our budget. That works for us!

The Real Cost of a Cup of Coffee and a Car

I want to give you a fresh perspective about the real cost of drinking specialty coffee and driving new cars. In this exercise, let’s assume that the money you save is invested.

Many of us go to coffee shops every day and buy a cup of specialty coffee, latte, or one of those iced coffee drinks. The cost varies, but let’s assume that we spend $5 each visit on the drink, and occasional brownie, and a tip for the barrista. Five visits a week at $5 a visit is $25 a week or about $1200 annually. If you’re 25 years old, and you save that money and put it into a mutual fund that grows 10% a year, when you’re 65 you’ll have $531,111. (Connie didn’t believe me when I gave her the total, so she got her pencil and did the math herself. Now she’s convinced!)

Now, let’s assume that you start leasing a BMW convertible when you’re 25 and you pay $400 a month for the lease. That’s $4800 each year. Now let’s assume that you learn to value your future more than your fine ride today, so you decide to spend $200 a month on a small Toyota or Honda and invest the rest. When you’re 65, that $200 a month at 10% interest will have become a whopping $1,062,222!

I N T E N T I O N

The wisest man on earth had a lot to say about financial planning. Even a casual reading of the Proverbs shows us that Solomon understood the importance of having a clear, intentional plan for handling money. Throughout his statements in Proverbs and Ecclesiastes, he reminds us that a plan helps us make good choices, and those choices make a difference—a big difference. He wrote, “Careful planning puts you ahead in the long run; hurry and scurry puts you further behind” (Proverb 21:5).

Small steps in the right direction, he assures us, eventually take us places we want to go. He observed, “Work your garden—you'll end up with plenty of food; play and party—you'll end up with an empty plate. Committed and persistent work pays off; get-rich-quick schemes are rip-offs” (Proverbs 28:19-20).

In the study of wealthy people in The Millionaire Next Door and in my observations of people who have attained both financial and relational wealth, we see that seemingly small steps of planning and choices to be frugal in spending are two of the hallmarks of people who accumulate real wealth. That’s not a secret. We can all apply these basic lessons of life.

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