Alex Thomas Sadler, Clark.com
It’s no secret that many Americans have a bad habit of wasteful spending. While some people don’t realize just how much money they’re wasting (and all the ways they’re doing it), there are others who would simply rather have and spend the money now — why have money if you never spend it, right?
That’s true to a point — depending on your individual needs, goals and priorities. But here’s the problem with that attitude: it fails to consider the time value of money.
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How Americans are wasting $1.7 trillion in future savings
According to a study by the National Bureau of Economic Research, Americans are putting their current lifestyle (think new cars, vacations, expensive things) way above their future well-being — to the tune of $1.7 trillion. To put that in perspective, the total amount currently in U.S. retirement accounts is $14 trillion.
Economists call this type of irrationality ‘present bias’ — and according to the data, it and other biases (mindsets about spending and saving) are preventing millions of Americans from saving enough money for their future. People with ‘present bias preferences’ typically intend to save more in the future, but never end up getting around to it. Sound familiar?
Even those who do end up saving at some point later in life, when many of them reach retirement, they don’t have nearly enough saved to maintain their desired lifestyle. And in fact, more than half of Americans are at risk of not even being able to afford the essentials in retirement (housing, food, health care).
Read more: How to stop wasteful spending
Why it matters and what it means for you
This doesn’t mean people shouldn’t take vacations or splurge every once in a while. The problem is having the mindset that you can always save later, because you’ll probably find that later never arrives, or when it does, it’s too late.
The idea of ‘present bias’ means people aren’t thinking about their future needs and aren’t balancing priorities to consider both current and future happiness. And a big part of what’s holding people back is that they aren’t taking into consideration the time value of money.
Compound interest is an extremely powerful force that allows investors to earn exponentially larger gains on their money over time — so the money you save now is actually worth a lot more than the money you save later.
Here’s a simple example: You invest $1,000 today and earn an annual 5% gain, so $50. That $50 is added to the principal amount of your investment, and then next year, you earn a 5% gain on $1,050, so you earn $52.50. And so on…
So the earlier you start putting money away in a retirement account, the more time it has to earn you a lot more money. If you keep telling yourself you can always save later, and even if you do contribute a lot more later than you would now, that money still wouldn’t have the time to grow like it would if you saved now.
How to change your spending habits
It’s difficult to change your mindset and spending habits overnight, but if you take a step back and think about what your priorities are — for now and down the road — you can set yourself up for a much better financial future. And this applies for shorter-term goals as well, like maybe buying a house or saving for your child’s education.
One easy way to start changing your habits is to make saving automatic — for both short-term and long-term savings.
If you feel like you have no extra money to spare, start by contributing just 1% to your 401(k). The money will come out of your paycheck before you even see it in your account — and 1% is such a small amount that you won’t even miss it. Then every six months, bump that up by another 1%. Then in five years, you’ll be saving 10% of your income toward retirement — and the increases are so small that you’ll be able to adjust your budget over time.
You can do the same for your other savings goals. Once you’ve figured out what those are (emergency fund, buying a house, buying a car, a big vacation), set up your direct deposit to have the money automatically deposited into your savings account(s). That will allow you to save for each of your goals without being tempted to spend the money on something you don’t really need.
More resources to help you start saving more: