Picking up Pennies
“A penny saved, is a penny earned,” wrote Benjamin Franklin in Poor Richard's Almanack
Consider the Following…
America has ratcheted up its savings rate in the midst of this recession. Whereas increasing one’s salary was the dominant thrust of previous years, Americans are more apt to cling to what they take home nowadays. Don’t believe me? Check that link closer. People were spending MORE than they took home, pretty clear evidence the US was, on average, banking on a salary increase.
So what’s wrong with earning another penny? Nothing is inherently wrong with earning more money. The issue is the penny you save is superior to the penny you earn due to hidden (inflation) and non-hidden (taxes and levies) forces. In fact, for the hero of our article, one penny saved is .76366843 pennies better than earning another penny. Dang.
Joe Sixpack’s Salary
Allow me to give you a glimpse into the finances of Joe Sixpack (Joe Everyman’s cousin and Joe the Plumber’s client).
Joe makes $50,000 a year, and lives in California. His marginal tax rates are 9.55% state and 25% federal. He pays California Disability Insurance (SDI) at 1.1%. He pays Social Security tax of 6.2% and Medicare tax of 1.45%. At the margin, this adds up to a whopping 43.3%. (Yes, Social Security and Medicare technically could come back to him, as could the SDI. Run the numbers for me in comments if you want different assumptions)
Joe spends all $50,000 of his gross salary every year, but he decides he wants to be a penny in the black at the end of the year. (Maybe he isn’t so average after all?) Joe complains to his boss, and asks for another penny of salary. Does he have enough?
No. Joe would be better off figuring out where he can cut a penny out of his expenses, and throw that penny in the bank. If Joe’s boss gives him a $50,000.01 salary, he will have .567 pennies left at the end of the year. (That’s .567 cents or .00567 dollars, see here for a hilarious description) If Joe saves 1 cent from his previous $50,000 salary, he will have… drumroll… 1 cent. In fact, Joe’s salary would have to be $50,000.0176366843 in order to save a penny at his current consumption rate. I don’t know if his boss will go for that!
Joe Invests in California
Joe makes a bet that California will still be able to pay its municipal bonds in a year on January 1st. From the same article, it’s possible Joe find a bond yielding 3% annualized. His penny saved is worth 1.03 pennies at the end of the year. How many pennies is that worth? 1.81657848. The extra money is ‘Opportunity Cost’, or what Joe would have earned if he had invested the penny instead of waiting to earn it.
When a Penny Doesn’t Mean a Future Penny
What about inflation? Assume for a second inflation runs at 3%. If Joe invested that penny he saved on January 1st at 3% post tax (A Municipal Bond is exempt from tax), his 1.03 pennies of the future are worth 1 penny today. It gets worse. His pay (assuming it comes on the last day of December… he has a weird pay schedule!) is in future pennies. To factor in taxes, levies, inflation, and opportunity cost Joe has to get a raise of 1.87276132 pennies to keep up.
Don’t Get Greedy Joe…
I hope you enjoyed this article and took the points to heart. Your own situation is different, and you’ll have to run the numbers on your own to compare yourself to Joe. Americans are starting to realize saving is superior to earning, especially in a climate of declining or stagnant wages and layoffs. Don’t get bogged down in pennies, however. A quick rule of thumb is that you need to earn about twice as much to keep the same amount as if you had saved that amount. Looks like we’ll need to have Ben Franklin write a guest column at some point…
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