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. Or at least you’ll 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 rich — 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. You have to pay people to do it. Employment is not about happiness, it’s about income.
Borrow the minimum. Your biggest asset is zero debt. So, avoid debt like the plague. Never borrow to pay for luxuries. Borrow for necessities only if you must. When you do borrow, minimize the total cost. Minimize the loan amount, the repayment term, and the interest rate. Be sure to maintain a good credit rating.
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.) But if an investment can produce a higher rate of return than debt repayment, invest the money instead of accelerating debt repayment. For example, if the interest rate charge on your debt is 3 percent but you can earn 6 percent by investing, then invest and don’t accelerate the repayment. It’s the smarter use of money.
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.
Keep a cushion. Accumulate an emergency fund equal to at least six months’ worth of basic living expenses. You can keep it in cash, but it’s probably wiser to keep it in a liquid, easy-to-access vehicle like a high-yield savings account, brokerage 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. It’s useful in an emergency because it tends to hold its value and can be converted into cash fairly easily. The same is true of booze and cigarettes.
2. Buy Low, Sell High
Put your money to work. Try to put every penny you can, beyond your emergency funds, 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 if possible 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). Use it for routine medical expenses. An HSA lets you save and pay, tax-free, for medical expenses like copays, deductibles, doctor’s appointments, and prescription drugs. Under current rules, you cannot use it for insurance, for the most part, nor unfortunately for a monthly subscription to a direct primary care arrangement. But 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.) So, overall, it’s 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. Additionally, an HSA is a great way to save for retirement. Withdrawals must be for qualified medical expenses. 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 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. 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 a traditional or Roth IRA, participate (prefer the Roth variant) and accept every penny of available employer matching contributions. Don’t feel obligated to contribute beyond that amount. Instead, if you want to invest more, 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 balances 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.
6) Debt repayment. As discussed earlier, debt repayment should be a high priority when the interest rate on your debt is high — and lower when it’s low.
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 like giving yourself a guaranteed 8-percent higher rate of return. But this boost ends at 70. You can of course claim earlier, if you’re not in good health. Also, be sure to know the Social Security rules. Making the wrong choices could cost you hundreds of thousands of dollars in missed income during retirement. And get your advice from experts. Don’t trust what government employees tell you. The system is so complicated, they can and do get important details wrong.
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
Plan for the worst. 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 the worst, 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.
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. And be sure to 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. 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.