These three rules trump all others.
- Spend less than you earn
- Buy low, sell high
- Watch every penny
That’s it. You’re probably thinking: Wait. That’s it? Yup. Follow these three rules religiously, and you’ll almost certainly end up wealthier. You’ll certainly have more peace of mind. You’ll take control of your financial future, instead of merely hoping for a lucky break.
Over the years, I’ve tried to flesh out these rules. See what you think.
1. Spend Less Than You Earn
Limit spending. This is critical. The only way to get and stay rich is to save. If you do nothing but that, you still have a better than even shot at living comfortably.
Maximize income. Within reason. Don’t make yourself, or your loved ones, miserable. Learn a trade or profession, so you’ll earn more and never be without work. Always be improving your useful skills and knowledge. Do what you love? Follow your passion? Sure, if it pays. Otherwise, go with what pays, and do what you love during your off-hours. They call it ‘work’ for a reason. They have to pay people to do it. Employment is not about happiness, it’s about income.
Borrow the minimum. Your most rewarding asset, after the ability to generate income, is zero debt. So, avoid debt. When you do borrow, minimize the total cost. Minimize the loan amount, the repayment term, and the interest rate. Borrow for necessities if you must. Never borrow for luxuries. To get the lowest possible interest rate, maintain a good credit rating by minimizing debt balances and paying them off on time, in full, every month at the regularly scheduled date. Credit scores are determined mainly by the amount of debt as a share of your credit limits and the regularity of your payments. Minimize the number and size of loans and the number of credit card accounts.
Pay down debt. Pay off high-interest debt first. Pay down principal ahead of schedule, if there’s no penalty for doing so, including on your home. Don’t buy too much house or too many cars. But if an investment can produce a higher rate of return than debt repayment, invest the money instead of accelerating the debt repayment.
Keep a cushion. Accumulate an emergency fund equal to around six months’ worth of basic living expenses. You can keep it in cash, but it’s better to keep it in a liquid, easy-to-access vehicle like a high-yield savings account or certificate of deposit (CD). Don’t keep it in a hard-to-access account like an IRA. If you can, keep a small gold stash as well, equal to, say, one percent of your investable net worth. It’s useful in an emergency because it tends to hold its value and can be converted into cash or necessities fairly easily. The same is true, by the way, of booze and cigarettes.
Save. Put every penny you can, beyond your emergency fund, into appreciating and income-generating investments. For example, a brokerage account. An IRA or workplace 401(k) is also a good savings vehicle, and will give you the highest rate of return, but remember that it’s hard to access retirement savings before age 60.
2. Buy Low, Sell High
Protect your seed corn. Avoid dipping into your income-generating investments. Never reduce the principal, except when absolutely necessary. Never eat your seed corn unless you are literally starving.
Invest in Social Security. One of the best deals around. Get your 40 quarters in. (To qualify for Social Security retirement benefits, you must, before you file for benefits, have earned $7,200 or more in a payroll-tax-covered job during at least 40 calendar quarters. This dollar figure changes with inflation. To qualify for Social Security disability benefits, you need fewer credits. The number varies with age. After age 30, you need 20 credits.) Annually check your ‘taxed Medicare earnings’ history at ssa.gov to make sure the Social Security Administration has an accurate income history for you, so they pay you every penny to which you’re entitled. Plan to claim Social Security later than your normal retirement age (which is 67 for people born after 1960). Every year you delay filing for Social Security, after your normal retirement age, is like giving yourself a guaranteed 8-percent rate of return, a good investment. But this boost ends at age 70. You may claim earlier, but try to do that only if you really need the money or are in very poor health. Also, take time to learn the Social Security rules. Making the wrong choices could cost you hundreds of thousands of dollars in missed income during retirement. Be sure to get your advice from experts. Do not trust what government employees tell you. They can and do get important details wrong.
Invest early and often. If possible, participate in all of the kinds of investments listed below, and if you can swing it, contribute to each of your accounts the maximum amount the law allows, every year. I’ve listed them in order, from most valuable to least.
