For this post, I want to anchor the concept of saving to an easy-to-remember acronym—SOS.
Before we begin, here’s a quick history lesson to gain some context and clarity around the topic. SOS was first created in the early 1900s in Germany and is the original distress signal used in Morse code. When used, the SOS signal would precede any information communicated via radio whenever there was a catastrophic situation that was about to happen or had already happened. It is composed of a sequence of three dots, three dashes, and three dots. SOS is just a sequence of characters and does not actually stand for “Save Our Ship”, “Save Our Souls”, or any other number of phrases. It has evolved over time to become an internationally-recognized signal for help and can be communicated via Morse code or in writing; it can be verbally communicated or even via flashes of light (e.g. from a flashlight or a handheld mirror). If you ever need help starting to save or getting back on track saving, remember: save soon, save often, and save sufficiently (my take on the three most important habits of saving). To make things even better, SOS is a palindrome—same spelling backward and forward—and can also be flipped upside down and read the same way.
How is this applicable to me?
The concept of SOS in personal savings is relevant to everyone, regardless of where in the journey to financial freedom they stand. For someone who’s just beginning, it is most beneficial to focus on step one—saving sooner rather than later. By contrast, for someone who’s been saving for years, maybe they have mastered saving soon and saving often, so now is the time to focus on step three—saving sufficiently (i.e. boost your savings rate).
As with most new things, the first step is often the hardest. For those who have never been financially able to save or those who are too intimidated by the thought of finding the right savings vehicle, I’m here to tell you the single most important thing you can do for your financial future is to start as soon as possible. Putting your money to work now instead of later is immensely rewarding. To borrow a quote from Albert Einstein, “Compound interest is the most powerful force in the universe.” This opinion is coming from a theoretical physicist who spent his entire life understanding and teaching about forces. If he believed that quote to be true, what does that tell us about the power of compounding?!
I’m a believer in learning through examples, so let’s compare two scenarios to illustrate the power of saving soon. Both hypothetical scenarios center around Mario, who is 35 and has a goal of saving for retirement. He determined he will need $500,000 to retire at 65 with his current standard of living
Scenario 1: Mario decides to start saving immediately so he can hit his savings goal in 30 years and retire to Costa Rica. He determines he’ll need to start saving about $510 per month now to hit $500,000 by the age of 65 (assuming a 6% rate of return, compounded annually). His account balances will be:
Age 40 = $35,610
Age 45 = $83,265
Age 50 = $147,037
Age 55 = $232,379
Age 60 = $346,586
Age 65 = $499,421 (a mere $579 short of his goal—not bad!)
Scenario 2: Instead of saving right away, Mario decides he would rather buy the new car he’s been eyeing at the dealership near his house (even though his current car is paid off!). The monthly payment will stretch his finances to the point where he won’t be able to save any money toward retirement until he pays the car off in 5 years. Therefore, he will start the goal of saving for retirement at 40 instead of 35. His account balances will be:
Age 40 = $0
Age 45 = $35,610
Age 50 = $83,265
Age 55 = $147,037
Age 60 = $232,379
Age 65 = $346,586
Age 70 = $499,421
What can we conclude from the above examples? First, if he starts saving now, Mario will achieve his goal and be financially ready to retire at 65. If he waits 5 years to start saving, he’ll either be forced to delay retirement until 70 or retire at 65 and be satisfied with a lower standard of living. If he determines he still wants to retire at 65 and is unwilling to compromise on his standard of living, that means he would have to save $735 per month starting at the age of 40 as opposed to $510 per month at the age of 35. Now THAT is the power of saving soon! Why wait? Start now!
In this step, we’ve likely already mastered saving soon. Maybe you’re a few months or years into saving and don’t feel like you’re making much progress. Are you saving frequently enough? Do you send money to savings once a quarter when you get that commission check or maybe a couple of times a year when you can “work it into your budget”? Worse yet, do you save once a year when you get that long-awaited bonus? Please don’t misunderstand—any savings at any frequency is a great thing! What I’m trying to convey and encourage is the importance of saving as often as you can, even if it’s just a little bit.
In discussing savings over the years with many friends, family, coworkers, and colleagues, I’ve learned that most people are exceedingly good at saving money occasionally. If they get a windfall in their account, a lot of people will route that directly into savings, which is a great thing to do! However, if they’d done a little bit along the way instead of a lump sum in the future, it would have added up even quicker.
I’ll give you a good example. One of my previous coworkers used to count down the days until she could file her tax return (not making this one up—it’s a true story!). The reason was she and her husband typically got a very handsome refund each year—anywhere from $5,000 to $8,000, on average. For the sake of simplicity, let’s make it a nice, round $5,000. It always fascinated me how they chose to withhold extra income taxes each month, thus reducing their take home pay, so they could get that big refund come tax time. Let me explain a little further. To put their money to work for them along the way, what they should have done was reduce their tax withholding such that their monthly take home pay was higher. Now let’s assume she and her husband both tried to break-even and get no refund at all when they filed their joint tax return. This would mean each of their take home paychecks would be roughly $208 more each month, assuming they’re paid monthly ($5,000 / 2 people / 12 months = $208 / person / month). Think of how they could’ve put their money to work for them more often! If they’d each saved that $208 monthly, at a safe 3% rate of return they would’ve had $5,085 versus $5,000 without saving monthly. Spread that across 5 years and it becomes $26,958; if they’d made annual contributions across the same 5 years they would’ve only had $26,548 (5-year scenarios assume deposits are made at the end of each month and year, respectively). That’s an extra $410, ignoring the taxability of interest income if it’s in a post-tax account. Over 10 years with monthly contributions at 3% rate of return, that would be $58,272 versus $57,319 for a delta of $953 to the benefit of the monthly saver. These differences are relatively small, but as you increase the amount of contributions, stretch the time horizon, and increase the rate of return, the effect becomes more substantial. The challenge with this one is it requires more discipline and diligence to save daily, weekly, or monthly, than it does to save quarterly or annually.
When determining how much money you will need in the future, it’s all too easy to rationalize what you’re able to save regularly now will eventually grow to the balance you need. The keyword in that sentence is eventually—if given enough time, any amount of money can eventually grow to meet your future needs. To avoid this pitfall, it’s safer and more prudent to determine anticipated future needs first and then back into how much you should save on a regular basis to get there.
This last step can present a challenge, primarily because we all grow accustomed to how life is right now. Generally, we like how we spend our money and our current standard of living—it’s just plain comfortable and familiar. And, due to the way we’re all wired as human beings, we can be resistant to change. By this point, if you followed the SOS progression, you’re already saving soon and saving often but need one last push to get your savings where you want them.
In my experience, it’s possible to stay in this step for a while for the reasons mentioned above. On the many occasions my wife and I have saved for something, we start soon and save often, but then we go through several rounds of saving sufficiently—each time upping the ante. For instance, we may start off saving $500 per month; we’ll do that for six months to a year and then up it to $750. This step may be the longest of the three if you master the first two quickly, but that’s okay. The point is to be consistent and continually challenge yourself to save a little more and a little more.
In the end, the concept of SOS is about determination and persistence. When you make the choice to save for a goal, save soon, save often, and save sufficiently. Simple, concise, achievable.