My 1st Million At 33 – yes, you can do it too

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  • My Advice To Accumulating Wealth in 20s thru 50s

    Posted by Frugal on July 15th, 2006

    Once you create your wealth by having a good job or owning a business, and start to have money coming in, you can then slowly build your wealth by accumulation. The primary vehicle to accumulate a substantial wealth is obviously through savings. Yes, through savings. You may not want to believe it. But the old fashioned and traditional way is the way, and the primary way.

    However small the monthly saving is, a persistant saving that is multiplied and compounded through 30 years can become a large sum. For example, a saving that is compounded at 6.0% APR after 20 years gives you a multiplication factor of 462.04 (instead of 240), which also means that for every $1 you save today, it’s really $1.93 twenty years later (Of course, this is the part of good news about compounding the savings; see the bad news about compounding inflation in the next advice to preserving wealth in 30s thru 50s). Irrespectively to inflation or not, saving is the very first step to wealth. Withou savings, you are always at the origin on the number line, at zero. With some savings, at least you are moving positively forward. So how does one save money without pinching pennies and driving oneself crazy? What is the proper balance between saving & spending money? How does one properly budget one’s expenses? These are the questions everyone ought to ask himself or herself.

    There are no right answers to the these questions. Saving money is a personal choice. You can find my own answer to the proper balance between saving & spending money in the Definition of Being Frugal. I also have an article on How to Budget. But the bottom line of the process of increasing your wealth is (from Steps to Wealth)

    Saving = Income – Expense
    Networth = Asset – Liability
    Accumulating networth is a process by which one controls the expenses and trickle down the savings into growable assets, while reducing liability.

    Because the everyone’s income and spending needs are different, I don’t really think that anyone should have a saving goal as a percentage of their income, whether it’s 10% or 20%, unlike suggested by many personal finance books (see my comments for the mathematical version of the explanation). Just because you can spend more, doesn’t mean that you should spend more. Vice versa, just because you cannot save more, doesn’t mean that you should strangle yourself for that extra dollar or penny. It’s simply not realistic to apply the same rule to everyone. And it’s also the same thing with your saving goals. I don’t think everyone should use 1 million dollar for their saving/networth goal either. If you’re a medical doctor, or a lawyer, you may use a saving goal higher than a million. If you’re the average US household, I won’t advise you to use 1 million dollar for your saving goal at all. Why? While it’s feasible to reach 1 million dollar (not adjusted for inflation) for the networth eventually, it simply does you no good to set a goal that may be reached after 30 or 40 years of hard work. Setting a goal that can only be accomplished that far out will simply drive your mental mind sick of reviewing your progress towards the goal. Every month or year when you review your goal process, your mind will tell you that “boy, I’m so so far away from my goal. Why am I bothering to accomplish it at all?” Eventually, you will quit from even trying to accomplish your goal even when it is possible. I know of no one who can happily and objectively review their goal when the goal may only be accomplished after 30 or 40 years. Human mind just doesn’t work that way. You need to “feed candies” to nurture your mind. Setting a goal just for 1 year is much better. If you don’t know how much you can save, you should start with a monthly goal. If you can achieve your monthly saving goals, you can up your goal by a little more, and set up a goal for the following entire year. Little by little, your mind can be satisfied with being able to reach your saving goals in small steps. Then it is possible to discipline your mind to carry out your daily struggle between the choices of saving & spending, fighting against your desires for immediate gratifications. If your mind does not get this constant positive feedback of reaching your near term saving goal, you can pretty much expect it to retire from trying. It’s simply human nature. Why bother, when you think you can’t even reach it? In fact, if your mental mind cannot be satisfied with the abstract satisfaction of reaching a saving goal, I would even go as far as suggesting people to allocate a 5% or $50 (or whatever number that is suitable to your situation) to simply materially reward yourself/family. Yeah, a sweet bonus waiting for you at the end of month or year after all the hard work of saving money frugally and diligently. An extra and regular festival on reaching saving goals may set you back a little, but hey, it’s really a million times better than not saving at all. Alternatively you can also use an allowance system for everyone in the family. This system works the best when not everyone in the family is on the same page on signing up the saving goal. An allowance system for kids, and also husband and wife, gives each of the family members a personal space allowed by the allotted money which can be accumulated on an individual basis for a bigger individual spending need.

