The Truth About Getting Rich

Wealth is relative.  That is, people tend to consider themselves wealthy by comparing themselves to those around them.  The fact that most people today live healthier, longer and more comfortable lives than King Henry the Eighth is irrelevant to them.  They care more about where they stand compared to the people next door or the colleague across the hall or the persons featured in today's news.

This means you can feel rich only if you have more wealth than others around you.  That, in turn, means you have to be different from most people.  You can't be just like everyone else and yet be wealthier than everyone else.  But if you see yourself as just an ordinary, middle class person, does that mean you haven't got a chance to be wealthy?

No.  You can be wealthy.  While some wealthy people inherit their riches, most millionaires get there on their own by saving more.  It helps if you earn more.  You'll have more money to work with.  But earning more helps only if you save more.   If you spend all your above average earnings, expect to dine on dog food in your retirement.

You have to resist temptation to spend.  An 856 inch big-screen TV and a 4,300 horsepower SUV won't make you wealthy.  The same goes for $700 shoes and $1,200 handbags.  You have to be comfortable with fewer European vacations and plenty of home cooking.  When people laugh at your frugal ways, you have to focus on getting the last laugh.

Most people won't make it.  They won't become wealthy.  That's inherent in the definition of wealth as a relative concept, and it's also a result of the human tendency toward conformity and group think.  But plenty of middle class people end up having comfortable retirements or better.  In part, that's because of social welfare programs like Social Security and Medicare.  But these programs alone don't provide a good retirement.  You must be responsible and save.

What to do?  It's not complicated.  The main thing is save early, often and in significant amounts, like 15% to 20% of your income.  Invest in a diversified portfolio to increase your chances for good long term returns.  (See http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html.)   There are a variety of ways to build up your wealth:  http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html.  Look at each dollar you receive as a saving opportunity.  Remember that no matter how much money you make,  in the end you will have a finite income (we all do), and what you spend can't be retrieved.  It's gone. So don't waste that opportunity to save (see http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html).  Avoid debt as much as possible (see http://blogger.uncleleosden.com/2010/07/why-you-should-avoid-debt.html).  Don't give up, even if you have financial setbacks.  Like so many other things in life, quitters aren't winners when it comes to building wealth.

You can have a somewhat decent retirement even if you don't save much, by building up your benefits and eliminating debt. (See http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html).  But if you want to climb into the ranks of the wealthy, be different.

Managing Personal Risk

Modern businesses put a lot of effort into managing risk.  They take risks, because that's how they might make big money.  But they also work to mitigate the downsides of their risks, because employee stock options don't pay off real well if the CEO, or someone or something else, blows up the business.

Individuals need to manage risk as well.  Bankruptcies most often result from unexpected problems, like a medical crisis or job loss.  If you don't deal with the ways that life can fall apart, the chances of your life fallling apart increase. The need to manage personal risk may be one of the most under-appreciated aspects of financial planning. While there's no perfect or complete way to analyze personal risk, here are some things to think about.

Age.  As you grow older, reduce risk.  If anything goes wrong, you will have less time to recover, and less ability to recover as your value in the labor force declines (and it eventually will).  There are variety of ways to reduce risk discussed below.  The important point is that as time passes and you accumulate more gray hair, reduce personal risk.

Occupation.  Your occupation can be a major risk factor.  Some types of work can't be performed by older people.  This would include construction, law enforcement, military service, fire fighting and other jobs that demand physical strength and endurance.  It could also include jobs that don't demand physical strength, but do require certain abilities that deteriorate with age, such as flying, working as an air traffic controller, or performing surgery.   If your job has a relatively limited time span, start building wealth at an early age and persist.  You may be able to have a second career when the first one ends.  But then again, maybe not.  Don't count on what's highly uncertain.  Assume your first occupation is all that you'll ever have and base your financial planning on it.

Employment stability.  If your job security is unstable, build up a large pool of savings to tide you over the rough spots.  A year's worth of living expenses, or more, in an emergency fund would be a good idea.  If you work in a boom-bust industry, like construction or oil and gas drilling, or an unpredictable job, like entertainment, your savings account is your best friend.  If you have to take on debts, or lose a car and/or house, because you didn't prepare for a layoff, your long term financial future may be cloudy.

Health.  Factor into your financial planning your health problems, especially any chronic ones you have.  There is no way to avoid having health problems, especially as you get older.  That's why having health insurance is so important--you will definitely use it.  Also have some savings available for health care expenses not covered by insurance--these expenses are one of the leading reasons for personal bankruptcy filings.  If your health is good, save plenty because you may need to finance a long life span. 

Debts.  Debts are one of the most dangerous risks.  Jobs may not be secure, but debts, once incurred, are a certainty.  If you're poor, but debt free, you won't end up in bankruptcy.  Poverty doesn't lead to bankruptcy; unmanageable debts do.  But debts are also one of the most controllable risks.  Avoid taking on debt unless it's really necessary.  Pay off debts as quickly as possible, especially as you get older.  A mortgage-free house is better than a sleeping pill.  There are some financial planners who will tell you to have a mortgage and invest your cash in stocks.  Well, if stocks maintained a nice, steady upward trend all the time, this might well be a smart move.  But if stocks are sometimes volatile--well, some people do manage to eat dog food.  Avoid debt and you avoid risk.

Moral and voluntary obligations.  Lots of people help their kids pay for college--and then help some more when the kids rebound home after graduating.  Many help their aged parents.  Quite a few help siblings, nieces, nephews, friends and so on when the going gets tough.  If you are likely to accept these obligations, manage your finances to be able to meet them.  Being nice can be a major financial risk factor. 

