By: Rutvij Thakkar
As the Parable of the Talents tells us, one should consider all currency they acquire as a personal measure of value. If you haven’t heard the parable, it posits that one should take risks with their gifts to advance their prosperity. So naturally, in the real world, it means all actions that are deserving of some returns require a principal and an appetite to potentially lose that principal. Keeping one’s finances in order in America has never been about people losing their money due to risky judgment alone, but rather it has been missing the management of risk and lacking foresight in the possibilities of the future.
A poor financial situation is one of America’s biggest tragedies now, with about 40% of Americans not having $400 in savings to cover an emergency [1] and many more Americans relying entirely on the Social Security system for their retirement. The first part of intelligent investing comes in actually accumulating a sufficient amount of capital for your investments to be diversified and meaningful. The power of compound interest illustrates this idea pretty well, where you can calculate what your future savings look like with fixed monthly deposits and principal payments, and an average interest rate compounded every year. This calculator is easily available to anyone with an internet connection at Investor.gov.
First, the prospective retiree needs to set a goal. What expenses are their needs versus their wants? What are they willing to sacrifice for more security in the future? And once these basic questions are answered, you should be able to arrive at a round figure of how much money you might need 10–50 years down the line depending on when you’re starting to save. Sixty percent of millennials making over $100k are living paycheck-to-paycheck [2], while there’s also the story of a janitor who worked minimum wage jobs all his life and managed to save over $8 million which he donated all of to charity [3].
The reason this phenomenon can exist is that earnings do not directly equate to savings! If American spenders behave entitled and believe they need certain lifestyle items to live when they just want luxury goods, the amount of spare cash at the end of the year runs out pretty fast. We should be elastic when it comes to things like buying a new car or the best-branded clothes, and we should be immovable when it comes to that set amount of money we need to save every month. This amount varies for everyone because the standard of living is different for everyone. When do you plan to retire? How long do you have to save? How will your living standard change, and subsequently your means to support it?
You can also with these same questions calculate how long it takes you to retire. By knowing this timeline, you can budget every year unique to your particular circumstance. The first step every American can take is to set aside a fixed portion of their income. The second part of the savings equation is the interest rate earned on an investment. Having a high percentage return can be one of the biggest catalysts to retirement earnings outside of saving early and frequently. You should always measure your returns by their alpha, or risk-adjusted returns when benchmarked to the general market. Investing in a general mix of stocks and bonds that represent the market can return you enough for your contributions so that you can retire if you invest early and frequently.
For example, if you just start with a principal of $5000 and contribute $200 per month with an annual market return of 10%, you’ll have ~$482k by the end of your retirement horizon. But if you turn up the return to 12%, you’ll have ~$728k. This is where investment strategy and risk analysis come in. If someone can get themselves to save and set money aside, they’ve solved the problem of future financial insolvency. But to be a cut above the rest, you need to know how to invest.
The first step is to not fear the stock market. Historically speaking, stocks have always reverted to a better risk-adjusted return than bonds, and they are worth the risk especially if the prospective retiree uses a tax-deferred account. One of the biggest cons of using short-term trading and frequently buying and selling securities instead of holding a portfolio of diversified stocks is the tax penalty. Short-term capital gains taxes can be as high as 50% of the return, so even if someone happens to be an amazing trader they would lose a large portion of those gains in taxes along with having much more stress and risk.
All young Americans expecting their earnings potential to increase should have a ROTH-IRA, a tax-deferred asset that allows you to invest up to $6500 annually without paying any immediate capital gains. This takes away a large expenditure associated with capital markets investing. Retirees should also be invested in hard assets like real estate which actively return cash so that they can have something that functions effectively like a bond. This is because having free cash flow on your person instills a sense of financial freedom, receiving a rent payment or a bond payment is like a second source of income and real estate’s high-yield returns from rent collection along with increased intrinsic property value make it a prime commodity in today’s day and age.
To protect the downside, all Americans should steer clear of high-interest debt. As a college student and a United States Air Force service member, I’ve been briefed on the dangers of high-interest debt time and time again. If you’re in my situation, you can lose your security clearance and college debt isn’t even defaultable. High-interest debt leads to the most severe depreciation of net worth by using compound interest with an inverted effect. As the interest rate payments on your debt balloon, the negative effect on your net worth increases. Creditworthiness, the balance of revolving and fixed credit, and budgeting indebted spending are all responsible for increasing financial success. There are plenty of apps that help you budget and find the best credit card for your situation, and getting into perspective your spending and source of funding will help sustain your financial responsibility.
A balance of a consistent saving schedule, a consistent spending schedule, and investing in consistently safe assets like ETFs can be the key to most people’s financial independence. Of course, there are struggles in generational wealth, inflation, and the general ruin of capital markets caused by meme and hype investing. These things can be setbacks for the traditional investor or saver, but failing to take any logistical investment risk leaves individuals in the wake of inflation’s dust. All rational choices, business, or individuals come down to the decision-maker’s ability to remain objective and dutiful to their morals. Purposefully taking on high-risk loans, and making risky short-term investments in the hopes of winning big dissuades future decision-making from being conducive to long-run sustainability.