    Savings can be done in various forms, not necessarily in your bank account. You can also save by paying down your mortgage debt under the regular amortization schedule, if you own a home. The amount of principle that you pay towards the mortgage balance is your true saving. Obviously, if you have those interest-only or negative amortization loans, you won’t be saving anything in your home, but rather may even be building additional debt when you negatively amortize the loan. Often, paying down your mortgage according to amortization schedule is the most practical way of saving, since you need to pay your rent in an alternative case anyway (see Why Is Your Home the Best Investment). Of course, you need to carefully evaluate the decision between rent vs buy carefully in this housing market. If the mortgage payment on a 30-year loan using a 20% down payment is much bigger than prevailing rent, I am not so sure that buying a home will turn out to be a wise decision. To carefully evaluate your personal situation, you can use my Rent vs Buy Calculator and compare whether you will come out ahead financially by buying a home (or investing in a second home).

    Another very good way of saving money is utilize your 401K or IRA account. The money you save in your pre-tax retirement account gets an immediate boost of some 15% to even 45% simply due to your combined marginal federal and state tax brackets. Besides, your money can grow tax-free. Tax consideration is the primary benefits for pre-tax accounts. Unless you have very substantial assets in the pre-tax accounts, and that you’re expecting a higher tax rates than your current year tax rate, otherwise, most of the time, you could take tax advantage and build up your pre-tax assets. Roth IRA is a good alternative to consider when you don’t want to contribute to your 401k/IRA.

    At last, you should begin saving as soon as possible. When you just got your first significant paycheck from your first job, you may be celebrating your financial independence, and tempted to spend it all. But wealth must be accumulated, and accumulated through time. It’s obvious that if you are only 5 years to your retirement, and you just started saving for it, it’s simply too little too late. I’m not going to be a cheer leader for you. That is just the cold and hard truth. Definitely start early. Stages in life often don’t give you second chances to go back in past to save your money. Demand for spending your income will simply keep growing without stop. It’s always better to have money in the bank, than worries in the head.

    In summary, I advise (See my comments too for the mathematical version)

    1. Save as much money according to your own financial situation. Use short-term saving goal for smaller steps forward, and/or an allowance system if you need them.
    2. Save money in your home by paying down mortgage under a regular amortization schedule.
    3. Save money in your 401k/IRA accounts to take advantage of the tax benefits.
    4. Start saving as early as possible.

    At last, you need to do any longer term financial planning for your saving goal or retirement needs, you can try my Saving Goal/Retirement Calculator. The calculator is for realist, and may depress you with the cold facts. But that’s where the next article comes in, My Advice To Preserving Wealth in 30s thru 50s, hopefully to give you some tips on investing to combat inflation.

    P.S. The number of links to my own posts may seem excessive. But it simply shows how important I think savings is to one’s wealth.

    More related posts:
  • A Short Navigation Guide to My Site
  • Steps to Wealth

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    6 Responses to “My Advice To Accumulating Wealth in 20s thru 50s”

    1. traineeinvestor Says:

      Can’t argue with this advice. I particularly like the concept of using small achievable short term goals as a means of keeping on track for the longer term goal.

      The only thing I would add is that, while savings are the most important part of saving for retirement, the “what you do with your money” is almost as important. The difference between a return on investment of 6% and, say, 8% over a lifetime of savings can make a huge difference.

    2. John Says:

      Some people have 5% fixed mortgages. Compare that to 5% return on CD’s. And rates may rise a bit more. There are scenarios where mortgage paydown doesn’t make sense.