Riskiness of your assets.  This isn't quite the same as asset allocation.  This is preparing for things to go wrong with your choice of assets.  Don't think your allocation is necessarily right.  Almost no one predicted the financial crisis of 2008 and hundreds of millions of savers worldwide got a big tummy ache as a result.  If you really think that you and your financial planner have it all figured out, contact me about buying a very nice bridge in Brooklyn, and at a bargain price, too.

But back to the first point.  Stress test your investments (see http://blogger.uncleleosden.com/2010/11/stress-test-your-retirement.html).  If you are uncomfortable with the potential losses you could incur, change your allocation.  Of course, no matter what you do, you'll end up with some kind of allocation.  The important thing is to end up with something that you can live with on good days and bad.  

Insurance.  Only Congress is less popular than insurance companies.  But having some insurance coverage is important to mitigating risks.  We've already covered health insurance.  Have homeowners or renter's coverage.  Maintain plenty of liability coverage on your auto policy, and buy an umbrella policy if you have a significant net worth.  Get disability coverage (first check to see what your employer offers, and supplement it if appropriate).  If you have dependents, like minor children, buy life insurance.  Think about long term care coverage if you have significant assets.  Granted, writing a check to an insurance company feels like eating sawdust.  But if life takes a u-turn, it's comforting to be able to forward the bill to an insurance company.

Boost your benefits.  Work as long as possible to build up your Social Security credits and any pension benefits for which you are eligible.  Okay, Congress, the White House, City Hall, the boss, or somebody is always threatening to trim or take away these benefits.  But they will very likely survive in one form or another, and you benefit from maximizing them because they may offer the best shelter available when cold economic winds blow.

Little Money Secrets

Little things can make a difference in money matters. Just as small adjustments to a swing can change a golfer's game or a batter's average, paying attention to a few details can make you better off financially speaking.

Calculate your net worth. This is the most basic thing you can do. At least every three months, figure out where you stand. If you don't keep score, you won't know how well you're doing and whether or not you're making progress. You can't do any financial planning without knowing your net worth.

Reinvest dividends and interest. Rolling your investment income into new investments allows you to compound your earnings. The leverage from compounding over time is astonishing (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html). If you reinvest your investment income, you'll have a more reliable source of growth in your wealth than stocks, gold, oil or any other asset class.

Sweep excess income into savings. Let's say, near the end of the month, you've been true to your budget and have some excess income from your last paycheck. Sweep the excess income into a savings vehicle. The savings vehicle can be a savings or money market account at a bank, or a money market fund account. As funds build up in the savings vehicle, you can transfer them to a mutual fund or other longer term investment, if you like. But the point is to get them out of your checking account, where they may be viewed as immediately spendable, and into the category of savings. Resist the urge to view excess income as mad money. Sweeping even small amounts adds up. If you sweep $50 a month, on average, after one year you'll have $600. After ten years, you'll have $6,000, plus investment returns. After twenty years, the total will be $12,000. With investment returns, it might have grown to $20,000. After thirty years, you've swept $18,000, and investment returns may have made the total $30,000 to $40,000. Remember that this is in addition to your 401(k), IRA and other retirement accounts. Little crumbs can be made into crumb cake.

Focus on saving. Too much time and energy are devoted to searching for the ideal investment strategies, and not enough to saving as much as possible. There is no way to pick the optimal investment strategy for the next five years, let alone the next thirty, forty or fifty, because no one can predict the future with certainty. Look at the past five years if you think otherwise. People who save more have more capital to invest and diversify among different asset classes. People who save only modest amounts may find themselves taking big risks in order to ensure a comfortable retirement. The Great Recession has taught us that taking large risks doesn't always yield high returns, or any returns at all. Saving more, and moderating risk, is a smarter long term strategy.

Avoid debt. This is the biggest secret of all, because, judging from the growth of consumer debt in recent decades, so few people seem to understand it. Since most people borrow money to consume, they get no financial return from it. It's a pure cost item, with the repayment of principal and interest coming out of future income. Of course, most people need to borrow to buy large items, like a house, an education, or a car. But borrow only when you must and when there is an important reason. You have a finite lifetime income, and the more of your finite income you devote to debt repayment, the less you'll have for everything else. Why enrich banks? (For more on this point, see http://blogger.uncleleosden.com/2010/07/how-to-think-about-saving.html.)

In baseball, most hits are singles, even for Hall of Famers. The same is true for financial planning. Apply these little secrets, and your golden years will likely glow more brightly.

Why You Should Avoid Debt

Many voters are clamoring for the federal government to reduce its debt levels. There are a few simple, bottom-line reasons for all of us to avoid borrowing, and to pay off the debts that we have.

You can't go bankrupt if you don't have debts. You can be poor. You can have a modest lifestyle. But you won't have to plead with debt collectors, seek out credit counselors, get painful scowls at the Bank of Mom and Dad, or file for bankruptcy.

You can't lose your home if it's not mortgaged. Pay off your mortgage, and no bank will have a reason to foreclose. Whether you're gaining equity or losing it, you won't go underwater. Of course, you have to keep paying property taxes and similar assessments. But if you have the money management skills to pay off your mortgage, those other obligations will be easy.

You won't have to sweat your credit rating if you don't borrow. For obscure and arcane reasons, your credit rating can fluctuate from month to month. It won't matter if you're not trying to borrow.

You'll live better in the long run if you spend less on interest payments. Why enrich banks? Pay less interest and you'll have more money to buy stuff.

You'll have a more secure retirement with no debt. Once you're on a fixed income, debt can be a real monster. Retire your debts and your retirement will be better.

It's hard to avoid borrowing for some things. Many can afford college, cars and homes only by taking out loans. But keep the borrowing to a minimum, and pay off the loans that you have as fast as possible. You'll enjoy the peace of mind.