Third-Quarter Review of Investments and Personal Finance : Playing the Money Game

SPECIAL TO THE TIMES

Frustrated by 1995's fabulous investment performance because you didn't participate? It's time to follow the simple advice of Samuel Johnson, the noted 18th-Century essayist: "Resolve not to be poor: Whatever you have, spend less."

That is, in fact, the only way to save. Without saving, you have nothing to invest. Without investing, your chance of building wealth--or even avoiding poverty--is slim.

Still, spending less than you earn is difficult. It takes discipline. It requires a certain amount of sacrifice. And, the more modest your means, the more difficult the sacrifices become.

Yet, in the long run, it pays dramatic dividends. Without doing anything fancy--without ever earning six-digit salaries--a modern couple could easily become millionaires. All they have to do is save a little, invest with a little common sense and give themselves plenty of time.

It's true that this year's stock market performance may not be repeated for some time, and if you haven't invested in stocks yet you may feel that you've already missed the boat. But there are other places to save your money and there will be more up-markets if you are patient. Just get yourself started.

The final goal is up to you. Your financial aim may be to create more security and comfort while you are working, but if a major part of your game plan is to be comfortable when you are old, the key decision is how well off you want to be then and what sacrifices you are willing to make now. One thing is certain: Social Security will be changing and you may not want to plan on its current generosity--especially if you are young.

When planning for retirement, remember that you live on much less than your gross income. For example, a single person making $40,000 a year might be living on $25,000 a year after taxes and savings. To maintain that over a 20-year retirement may require $200,000, assuming a fairly high annual interest rate.

But if you want real security, you don't want to cut it so close. And you don't have to be a CEO to do it.

Consider Lucy and Raul, a fictitious couple who are both college graduates. They get jobs, marry in their late 20s and do what most people do--have children, buy a house and cars and do their best to save for big expenses such as college costs and retirement.

As illustrated on this page and the next, they never earn more than $70,000 between them. And even though they stop saving in their 50s while they help send their children to college, they end up with an astounding $2 million at retirement. That's enough to pay them monthly income approaching $170,000 a year for life .

How did they do it? They made wise decisions and stuck to the program over an entire lifetime. You, too, can be wealthy and wise. Here are the key lessons from Lucy, Raul and a smattering of economists, statisticians and financial planners.

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Go to college: Just how much is a college degree worth? About $795,000 if you're a man. (Women tend to make less over a lifetime.)

The Census Bureau, which compiles statistics on annual income by education level, has found a definite correlation between how many years you attend school and how much you earn later.

The average male high school graduate, age 25 or over, earns $21,782 per year. However, graduate from college and your average annual earnings expectations soar. The average male college graduate earns $41,649.

Over a working lifetime--the 40 years between age 25 and age 65--the difference that four extra years of school makes adds up to a fortune.

It's also worth mentioning that more than 70% of the families reporting annual incomes of $70,000 or more boasted a college graduate in the household, according to the Bureau of Labor Statistics.

"That's not to say that if you didn't go to college, you aren't going to make it," says Kathleen Stepp, a financial planner in Overland Park, Kan. "It just increases your chances."

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Economize when you're young: Did you know that 30-year-olds who earn between $30,000 and $40,000 save about three times more than 50-year-olds with the same income? It's hard to know precisely why, but some believe it's because family financial pressures begin to heat up in middle age.

And in your 20s, before many people marry and have children, you're in a great position to economize. You haven't raised your living standards yet. You can share an inexpensive apartment friends, drive an inexpensive car or take the bus. Housing and transportation costs typically eat up more than half of the average 25-year-old's take-home pay, according to census figures. If you can cut that, you can pay off your debts fastser or create an emergency fund.

Sure, you won't appear as prosperous as friends who drive BMWs and lunch at the Ritz. But stick with the program for a few years and you'll be better off.

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Pay yourself first: Every financial planner says it; few people do it. Make your savings program as much a part of your budget as your mortgage. When things are tight, give up the night out, the new suit or the expensive pair of shoes--don't fail to contribute to your savings plan.

Saving regularly actually has two purposes: You accumulate wealth and you get in the habit of deferring gratification and living below your means. Why would you want to do that? If you ever hit a tough stretch--where you are out of work or face big, unexpected expenses--you'll have money in the bank and know how to make it last.

The easiest way to save regularly is to make it automatic by contributing to a 401(k) plan at work--where contributions are taken out of your check before taxes and before you get your fingers on the money, says David Hemstreet, a Pasadena-based financial planner. If you don't have access to a 401(k), consider setting up an automatic investment program with a mutual fund company. "After a few months, you don't even miss it," Hemstreet says.

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Take advantage of your employee benefits: Despite layoffs, downsizings and a general decline in collective bargaining through labor unions, most companies continue to be generous when it comes to employee benefits. The average company spends an amount equal to 22% of wages on a spectrum of company-subsidized perks, ranging from retirement accounts to health and life insurance plans, compared to benefits costing about 9% of wages in 1960, according to the Employee Benefit Research Institute in Washington.

In most cases, there are benefits that can inexpensively improve your standard of living.

Consider, for example, tax-saver accounts, which are offered at many large corporations.

Tax-saver accounts are automatic savings plans, where you have your employer deduct a set amount of your wages from your paycheck each month. Your contributions are taken out of your wages before taxes are calculated. As far as the government is concerned, you never earned the money. That cuts your taxes.

These accounts can pay either day-care expenses--"dependent-care accounts"--or unreimbursed medical costs--usually called "health care accounts."

Assuming you pay 28% of your income in federal taxes and 7.65% in employment taxes (for Social Security and Medicare), paying $5,000 from your dependent-care account for child-care bills rather than from your checking account saves you a stunning $1,782 in taxes, says Philip J. Holthouse of the Los Angeles accounting firm of Holthouse Carlin & Van Trigt.

There is just one drawback. If you don't spend the account by the end of the year, you lose it. So don't contribute too much.

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Don't borrow for consumption: When you buy a house, you're investing in a place to live. When you buy a car, you're investing in transportation that will take you to and from work. There's no sin in borrowing to make these major purchases--as long as it's not more debt than you can afford.

However, a big-screen TV is not likely to improve your earnings potential. A fabulous vacation probably won't affect the cost of your house. Certainly if you want these things, you should buy them when you can afford them. But you'd be wise to wait until you can pay for them with cash.

All too often people fail to recognize that buying an item on credit vastly increases the cost. For instance, if you bought a $1,700 big-screen television with your 18% credit card and paid just the minimum balance each month, the cost of the television and financing adds up to a whopping $3,673, says Ruth Susswein, executive director of Bankcard Holders of America in Salem, Va. The person who waits and buys with cash can buy two big screen TVs and a VCR for the same price as the person who bought one TV on credit.

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Get started on saving: The value of saving early is compelling. If you start saving $200 a month from the time you're 25 until you retire at age 65 and earn 10% annually on your money, you'll have a cool $1.26 million to spend in retirement. A 401(k) with a company match would mean even more money.

What happens if you start at 40, but save twice as much--$400 a month? You'll end up with $303,747.

In both instances, you would have contributed a total of $96,000 to savings. But the person who saved early got the benefit of 20 extra years of compound interest--a powerful force.

It's too late to start early? Then start now. Every extra year helps.

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