[jIM_Ohio]

Originally Posted by jeffrey

You probably all know the story of the Ugly Duckling. In summary, the Ugly Duckling was pushed aside and ignored because the others on the pond didn't take the time to understand that the Ugly Duckling was in reality a baby swan. It was only much later, after the Ugly Duckling had grown-up, that all could see he was one of the most beautiful birds on the pond.

Let's be perfectly honest. "Saving Money" is the ugly duckling of the personal finance world. It has no respect. On the elementary school playground, it would be the last one picked for the ballgame. In baseball, it would be the out of the way minor league team. When financial news is being set for programming, it's the filler if there is nothing else that day. While all the other personal finance glamor areas fight for the spotlight, the saving money Ugly Duckling goes about his business in the background, ignored and misunderstood for the most part.




It's not difficult to see. All you need to do is think about it. When is the last time you went to a gathering where all the people huddled around each other were passing along the latest news about saving money? Now how many groups were there at the same event discussing the latest and greatest stock picks or other "hot" financial tips?

While stock and bond investing have their place, it's with Ugly Duckling investing that everyone should start. To show why, let's take a look at how an Ugly Duckling investing system compares to the big league glamour of stock investing. Let's say you have an extra 30 minutes a day that you can devote to either helping yourself save money or to learning how to invest better in the stock market.

For the sake of ease, let’s assume that for the ten year period in question, the S & P 500 returns 10% annually and both people start out with $10,000.

Let's say that putting that 30 minutes to work learning to save money will produce an extra $100 each month you wouldn't have had if you had not spent the time studying and implementing ways to save money (this is an extremely conservative number for most people to achieve).

Now let's also assume that the knowledge you gain by spending that 30 minutes studying how to invest will produce a return 5% higher than the S & P 500 (a number that any stock investor should be more than happy with over a 10 year period). How do the numbers come out after 10 years?

If you do a straight calculation, the person starting with $10,000 a year while adding $100 a month that he saved would end up with $47,555 after 10 years (assuming he invested in a S & P 500 Index Fund and added his $100 in savings each month to it). The person who improved his investing knowledge to achieve a 15% return ended up with $3,000 less at $44,402.

While this in itself should show the power of Ugly Duckling investing, to truly see the impact that it can make, let's do the calculations with a more realistic scenario. Instead of straight calculations, let's add a federal tax rate of 25% and state tax rate of 6% into the equation. When you take these into account, the difference in savings at the end of 10 years comes to over $8000 in favor of the saver($41,147 versus $31,906). Much of this is because while all the gains by the stock investor are taxed, the $100 saved each month is post tax dollars.

For those who are just beginning to invest, the best investment you can make is to learn to save money. While saving money may be an Ugly Duckling in the personal financial world, if you embrace the approach, you'll have a retirement account that is a beautiful swan and the envy of the entire pond.

Adapted from the article Cinderella Investing

This appears to be funny math. 25% tax on a long term capital gain? I thought those rates were 10% and 15%?

If I invest 10k in a mutual fund returning 10%, after 7.2 years it's worth 20k. I would be taxed on 10k (20k-10k=10k). 15% of 10k is $1500 tax owed (assuming 15% capital gains tax rates). Tax only occurred at end (when investment is sold) at 15% long term capital gains rates.

If I save 10k in a money market fund yielding 5% annually, I must pay taxes on interest (at marginal tax bracket rates). $10,500 after year 1, tax paid is 25% of $500=$125 so balance after taxes is $10375. yr 2 tax paid $129/balance=10764.75. yr 3 tax paid 134/ balance=$11169, yr 4 tax paid 139/balance 11588, yr 5 tax paid 145/ balance 12022, yr 6 tax paid 150/balance 12473, yr 7 tax paid 155/ balance 12941 yr 8 161 tax paid/ balance of 13427.

Cash investment balance is 13427 with taxes paid of $1138.
S&P investment balance is 18500 with taxes paid of $1500

granted I did not factor in reinvested dividends for S&P (which are taxed at 10%/15%).

If you add more each month, those calculations are more complex, but will amplify the benefit of the S&P investment. It is always best to defer taxes, than to pay them along the way. Not to mention if I was a few hundred short of a higher tax bracket, the interest from the savings account might have pushed me to 28% or 33% tax brackets (and made S&P investment look even better).