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? Yep. Follow these three rules religiously, and you’ll almost certainly end up wealthier. At the very least, you’ll have more peace of mind. You’ll take control of your financial future, instead of bobbing about on the capricious seas of fortune.
Over the years, I’ve tried to flesh out the three rules. See what you think.
1. Spend Less Than You Earn
Limit spending. This is critical. If you do nothing else, you still have a better than even shot at living comfortably, because the only way to get rich is to save.
Maximize income. Within reason. Don’t make yourself, or your loved ones, miserable.
Borrow the minimum. Your biggest asset is zero debt. So, avoid debt like the plague, because it is. Never borrow to pay for luxuries — or necessities. When you must borrow, minimize the total cost. Minimize the loan amount. Minimize the interest rate. Minimize the repayment term. Also, maintain a good credit rating. How? Never miss a payment and pay off your credit card bill on the same date every month like clockwork. To maintain a good credit score, don’t open too many financial accounts in a short period of time, and don’t close any potentially useful account if you can avoid doing so.
Pay off 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.) But there’s one exception. When investments can produce a better return than debt repayment, prefer investing. For example, if the interest rate on your debt is 3 percent, but you can earn 6 percent by investing, then investing is the smarter use of your money.
Keep a cushion. Maintain an emergency fund equal to, say, six months’ worth of basic living expenses. Keep it in a liquid, easy-to-access vehicle like a high-yield savings account, brokerage account, or certificate of deposit (CD), as opposed to a harder-to-access account like an IRA. (Also, it doesn’t hurt to keep a little gold stash on hand, as a hedge against inflation.)
Save wisely (and avoid needless taxes). Invest any savings above and beyond your emergency fund in an even higher-yield (and harder-to-access) Roth IRA or workplace Roth 401(k). You could also keep money in a tax-deferred retirement account such as a traditional IRA or 401(k), but in my opinion a Roth-style account is always preferable to the traditional variety.
2. Buy Low, Sell High
Put your money to work. Try to put every penny you can, beyond your six-month emergency fund, into appreciating and income-generating investments.
Protect your seed corn. Never eat your seed corn unless you are literally starving. Avoid dipping into your income-generating investments. Never reduce the principal, except when absolutely necessary.
Invest early and often. If possible, participate in all of the kinds of investments listed below, and contribute to each of your accounts the maximum 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 qualify for the pension and keep the money your employer has contributed to it. If you leave your employer’s pension 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, you should go ahead and skip the workplace coverage. But otherwise, prefer it. To keep your premium costs down, choose the highest deductible you can afford.
3) A Health Savings Account (HSA). Use it for routine medical expenses. An HSA lets you pay for medical expenses like copays, deductibles, doctor’s appointments, and prescription drugs, tax-free. So, you effectively get a discount on every purchase. An HSA is also a great way to save for retirement. Contributions, withdrawals, and interest and earnings, are all exempt from income tax. (If your employer contributes to your account, that money is additionally exempt from payroll tax.) Note: withdrawals must be for qualified medical expenses, but non-qualified withdrawals are taxed and incur a stiff penalty tax. After you turn 65, you can take the money out of your HSA, penalty-free, for any purpose. Note: HSAs are currently linked to health insurance. In any given month, to be able to contribute to an HSA account, you have to have an health plan that is HSA-qualified. Make sure yours is.
4) Your employer’s defined-contribution retirement savings plan, if offered (preferably a Roth 401k). A defined-contribution plan is always 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 an IRA or Roth IRA, participate (especially in the Roth variant) and accept every penny of available employer matching contributions, but as a general rule, don’t contribute beyond that amount. If you want to invest more, do so through a private Roth IRA that you purchase, own, and control (see next point). P.S. Be sure not to forget about your account after you change employers. (Many people do not, incredibly, and leave the money stranded.) Consider rolling your 401k account balance over into a new account elsewhere.
5) Personal Roth IRA. As soon as you can afford it, open a personal Roth IRA, outside the workplace.
6) Debt repayment. As a general rule, this item should be low on the list of your investment priorities, when the interest rate on your debt is low — and high when it’s high.
7) Social Security. Plan to claim Social Security around age 70, not your normal retirement age (which is 67 for people born after 1960). Every year you delay filing for it, after your normal retirement age, is the equivalent of receiving a guaranteed 8-percent return. You can claim earlier, though, if you’re very unhealthy and afraid of dying.
With respect to the above, a few bits of additional advice:
- Use a passive investment style.
- Employ dollar-cost averaging.
- Rebalance — automatically, if possible.
- Reinvest dividends — automatically, if possible.
- 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
Read your statements. Yeah, it’s boring, but you’ll thank yourself. You’ll find mistaken and fraudulent charges and needless fees. It’s fun to slay them! Track your spending habits. 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, just in case. And be sure to annually check your ‘taxed Medicare earnings’ history at ssa.gov to make sure Social Security will pay you, in retirement, every penny to which you’re entitled. Have a financial game plan and reassess it from time to time. (I use MaxiFi for this.)
Be the captain of your fate!
Note: Not professional investment advice. Follow at your own risk. Use common sense. Drink responsibly. Bathe regularly. Eat your peas.
Dean Clancy, a former senior official in Congress and the White House, writes on U.S. health reform, budget, and constitutional issues. Follow him at deanclancy.com or on twitter @deanclancy.