Monday, 4 April 2011

Save £10 a day - it's worth £70,000 (or more)!

A fundamental part of the DIY Income Investor approach is to constantly re-appraise (and hopefully reduce) your living costs because:
  • a) it reduces the (eventual) amount of income you will need from your savings/investments
  • b) it allows you to save even more
This process helps to generate more speed on the Money Snowball - that almost magical process that probably has to be experienced to be fully understood.

But how can I claim that such a relatively modest daily saving will result in such a large figure?

I'm trying to make a point  - obviously - so bear with me.

To keep the numbers simple, let's assume a rate of return (or interest rate) of 5% per year (you could earn that from the pick of the 5% dividend yield shares). That means that to generate £1 in 'passive' income you would need savings/investments of £20.

So, if you needed your savings to generate an income of £15,000 a year (say, to supplement your pension or other income), you would need to have saved £15k * 20 = £300,000 - a tidy sum. To appreciate how substantial that is, consider that over, say, 20 years you would have to save around £15,000 a year (a bit less, actually, as you would be earning interest on your savings), which is a lot of money to try to put aside.

However, let's say you are able to permanently save £10 a day in living costs. Over the year that would amount to 356 * £10 = around £3,500 (rounding down to keep the numbers easy). How much capital would you need to have to generate that income? Using the 5% rate of return above, the capital sum required would be £3.5k * 20 = £70,000.

That's a pretty big chunk of the £300,000 we calculated earlier (nearly a quarter), generated through a relatively small daily saving. That would mean that you would only need a capital sum of £230,000, requiring over 20 years £11,500 of savings - a 25% reduction (on the assumptions we've used).

But there's more. If you save that £10 a day you will have saved £3500 over the year, reducing the amount that you need to save elsewhere from £11,500 to £8,000 a year (over 20 years - remember). This is total reduction in the annual savings required from other sources from £15,000 to £8,000 or nearly half the required savings. 

All from saving only £10 a day.

So, if I've convinced you - how could you save £10 a day? As a starter, here's 50 things (almost) not to spend your money on.

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.