I'd like to lay the ground work for what I believe are the eight most important aspects of wealth building and properly planning for your financial future. These principals apply whether you have a low paying job or are raking in six figures, whether you are single or part of a family, or young or old (although youth definitely helps). These are not ground-breaking ideas, and they’re all interrelated, but the problem is far too many people acknowledge them but then don’t follow through. To make a difference in your life, really take them to heart.
Make concrete goals. It is impossible to know how to get somewhere without knowing where you’re going. Think realistically about what you want to improve in your financial life. What type of lifestyle do you want now and in your retirement? How much will you need saved when you retire to live comfortably? Figure out that number and then work backwards to see what steps are needed to get there.
Time is your most valuable asset. Use it to your advantage. People tend to think that a bigger paycheck is the best way to secure a brighter financial future. That certainly can help, although for many people it doesn’t (they just increase their spending and pay more taxes without saving any more for the future). However, utilizing the power of time is a much more powerful way of building wealth. Even if you can only make small, but regular contributions to a savings or investment account now, the power of compound returns can turn that into great savings down the road. You’ll never be as young as you are today, so start now.
Pay yourself first. Everyone wants your money. The government, landlord, utilities, retailers, cable companies, department stores. Everyone. The problem is that the vast majority of people who say they live paycheck to paycheck and can’t save enough for retirement do this because they pay everyone else first, and then have nothing left for themselves. This is the reverse of what we should do. Instead, take a portion of your paycheck (10% is a common recommended target) and immediately put that aside to only be used for your future (emergency fund, savings, retirement, etc.). With the remaining 90%, you pay the rest of your bills and use for discretionary items. The surprising part to most is the reduction in disposable income isn’t nearly as restrictive as they expect, and they are able to adjust accordingly without huge sacrifices to their lifestyle. And in the process, they’ve started creating a much brighter financial future.
Accumulate income-generating assets. So you’ve saved 10% of every paycheck, which is a good first step. But to make it a truly powerful wealth building machine, that money needs to make itself useful and start generating you more money. The main options are by either buying appreciable, income-producing assets (such as stocks, income properties, and small businesses) or by lending it out for a fixed return (including bonds, peer lending, or certificates of deposit). The key to growth is that not only are you continually funding these accounts with a portion of each paycheck, but you will also be re-investing 100% of your proceeds back into these investments so the compounding effects can continue to build. This is where the power of time mentioned above really becomes powerful.
Avoid bad debt. Heavy debt burdens can cause stress and eat away at your savings through hefty interest payments. There are varying opinions on what constitutes bad debt and how much is reasonable. Some say that any debt is too much. Others would preach the power of leverage. My opinion is that any debt that slows you from reaching financial goals is bad debt and should generally be avoided. Paying down high interest loans (credit cards, and most student loans, for example) quickly should be the number one priority toward financial freedom, even before retirement savings. As a rule, credit card debt (not paying your balance off in full each month) should be avoided like the plague.
Avoid taxes. This isn’t a recommendation for tax aversion or tricking the IRS. But it is sound advice to use as many legal techniques as you can to reduce or defer taxes. Maximizing tax credits, making tax deductible contributions to retirement accounts, and being smart with investment transactions are all important ways to reduce your check to Uncle Sam by thousands every year.
Stay educated. Even if you’re not “in charge” of finances in your household, it is important to stay financially literate and have money on your mind. The more you are aware of money concepts, the smarter you can spend, save, and invest. There are countless great books on the subject, and also numerous sources with free advice and information (off the top of my head, this blog would be a great example!).
Track your progress and evaluate. Keep track of your financial stats such as your budget, your credit score, and your total net worth to evaluate your progress toward reaching your financial goals. Note that it is much more important to check on the areas that you control (sticking to a budget, making regular contributions to savings, etc.) rather than external factors (short term fluctuations in the stock market). Free aggregate software or websites such as Mint are great tools that can be used as a scorecard for your financial life.
Thanks for reading these eight essential money concepts toward building wealth. I’ll try to expand on some of these points in more detail in their own individual posts in the future.
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