DevRaga Podcast Episode 1 - Power of automatic savings and compounding

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Dev Raga Persona Finance Podcast - Episode 1 - Power of automatic savings and compounding

This is a summary of the Dev Raga Personal Finance Podcast - The original podcast can be found here: Episode 1 - Power of automatic savings and compounding by Dev Raga Personal Finance • A podcast on Anchor.

Please Note: The material on this site, and in the podcast, is purely for educational purposes only. It is not intended to be financial advice. If you need advice regarding your personal financial circumstances, please see a financial advisor or financial planner. Please read the full disclaimer here before participating in this thread.

Hi everyone, my name is Raga! Despite being a Melbourne-based podcaster predominantly focussed on medical education (particularly general practice), one of my personal interests is in the field of personal finance. While I don’t claim to be a financial advisor of any sort, I believe some of the research I’ve conducted over the years into this area yields valuable insight into the alienatingly complex world of finance and I hope this podcast provides some benefit for junior and senior doctors who are understandably a bit lost in it all.

My motivation for doing this stems from the paradoxicality that there are so many junior and senior doctors who earn a significant amount of money from their jobs and are clearly intelligent, yet do not have the financial literacy in order to ensure their savings are well-kept. Hence, this podcast is primarily about automating your savings, and finding ways to maximise your returns on investments through techniques such as ‘paying yourself first’ and 'automatic compounding', which will be the focus of this first episode.

Before you delve into any of this, I once again stress that I am not a financial advisor, and these recommendations are not directed at individuals in any form of debt. If this is your situation and you need some advice, I’d recommend Dave Ramsay or the Barefoot Investor to help with debt management.

Biggest wealth building tool
It should come as no surprise that wealth is derived from income, and such income comes from the synergy of your education and level of skill. But let us not forget that you need to stay healthy so you can maintain that productivity to earn wealth. In Australia, the power of automaticity is perhaps best typified by superannuation, which guarantees (assuming you’re working in Australia) that your employer will pay 9.5% of your income into a super account, with the option of adding more. This money is of course, by design, not able to be touched until retirement, hence its classification as "automated". But superannuation is a whole different financial area which is outside the scope of this episode – I will instead by focussing on how to use this general principle of compounding to your advantage.

Pay yourself first concept
Traditionally, the way most people have dealt with finance is you first earn a wage and pay out all your bills to everyone else, leaving some funds as “leftovers” which you then classify as your savings. This concept has led to paying yourself last. The ‘pay yourself first concept’ reverses this, whereby you take your net savings of the month and take a set percentage of it at your own discretion, and instead put it into a savings or investment account before dealing with your bills. This repeats over and over creating an automated process which guarantees you a return on your income that compounds each year. This is money that you don’t see or use, but through this method it snowballs into greater savings, and you will get used to living on 80% of your income, with the payoff being delayed gratification.

Let’s do a little case study.

David is a full time working Aussie who earns on average $75,000/year. For the sake of this argument, let’s suppose we’re putting aside employer contributions and David is debt-free. David decides to take 20% of his net income using the ‘pay yourself first concept’ and puts that money into a well diversified stock portfolio, such as an ETF. After 30 years, assuming a conservative annualised return of 6%, David will end up with AUD$968,000. If David did this for 40 years he’ll end up AUD$1.918 million dollars. Notice how the extra 10 years makes a large difference.

Two main concepts can be derived from this example:
  1. Pay yourself first: invest after tax income
  2. Start early: delaying makes a huge difference to net wealth
The main justification for doing this is that finance is mostly behavioural, and about preventing impulsivity. If we assess the world around us, we have complex systems and rules we follow, and it is only logical that we should apply this to the world of finance. By taking out this money early, you’re restraining yourself from impulse spending which can be financially irresponsible.

Money you can’t see = money you can’t spend = money you can’t squander.

A simple way of doing applying this is if you get paid monthly on a Tuesday, then set up a plan that ensures that 20% is automatically taken away from your savings account and invested into a relevant savings account. Just put it away - where you put it is a secondary matter.

Additional advantages stem from the fact that this example assumes you won’t get a pay rise. Statistics support the simple fact that the income that 20% yields will rise alongside wage growth, promotions, and is irrelevant to the superannuation bonus. It is also discrete from personal assets, additional income or tax benefits. While inflation will eat away at your savings and net return regardless, the alternative of doing nothing solidifies your loss. Investing it is always the better option.

It should also be stated that the 6% rate of return is a conservative estimate. While I fully concede past performance is not causally linked to future performance, there is certainly a cautious correlation that can be drawn from the success of the Australian markets which have historically performed better much than this. Suppose you assume a 7% return, after 30 years you’ll have 1.169 million dollars, assuming the same 20% rule based on an average Australian wage. After 40 years, you’ll have 2.517 million, showing the rate of return exponentially increases your net worth and savings. Since 1900, the Australian Stock Market has grown by 9.96% per annum, and over that period, 95 of those years it’s been in the positive, and 22 years it’s been in the negative. We’ve had oil crises, world wars, disease crises, and numerous other global disasters. Yet, here we are in 2018, still going reasonably strong (this aged poorly).

If you’re uncomfortable with the stock market, you can take the 20% and put it into your mortgage offset account, to get an instant return that is tax free. If your mortgage has an interest rate of 5%, you can get a 5% instant return on any money you use to offset your mortgage.

In summary, paying yourself first can be extremely powerful. Especially if you’re young and in your 20s, be consistent and take away the emotion out of putting away your income. It doesn’t matter what percentage you put away, it’s the consistency that is key. Money that you don’t see is money that you don’t spend, and this method will (hopefully) yield great results long term.

That concludes my first personal finance podcast episode, and hopefully you’ve enjoyed it and found it as interesting as it was for me. Feel free to PM me on Facebook for any questions, and I’m perfectly open to have a chat with you.

But to finish off, I once again stress that if you’re seriously considering any of my advice, you should see a financial advisor first.
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