Jason Flurry, CFP
What kind of saver are you?
How a tin can can actually help you make paying for college easier.
One of the key questions that I ask people a lot is, “how do you plan to pay for college?” In some cases, people have done a great job of saving and they have all the money they need set aside. They just don’t want to overpay for college and they want my help on how to get things down to where it they’re only paying their fair share of the bill.
In other cases, people of saved some of the money they need to pay for college and they plan on using income or some amount of student debt to cover the difference. With some careful planning, that can be a workable solution.
But then there’s always some that say, “That’s why I’m here!” For whatever reason they haven’t managed to save hardly anything for college. And any money they do have the ability to save now likely needs to go to retirement because they’re underprepared there too. In those situations, it’s not that college is more important than retirement. College is just happening first. And, if they mess things up for college, it’s likely to have a nasty carryover effect into their retirement years.
Maybe you can identify with folks in that situation, but hopefully you’ve had more success with your savings efforts when it comes to college and the rest of your financial life. Saving money can be challenging when you have kids, but you don’t need me to tell you that. What I really need to share with you is something I think can benefit you a lot more. If you’re planning for college, I believe you could really benefit from some of the insights that I’ve gleaned over the years related to how people save money. Understanding what type of saver you are can make a huge difference in how successful you are at meeting your savings goals.
Getting the financial pieces right is a key component in building a successful college plan and my background is a CERTIFIED FINANCIAL PLANNER™ professional has given me an advantage in helping people build comprehensive plans that meet their college goals in the context of their life goals. I shared some of these insights recently in one of my financial planning blog posts and I thought it would include it here for you today.
While the article doesn’t relate to college planning strategies exclusively, it does address one of the core, fundamental principles that everybody faces when trying to save for college. Sit back and relax and get ready to learn about the Tin Can Theory. I’ll be back after this lesson with a few wrap up comments for you.
Shared from MyLPFG.com/blog.
You’ve probably heard or read stories about people who find thousands of dollars stuffed in the walls or in some hidden safe while doing some renovations on an old home they bought. Or maybe you know someone whose Depression Era parents or grandparents died leaving a fortune in mason jars or coffee cans stashed in their shed or buried in the back yard. It used to happen a lot and the phrase “putting money under the mattress” is still not only commonly used, it’s also common practice for millions of people and millions of dollars!
With the generations that have followed those who witnessed the Great Depression first hand, and with the improvements in security and technology, more people have a comfort level with banks and the banking system. And now that we’re moving even closer to a cashless society with electronic purchases and new financial vehicles, like cryptocurrencies, the future of how we handle money may look unrecognizable compared to how we did things just a few decades ago.
So with that in mind, this article will cover two very important concepts that you’ll need to build lasting wealth and look out for your own best interest. The first one is the act of saving itself. We can’t have savings without saving money, right? So let’s discuss the activity of saving money and then analyze the various categories of where you can put your savings to make sure it is working hard (and smart) for you.
The sport of saving
Most people I know save to spend. That means they set a goal, like maybe going on a nice vacation, and when they have the money saved, they go spend it. I love that. In fact, I think you should regularly set goals like that and engineer your life so that you can spend as much time and money smelling the roses and making memories with those you care about as often as possible. Life is meant to be lived and we never know how long we have to enjoy it.
So saving to spend it a good habit to develop, but I’ve also seen another type of saver. This person saves to save. They just like the act of saving money and it becomes almost like a hobby of theirs. While others are out playing golf and tennis, this super saver is dedicated to the sport of saving. He or she may also have many other interests, but saving is a passion of theirs and they hardwire it into their lifestyle for the sheer joy (and financial security) it brings them.
This used to be a much more common pastime. In fact, if you look back at the average savings rate from the 1950’s through today, you’ll find that the typical family saved well over 10% of their income each year. Contrast that to what the typical family does today, roughly about 3% on average, and you can see why money, or the lack thereof, is a point of stress for a lot of people.
Making the lack of savings worse is the rise in spending during this same period of time. The size of the average American home has tripled since the 1950, and with all of the extra space comes the need to buy stuff to fill it up. There’s the cost to maintain a larger home, cover the cost of utilities, and pay the property taxes and insurance. Owning a home, especially a larger home, can be nice, but it can also be expensive. Consider that the typical 1950’s family allocated roughly 22% of their income toward the home’s expenses and today the average family uses approximately 43% of their income to accomplish the same thing.
Cars have certainly gotten nicer since the 1950’s, even though I have a special affinity for the beautiful 1957 Chevy Bel Air my father in law left my son when he passed. As gorgeous as it is, it pales in comparison to the features my family’s other vehicles have. Those features cost money and that has required the typical family today to allocate 10% more of their household income to purchase, operate, and maintain their vehicle(s) compared to what people did in the 1950’s.
There are other big categories, like healthcare for instance, that have gotten better but more expensive over time, but one category that has really changed for families today compared to those in the 50’s is the cost of education. In the 1950’s, far fewer people went to college, and for those who did, the cost of getting a college degree wasn’t something they had to go deeply into debt to afford. Today, a much higher percentage of kids attend college and the average college graduate is turning their tassel with the weight of a huge student loan strapped to their backs. That burden has strained families to a breaking point and created a massive mountain of debt that threatens to cripple our economy.
