Frugality is an important part of
We all know we have been taught not to be spendthrifts.† Itís also in bad taste to be pretentious or make it look like we have more wealth than we actually have.† Pretense leads to the ďneedĒ to keep up with the Joneses.† Sometimes itís something that occurs in adults who feel a need to remodel, buy up-to-date furnishings, wear more fashionable clothes, etc.† But even more often it comes through our children.† The children feel peer pressure from their classmates who have a special cell phone, access to more media, computer games, and so on.† This gets more expensive and the children age when they want an automobile of their own, substantial allowances for elaborate dates, designer clothes, cell phones or whatever.
The solution to all of this is an old-fashioned budget.† This is a list of all of the categories for which you spend money and make deposits to savings.† Of course, the budget has to include taxes, your church offerings, debt payments, transportation, utilities, insurance, food, clothes and so forth, but it also has to include categories for savings such as the all-important funds for retirement, savings for high value items that would otherwise require more debt, and even a reserve for unknowns such as possible loss of a job.
Most often there is a huge difference between saving for something before you purchase than buying it on credit.† Thatís likely to be true even when you see things advertised for no interest for a certain period.† Almost always there is a setup fee, and the net cost will be more than you can get a comparable product elsewhere, particularly if you can pay cash and can negotiate.† Young people often must buy large items on credit but should start savings that will reduce the need for future credit purchases.
After you have saved enough, the general financial rule is that itís better to use money from savings rather than buy on credit if the after-tax return on your investments is less than the after-tax interest rate on the loan.† After-tax interest is the interest rate times 1.0 minus the tax rate.†† With a 15% income tax rate, the after tax return on 7% interest earned in savings would be 7% x (1 Ė 0.15) = 5.95%.† A fully deductible mortgage interest rate of 6% at a 15% income tax rate would be 6% x (1.0 Ė 0.15) = 5.1%.† Credit card and other kinds of debt interest are not deductible on your 1040 tax return, so a 10% interest rate on a credit card would be simply 10%.† With interest rates in the examples, you would not use savings to pay off the principal on a mortgage but you surely would use savings to pay off credit card debt. ††Of course, the all important assumption here is that you have saved enough for the purchase in the first place.† If you havenít saved enough, you are probably living beyond your means.
Merchants use the same rule as above and know that they can make more on the interest (and fees) they charge you than they pay to finance their inventory. †Otherwise, they would not make the offer.† The net of all of this is that itís unlikely the interest rate (and fees) they charge will be lower than what you can earn on your savingsóunless the product is not competitively priced in the first place.† Besides, you can be earning interest for very long periods while you are saving instead of paying interest for very only periods after the purchase.† This is one of the ways people build wealth.† Conversely, the lack of savings make the poor poorer because they have to buy on credit.
Adherence to a good budget can be very difficult.† There are always things that you forget to include which then require a readjustment of the budget.† But one thing remains firm.† Thatís the fact that your outflow of money together with your deposits to savings canít exceed your income.† †Further, financial advisors usually stress the importance of saving for your old age even if it means that you cannot enjoy some of the early pleasures in life and even if it means that you have to choose between your savings for retirement and helping one of your adult children in financial difficulty.† Obviously, there have to be exceptions to this rule, but you should thoroughly investigate the resulting long-term impacts on your family either way.
If you are not assured of a substantial pension (rare today for non government jobs), you should probably be saving about 15% of your gross wages from the day you first start work just for retirement. †Otherwise you have to save lots more later on, and you miss out on the benefits of compound interest. †Some employers will match part of your deposits to an employerís savings plan like a 401(k) or 403(b).† Thatís free money that you should never pass up even though it may take significant sacrifice to do so.† Adding to the difficulty, itís wise to start building some savings for a time when you may lose your job for a period of at least three months in a good labor market and more time if your health is poor or you are in a field or environment where itís difficult to find work quickly.
You have heard of parental tough love.† This is financial tough love for both young and old.† Preparation for your future and emergencies points to the need for frugality.† The financial pain from frugality now will be small compared to that which you would otherwise have when elderly and/or in debt from which you cannot recover.