When it comes to saving, many suffer from a disease I call “assoonas syndrome.” They plan to start saving. As soon as the car is fixed. As soon as they receive a raise at the part-time side job. As soon as they get a speaking part. The rash of “as soon as” spreads on and on, and is difficult to cure.
The only way to cure assoonas syndrome is to start saving now. I know you’ve heard this before, especially if you’ve been reading this blog.
Wouldn’t it be wonderful if there was a little man who would go to work on days that you didn’t really feel well? He’d keep making money you could throw into savings while you focused on your craft. You’d spend your day completing life goals, unworried about saving because you know that the little man is out there earning money and making deposits into your bank account. Wouldn’t that be fantastic? If that little man existed, assoonas syndrome would be cured for life.
I have good news for you. That little man exists.
Sometimes it takes a good analogy to help people understand money-saving concepts. One difficult concept is interest. Although we’ve all heard of it, there is nothing that puts a room full of people to sleep faster than a discussion of compounding interest.
When a wealthy friend described interest as a little man to me many years ago, it changed everything. Suddenly, compound interest was the most exciting concept I’d ever encountered. I couldn’t wait to help the little man get started. There was nothing I wished for more than to have someone help me save.
When you deposit funds into an account, the little man named “interest” brings home a paycheck. Sure, it’s little, but it adds to the pile of money you’ve saved. The next day, the little man brings home a bigger check, because his income is based on the pile of savings you’ve accumulated. If you earn five percent interest, he’ll bring home five dollars a year for every one hundred you’ve saved. He doesn’t work slowly. He works rreeaallyy slooooowwly. Every day, though, his rate increases. If you have one hundred thousand dollars, he brings home five thousand dollars. If you can find investments paying higher rates, like seven percent, he’ll bring home seven thousand dollars.
Of course, the goal is to grow the pile enough so that one day he’ll be able to support you. That’s a difficult goal. But, it’s far easier than earning the money yourself. That’s because this little man works more efficiently than you.
A few years ago, I read a book called Rich Dad, Poor Dad, and was delighted to read that the author, Robert Kiyosaki, used the example of the little man in his story. He took the analogy further than I’d ever heard. He wrote about the little man’s efficiency secret. When I read how much more quickly the little man could accumulate funds than I could in my craft or side job, I realized that I had to start saving quickly.
I had to start saving now.
Here’s his secret. When you and I earn money, every cent filters through the tax system. Whether we’re paid via check or through client work, every dollar we earn is going to be federally taxed, state taxed (if you live in a state with a state income tax), and FICA taxed. I live in California. The average person in my state pays a five percent tax rate. The average American pays 15 percent federal tax. Medicare and Social Security taxes are 7.65 percent. Add these together and a California resident, on average, pays 27.65 percent of their wage to income taxes. For every one hundred dollars I earn, I get to keep only $72.35. Yuck.
The little man has it better. In a fully taxable account, where I can take out money wherever I want, interest avoids FICA tax. Suddenly, I’m keeping $80 of every $100. Not only is he working without much effort from me, but he’s keeping more cash every day. It only gets better if I search for investments that pay something called “qualified” dividends. These are taxed at an even lower rate. Money in IRAs allows me to avoid all taxes now and only pay tax later, when I remove the funds.
So, if you’re excited about the concept of freedom, it might be in your best interest to put a certain little man on the payroll. Although he’ll start off slowly, the longer he’s on the job, the more valuable he’ll become.