    3. frugal Says:

      Yes, investing is definitely important, and it’s in my next article of this Advice series.

      Sorry, I probably confused people by saying pay down. I meant the regular pay down under the 15 or 30 years amortization schedule. And definitely, at times like this, you should not pay additional amount towards your 5% fixed mortgage if you have one. I’ve made additional clarification in my original article.

    4. Doug Says:

      Frugal, I love your Blog site and the amount of effort and material you offer.
      However I don’t agree with your comment regarding savings goal by percentage of income; maybe your comment could be expanded to clarify….
      “I don’t really think that any one should have a saings goal as a percentage of income, wheather it’s 10% or 20%, unlike suggested by many personal finance books.”

      A savings percentage can be used as a good guideline which can be reviewed/adjusted annually with your spouse when reviewing family budget, etc. From this percentage you will come up with a specific savings target$$ for the month/year which I feel is a better way to come up with a savings number. Per percentage, it may actually force you/your family to seriously consider changing your spending habits or environment to increase the savings percentage as other more prepared families are saving more per their specific income/tax level.

      I guess, I simply don’t want to peg a savings number that may be too LOW for the family. I feel the dads/moms out there need to empower themselves to make the necessary changes to save for future childrens education, retirement, or health care costs.

    5. frugal Says:

      Doug, you have a good point. Using percentage indeed forces you to adjust your living expenses along with your income. However, the expenses are really not a linear function that crosses the origin. There are many circumstances that a family simply cannot cut more expenses from the budget. At that point, whether you have more or less income, it really doesn’t matter. You have to live/survive. Whether your income exceeds your expenses or not, you have to spend. Therefore, I view expenses as a function as A * X + B, where B is your absolutely basic essential expenses, and A * X are additional amenities or luxury that you can potentially adjust to your income level. I have no problems using a saving percentage for A * X term to adjust to your disposable income, defined as (After-tax income – B) . And now, it’s easy to adjust term A as a percentage.

      The problem is that it’s very hard to figure the value of B. It depends on where you live, and how many people there are in the household. The second bigger problem is that disposable income is often not much larger compared to B. In that case, it could be very painful to save using a percentage of your before-tax income number.

      I didn’t want to make this post too mathematical. But using math to explain my points may be more clear. Assuming your after-tax income is Y, and your savings is S, and your expenses are E = A * X + B = Y – S. Essentially, I’m suggesting to find and shrink your B (basic expenses). Then you should simply save pretty much everything of Y (after-income tax) – B, using a small value of A term from 0% to 20%. Let’s say you use A=0%, not spending anything beyond B, then your saving will be S = Y – B. Expressed as a percentage number, S = Y – B – A * X = (Y-B) * (1-A), when you make X = Y – B. In that case, your saving is proportional to your disposable after-tax income.

      Using my own expense budget as an example, I’ve pretty much cut everything to bare bone, without much amenity or luxury items. Most of the miscellaneous items are budgetted in to give the budget a healthy room (without driving yourself crazy). So if you sum up the expenses, it’s pretty much my B term. And I think that most people will probably have a bigger B term than I do. And then I simply save the rest of all the money minus allowances.

      In summary, I advocate not to use percentages for most family because for the median income family, Y is about the same or maybe 20%,30% larger than B. In that case, it’s better to focus your energy on reducing your B, than coming a with a A or the percentage number that simply fits into all the equations.

    6. Omar Lugo Says:

      What you’re trying to explain it’s the “Rule of 72″, you can find it on my Biz advisor: ,
      and also you forgot to mention that on 401k, people should not save more that they’re companies match, that they should match up the same percentage as the company is investing on, and after they quit or being fired, they can do a “Rollover” and put they money on a “Roth IRA”, but anyway if you knew all this by yourself, I congratulate you cause, you know how money works!!!