This article originally appeared in the Winter 2023 issue. View the full issue here.
Building wealth is simple. But that doesn’t mean it’s easy.
Buy-now-pay-later makes it appealing to consume goods we can’t afford, while the temptation of getting rich quickly can lure you into trading crypto on obscure Reddit tips. You may think complicated financial products and strategies will bring fast wealth, and while that can occasionally be true, it certainly isn’t for most of us. Instead, follow a few simple rules that will guide you in making good decisions in the complex and uncertain environment of money and investing.
Why do simple rules work so well? They provide clear solutions to complex problems, reduce the need for precise logic and calculation, and maintain a bias for action.
Economies, markets, and companies are complex. Successfully implementing investment strategies that predict and time the ebb and flow of markets is challenging, even for experts. Following a simple, understandable investment strategy keeps you from having to predict how monetary policy, geopolitics, and the balance sheets of thousands of public companies will affect your investments.
All financial decisions occur in an uncertain environment. Talking heads in the media may speak as if their forecasts are a certainty but that’s an illusion. Only in hindsight do we have certainty. Simple, flexible plans that account for the most likely contingencies allow you to act and adjust accordingly as the uncertain future unfolds. These simple rules can serve as foundational principles to help you in your wealth-building journey.
Save Before Spending
Save and invest 15 to 20 percent of your earnings before you ever have a chance to spend it. Calculate what your monthly expenses are (everything from mortgage to food to car payments and more). Start by saving three to six months of monthly expenses in a liquid and accessible emergency fund. You deal with emergencies every day so you know they happen. Not having enough cash on hand to deal quickly with stressful situations only compounds the amount of anxiety you feel.
With that emergency fund in place, you can then move on to investing. Investing at its simplest is laying out money today in the hope of receiving more in the future. You forego the benefit the money could bring now for the benefits it will provide later. If you let your lizard brain run the show, delayed gratification can be a tough pill to swallow so, don’t give your inner cave dweller the chance to squander your income. Automate your savings before it ever hits your bank account.
Your exact savings percentage will vary based on how much you have already saved, how long it will be until you need the money, and how you’ve invested it. But, generally speaking, the higher your savings percentage, the better. Never go lower than 15 percent and if you can go beyond 20 percent, you’ll be well on your way to a comfortable financial future.
Invest in a Low-Cost, Diversified Portfolio
Costs matter. Consider two investment portfolios with values of $100,000 that achieve an 8 percent annual rate of return for 30 years. One has yearly fees that total 1 percent, and the other is half of that. If you invested in the more expensive portfolio, you’d miss out on $100,000. As my favorite financial guru Benjamin Franklin once said, “Small leaks can sink great ships.” How do you avoid this? Invest in broadly diversified low-cost index funds. Learn more about low-cost index fund investing by reading John Bogle’s influential book, The Little Book of Common Sense Investing.
Diversification may make it complicated, but it is necessary. Investment markets may be up or down, but you can be sure not all industries will be affected equally. In 2022, during a bear market (when investors were selling rather than buying), tech stocks experienced much more significant declines relative to other sectors. If you invested heavily in tech, your net worth is now feeling it.
Broad index funds allow you to spread your investment across many companies. For example, the S&P 500 (an index of 500 leading publicly-traded companies in the U.S.) is one of the most widely followed indexes. Suppose you invested in an S&P 500 index fund. In that case, you’d spread your investment proportionally across all 500 of the largest companies in the United States.
Avoid Debt
Building wealth is about earning interest, not paying it. An affordable mortgage is OK, but if revolving credit card balances are a normal part of life, it will be tough to get ahead. If you’ve already dug yourself a hole, put down the shovel and create a plan to pay off your debts. Once your non-mortgage debts are gone, you can focus on earning interest via your low-cost, diversified portfolio.
Ask anyone who has had financial troubles in the past if having debt was a major contributing factor. Odds are that a resounding “yes” will be their answer. Building wealth is not only about taking the right actions. It is equally important to avoid the wrong ones.
Get 10 to 12 Times Your Earnings in Life Insurance
If your family relies on your income, you need life insurance and you should maintain 10 to 12 times your earnings. Depending upon your situation, you may need more or less, but 10 to 12 is a good starting point.
Your department may provide some group life insurance, but you’ll likely need more. A low-cost term policy is your best bet as it will cover you for a set period. When thinking about how long your term should be, ask yourself some questions: When will the house be paid off? When will the kids be out of college? When will we be financially independent?
It’s Simple, Not Easy
It’s not easy to follow a disciplined financial plan of avoiding debt and regularly investing for your future. You’ll see your friends and family mortgaging houses they can’t afford and financing cars they don’t need. Envy and jealousy are often our natural reactions but, remember, the ability to tolerate debt is what you don’t see. Follow simple rules, adjust as life evolves, and allow compound interest to work its magic. Before you know it, you’ll join the millionaire-next-door club.
This article originally appeared within the Winter 2023 issue. View the full issue here, or browse all back issues in theCRACKYL Library.
