The ABCs of Amassing Long-Term Wealth
By Jeff Greenspan, Managing Director, Financial Modeling Services
What does it take to retire wealthy? This is a very personal question, but it is not that difficult to devise a plan for achieving financial security. It is, however, sometimes difficult to stick with it! You need three things:
- Time: The more time you have, the less discipline and income you need.
- Discipline: The determination to invest even when you’d rather buy a new car or take an expensive vacation.
- Disposable Income: The more disposable income you have, the faster you can reach your goals. But even a small amount of income, properly invested, can grow into a large nest egg.
A formal approach to long term investing requires two pieces of information: your tolerance for risk, defined as your emotional ability to tolerate large swings in the value of your investments; and some idea of how much annual income you want in retirement. There is a great deal to be gained from the formal approach, but I suggest the most important factor is just getting started.
So GET STARTED. Here are the ABCs of amassing wealth.1
A. Pay Yourself First - I suggest that you allocate 10% of your earnings toward retirement investing. That money goes towards:
- An emergency savings fund of 3-6 months living expenses, in the bank, in a high-yield savings account. Once that bank is “full,” we invest in
- Your employer’s retirement plan, IF it has matching. Many employer’s will match 2-3% of your income, and you should take full advantage of this. If your employer’s plan is a “Roth” plan, put your full amount here. Roth accounts allow for tax free growth and tax free withdrawals in retirement, so they are the best thing since sliced bread. See The Stock Market: The Basics of Investing for more specifics on investing. If/when you’ve maxed out the Roth, money goes to
- Real estate. Technically it goes into the high yield savings account until we can deploy your “capital,” but it will be invested in real estate, an asset class that is considered less risky than the stock market but has had good returns over the long run. More details are below.
B. Make a Budget - This is a step that requires discipline but really pays off if your money is tight. After you have paid yourself, how much is left. You have to live on that amount or less for the rest of the month. This often requires difficult decisions and delayed gratifications. Sorry, that’s the price most of us have to pay to retire comfortably. [By the way, if you are not willing to pay the price, I’m OK with that! Your life, your choice.] For more information on Budgeting, check out Investopedia.
C. Keep Track of Your Money - Mint.com is a free tool that you can use to track your spending. Quicken is the tool I personally use. The tool is irrelevant; the process of tracking your money is priceless. Record all of your money flows (both in and out) once per week. Perform monthly reviews of your spending and compare to your budget. Track your Net Worth quarterly2. This step also requires discipline but will give you a sense of control and purpose.
D. Pay Your Credit Card in FULL Each Month - More discipline! If you can’t afford to pay off your credit card in full shortly after the statement cycle ends, you can’t afford whatever it is that you bought. Debt is OK when it is used as a tool, otherwise it is a drug that results in your giving your hard earned money to someone else. When is debt OK? IMHO, debt is acceptable when you buy a home. If you have to finance a car with debt, it had better be a used car and it had better be at least three years old! Debt must also fit within your budget!
E. Invest in Future Income Streams - Investing for retirement is really the process of creating one or more income streams for your future self. Current income streams typically come from your direct efforts (i.e., a job). Retirement income streams should not depend on your work, so they need to come from investments (assets) that create income3. The asset classes that are traditionally used to create income streams include dividend paying stocks, bonds, annuities, real estate, and business ownership. Business ownership has a number of interesting advantages if you can handle the level of sophistication and effort required. Real estate, on the other hand, is relatively easy and carries significant tax advantages.
Here in a nutshell are my suggestions for developing wealth through real estate.
- Buy your first property as soon as you can do so without breaking your budget. This property (and many others) will eventually become a rental property, so follow these guidelines:
- Look for lesser homes in nicer neighborhoods. Buy at the median level or below, because there is more room for appreciation.
- Think like a renter when buying. Three bedroom, two bath houses are always good. Condos can be good if the condo association is well managed. Consider the schools in the area and other locational factors.
- Plan to live in the house for 3-5 years maximum.
- Use Net Present Value to select a loan (see Picking the Best Home Loan or Refi).
- Double down on step A3! Save as hard as you can. Buy your second property when you can put 20% down.
- Repeat step 2! You are aiming for 5 or more properties. Why? When the first property’s mortgage is paid off in 30 years, that property’s rental income becomes a chunk of your retirement income, and you can start to decrease your workload. After 3-5 years, when the next property comes off mortgage, you get a raise!
F. Pick a Time to Retire - If you follow the ABCs laid out in this document, you will automatically know when you are able to retire. You will know how much money you need to live comfortably because you’ve been paying attention to your lifestyle for years. Add up the income streams available from your assets. If they total more than your lifestyle, congratulations! You’ve amassed long-term wealth.
Investopedia: www.investopedia.com/ is the first place I look for definitions and straight-forward explanations.
Forbes: Six Rules to Disciplined Investing describes the elements of a disciplined investment program
1 Everyone's situation is different, and the ideas presented here represent my opinion. If you act on them, the consequences are 100% yours. Please read our DISCLAIMER.
2 We can create a customized Excel model of your Net Worth for easy tracking and what-if analysis.
3 Assets can also appreciate (become more valuable), but that doesn’t create income until/unless the asset is sold. Yes, I know that some assets can be borrowed against. “Don’t interrupt me when I’m talking!” (Foghorn Leghorn).