Spending our prosperity in advance
In addition to working hard to keep up with the Jones’s, we as a nation have exceeded our own ability to earn what we “need” and gone into a lot of personal debt chasing the American dream. The size of the typical mortgage loan has skyrocketed over the past 50 years and the average family has one, and sometimes more than one, vehicle loan to manage. To fill and care for the house and keep those cars on the road, the majority of families have used personal credit to stay afloat. And then when the kids get ready for college, the debt pile grows even higher with education loans for both the students and for the parents.
The amount of money you have left at the end of the month is called “discretionary income.” Some of you have heard about it, but never actually seen it… Nevertheless, when you spend less than you earn, you have money to save and spend on the things you want vs. just the things you need. Personal incomes have risen in conjunction with the cost of living over the years, but what hasn’t kept up in the past 10-15 years is the level of a family’s discretionary income. That has fueled the need for credit and certainly hurt the savings rate with it.
Enter Mr. Market
Another major factor in the decline of savings rates is the increase ease of access people have to the financial markets through mutual funds and online brokerage accounts. The introduction of employer sponsored retirement account, like 401(k)’s, 403(b)’s and 457 Plans changed the behavior of companies and their employees forever.
Up through the 1980’s, most companies managed their employee’s retirement plans for them through company sponsored pension plans. The employee was entitled to a guaranteed stream of income that would last the rest of their life and the amount of that income stream was determined in part by the number of service years the employee had loyally put in for their company. It was a sure thing, but because the companies had to ensure that the money was going to be there when their employees needed it, they managed the account very conservatively.
As the 1960’s and 1970’s came along, they brought new investment structures called mutual funds to the average person on the street. No longer did you have to be fancy or wealthy to invest in the stock market. You could buy a mutual fund and build your fortune from the ground up.
The popularity of mutual funds exploded and by the 1980’s the cry from the baby boom workforce was, “Give us the option to manage our own money!” They felt that they could make it grow faster and amass a larger, more meaningful retirement account balance with the help of Mr. Market.
This shift in thinking started the decline in the savings rate in America. If you had previously saved 10% of your income at a conservative rate, now you could likely do just as well by saving less and earning more in your mutual fund. And some did! But, unfortunately, many did not.
Making money in the market can be tough, financially and emotionally. Companies who offered pension plans were more than happy to shift the responsibility for their employee’s retirement to the employees. It saved them money and relieved them of the ongoing liability involved with managing a heavily regulated pension account.
It seemed that as far as everybody was concerned, mutual funds were THE way to go and the masses embraced them with enthusiasm. The only problem was, very few people understood what they were buying. This was new uncharted territory for them. The terms were unfamiliar. There were penalties if you did something wrong, and the wide array of investment options were hard to digest. Nevertheless, the financial experts touted the many benefits mutual funds provided, which is true - they do provide some very valuable benefits. But without a safety net under them, more and more people felt like they were coming up short when it came to being prepared for retirement. The old fashion company sponsored pension fund died a quiet death, and today less than 30 of the Fortune 500 companies in American still offer a pension to their employees.
So money flowed heavily into mutual funds off we all went hoping for the best. The desire for growth, which is really fueled by greed, pulled us farther and farther away from shore in the late 1990’s and when the dot com bubble burst in 2000 and the tragic event of 9/11 occurred just a year later, the financial impact was devastating. Fear returned to the market and overshadowed the greed that had prevailed for so many years prior.
For the first time in a long time, people were looking for a safer place to put their money and that’s where traditional savings accounts came back in style. But here’s the thing – they never really were out of style for those who understood the differences between savings and investments. They sound similar, but they are very different in the way they behave. They also play different roles in your financial life – and you need both in order to be truly successful. The not so good “good old days” If we rewind the clock all the way back to the 1920’s, we’ll find the seed of change that have influenced 100+ years of financial thinking – so, let’s go there and see how all of this started.
Back in the roaring 20’s a person could buy a dollar’s worth of stock with only about 10 cents of their own money. The rest of it could be borrowed in what is called a “margin account.” These margin accounts provided enormous leverage for investors and boosted the stock market to record highs until things began to fall apart in 1929.On October 28th and 29th of that year the stock market lost almost 25% of its value causing panic among investors. Because of the high leverage they had in their margin accounts, the stock exchange required investors to make additional deposits to keep their debt to equity ratios in line with the exchanges policies, which meant either deposit more money fast or sell your investments to raise cash.
Naturally, no one wanted to sell their investments after such a steep drop, so investors flooded the banks to transfer their savings over into their brokerage accounts. When the regular people who weren’t rich enough to invest in the stock market saw the rich people in their town who were investors withdrawing large sums of money from the banks, they got worried. After all the stock market just crashed. Could the banks be next? What did the rich, well-informed people know that they didn’t know?