1) Your employer’s defined-benefit pension plan. Be sure to study the vesting rules. ‘Vesting’ means that you’ve participated long enough to keep the money your employer has contributed to the plan. If you leave your the plan before you’re vested, you forfeit that money.
2) Your employer’s group health benefit plan, if offered. A workplace health plan is almost always going to be a better financial deal for you than individually purchased health insurance, thanks to federal tax laws. If you can manage to find individual-purchase insurance (or an alternative like health care sharing) that’s a better value than what an employer is likely to offer you, go ahead and skip the workplace coverage. But as a default, prefer it. To keep your premium costs down, choose the highest deductible you can afford.
3) A Health Savings Account (HSA). An HSA is a good deal. It effectively gives you a significant discount on every medical item or service you purchase directly, out of pocket, using your HSA account. Contributions, withdrawals, and interest and earnings are all exempt from income tax. And if your employer contributes to your account, that money is exempt from both income and payroll tax. Withdrawals must be used for qualified medical expenses. Non-qualified withdrawals are taxed and incur a stiff penalty tax. Use your HSA to pay for things like copays, deductibles, doctor’s appointments, and prescription drugs. Under current rules, you cannot use an HSA to pay insurance premiums, for the most part, nor unfortunately for a monthly subscription to a direct primary care (DPC) arrangement. An HSA is a great way to save for retirement. After you turn 65, you can take the money out of your HSA, penalty-free, for any purpose. You’ll pay income tax, but no penalty. Note that, since HSAs are linked to health insurance, to be able to contribute to you account, you must also have a health plan that is HSA-qualified. Few, unfortunately, are. Make sure yours is.
4) Your employer’s defined-contribution retirement savings plan, if offered (preferably a Roth 401(k)). A defined-contribution plan is vested by definition. You own the money from day one. When you leave your employer, you keep the money and are allowed to roll it over into a personally owned IRA. If your employer offers a 401(k), take it. Prefer the Roth variant. Be sure to accept every penny of available employer matching contributions (don’t leave free money on the table). Don’t feel obligated to contribute beyond that amount, if you can’t afford it. Instead, open a personal Roth IRA as well (see my next point). Be sure not to forget about your account after you change employers. Many people, incredibly, leave the money stranded. Roll the money over into your personal Roth IRA.
5) Personal Roth IRA. As soon as you can afford it, open one of these outside the workplace. Be sure to know the contribution rules for both workplace and personal IRAs. They interact and are a bit complicated.
A few bits of additional advice:
- Prefer a passive investment style to minimize risk
- Employ dollar-cost averaging instead of trying to time the market or buy the dips
- Reinvest dividends, automatically if possible
- Rebalance your portfolio, automatically if possible, but not too often
- Prefer ‘fee-only’ financial advisors over ‘fee-based’ salesmen
- Don’t forget to designate your account beneficiaries
Get married. Yes. And marry well. A good spouse is your best long-term investment. Buy and hold.
3. Watch Every Penny
Plan. Have a financial game plan and reassess it from time to time. (I use MaxiFi for this.) For retirement planning purposes, assume you’ll live to age 100, just to make sure your money outlasts you. Have a will and a durable power of attorney with advance health care directives. If you’re reasonably intelligent, you can draft these yourself and avoid lawyer’s fees. To protect yourself against a sudden or chronic decline in the value of the dollar (inflation), own a bit of land and a bit of gold — things that tend to hold their value. Valuable artworks can also serve this function. And oh yes, don’t forget to buy some life insurance, if you have loved ones. Prefer term. It’s okay to have a small whole life policy as well. Don’t over- or under-insure. Keep the policies paid up.
Read your statements. Sure, it’s boring, but you’ll thank yourself. You’ll find mistaken and fraudulent charges and needless fees. It’s fun to slay them! Monitor your bank account balances. Track your investments and net worth. (I use PersonalCapital.com to do this.) Keep one eye on your home’s potential resale value. And most important, track your spending habits.
Be the captain of your fate!
Note: Not professional investment advice. Follow at your own risk. Use common sense. Eat your peas.