Just to be safe, and so as to not be left out in the cold in case their worst fears came true, many people all over the country started pulling their savings out of the bank too, which soon caused a run on banks everywhere. Those banks needed money and about the only way they could raise money fast was to go to their mortgage holders and call in their mortgages.
Can you imagine getting a knock at the door and having your banker inform you that your mortgage is due in full by the end of the month? That’s exactly what happened to tens of thousands of people. And just like it would be for most folks now, the vast majority of people couldn’t pay their mortgage off on such short notice. So that meant the bank foreclosed on their home and tried to sell it to raise cash.
The end result of this financial chain reaction was that thousands of innocent, hard-working people lost their homes. By 1933 roughly 4,000 banks had also failed taking $140 billion in deposits down with them. It was bad enough that good people had been kicked out of their homes for reasons beyond their control. Customers were even more horrified when they found out after the fact that their bank had been investing their deposits in the stock market. That market continued to drop and lost 90% of its value before it finally running out of steam.
People didn’t trust the stock market after that and they didn’t care much for those “crooks” down at the bank either. If they had not been directly impacted by the bank calling in their mortgage, almost everyone knew someone else who had been. And, because so many people didn’t trust the banks to hold their money, they resorted to hiding it in tin cans and burying it in the back yard. They felt better sleeping on their savings, literally with it under their mattress or in the mattress, than leaving it at the bank. And this practice didn’t stop when the Great Depression ended 12 years later. There are still tin cans hidden in sheds, walls, floor boards, and attics all over the country.
The Tin Can Theory
So now that you have the background, let’s talk about now the Tin Can Theory and how this applies to your savings today.
Let’s imagine that you have 3 buckets to choose from with your savings. There’s a Mutual Fund with a 10% rate of return, a Savings Account with a 3% rate of return, and just for sentimental reasons a Tin Can with a zero rate of return.
Okay now let’s think back over the last 10-15 years of your life and use your specific situation as our point of reference here. In your specific situation, let’s say you were putting $100/mo. away in each of these three buckets for retirement with the only stipulation being that when you put the money into the Tin Can, it had a lid that closed so you couldn’t withdraw the money back out.
Now over in the Savings Account the $100 each month you’re saving is designated for retirement, but if there was an emergency or something came up, you could withdraw some of the money from it. The same goes true for the Mutual Fund Account. Again, the goal is to save it until retirement, but if some emergencies come up, you could pull money from those 2 accounts. Make sense?
Alright, so based on your specific situation – your actual, real situation over the past 10-15 years, in which one of these savings vehicles would you have the most money? Here’s where things get interesting.
If you’re a save to spend family, I’m guessing you probably answered the Mutual Fund would be the most valuable account. You’re likely motivated by the hope of higher returns because your spending habits often require it for you to reach your shorter-term goals. Even though this exercise was focused on a longer-term goal, if we are looking at your actual situation over the past 10-15 years, it’s highly likely that you’ve dipped into your accounts more than once to fund other things that have come up. And if so, the Tin Can would have probably had the most money in it because you couldn’t touch it.
A save to save family welcomes the Tin Can more than the mutual fund, because even though it doesn’t offer a rate of return, they know where it is and that it will be there for them when they need it in retirement. It’s like the philosophy of the Millionaire Next Door. If you haven't read that book, I highly recommend you read it when you’re finished with this one. It talks about how you would never recognize most millionaires because they aren’t flashy spenders. They save to save – and most of them have never put a dime of their money into the stock market. They didn’t build their fortunes chasing higher rates of return. Instead they cared about the return of their money, rather than the return on their money.
I want you to know about the Tin Can Theory for a couple of reasons. First, it can help you better recognize your own spending habits and make changes if and where they’re needed. The second reason is to get you to understand that there is a relationship between risk and return. You usually can’t control the rate of return, but you can always control the level of risk you take with your money.
Wrapping things up
Alright. I hope you found that helpful. Were you able to identify what type of saver you are? That’s the first step, you know. Adopting save to save habits is one of the most beneficial things you can do to build your financial future and pay for college in a more comfortable manner. The colleges love to see that you have savings. In their minds, they feel you’ve done such a good job saving, you probably don’t need any money from them to help make college affordable. Like I said at the beginning of this article though, my experience is the people who have done a good job saving want to retain control of that money and only use whatever is necessary to pay their fair share of the bill. That’s where working with an experienced College Planning Specialist is essential to helping you get the most merit scholarships possible and take full advantage of any tax breaks that are available for you related to your college expenses.
If you’re not a save to save kind of person, but you’ve identified instead that you’re a save to spend kind of person, that’s okay too. Working with the College Planning Specialist can help you set your spending goals and take the correct steps necessary to reach those goals on time too. You may be able to use a combination of merit-based scholarships and need-based grants to supplement your savings and cash flows. That could greatly reduce your dependency on debt, protect your home equity, and help you get the biggest bang for your college savings dollars.
If you have any questions about the tin can theory or about how your savings will come into play in the college financial aid formula, let me know. Getting this part of the process right can make a huge difference both in the outcome of your college plan and your ability to enjoy the experience along the way.