“The best time to plant an orchard was 20 years ago. The second best time is now.” –Chinese Proverb
No matter what age group you belong to, investing in your future should start NOW! Sheldon Garon, Princeton University history professor and author of Beyond Our Means: Why America Spends While the World Saves recently said: “Americans just don’t save much. Even after the financial crisis hit, in 2008, there was a little bit of a spike in the savings rate, from 5 percent to 5.5 percent, but most households have not fundamentally changed their behavior.” Our primary goal as Drunk Millionaires is to cause a change in society where we once again elevate the ideology of saving above that of unregulated consumption.
Keep in mind, we don’t start to build wealth until all debts are paid off, and the disaster fund is complete! It’s important to focus on each step, in order, with all your effort as that’s the only way to win this war to become financially successful. Those who try to do 20 things at once never hit their goals. When you have pin-point focus on one thing at a time and pour all your resources into it, you will be amazed at how fast you can achieve success whether it’s paying off debt, building up a disaster fund, or in this case, building wealth.
Once you have completely paid off debt (although still having a mortgage is the only okay debt), and built up the disaster fund, you can finally start the fun part which is building wealth. The secret to wealth building is time and compound interest.
Time. It goes without saying, but the longer you invest, the more money you will have. If you save as a young professional at your first job, you won’t have to save as much because your invested money will have the chance to compound for a longer time than someone who starts saving late in life. We recommend purposefully saving 15% of your income each month. This doesn’t mean moving money from your checking account into a savings account. These days, savings accounts only generate around 0.02% interest and with a national inflation rate of ~3% each year, you lose money in a savings account because this money would become worth about 3% less from year to year, effectively making you loose money.
Compound Interest. Compound interest is a beautiful thing and every high school and college should demand that students learn about it before graduation. More on investments later, but if you put your wealth building money in something that earns interest every year, that money will begin to grow. Perhaps the easiest way to explain compound interest is with an example:
Bill earns the national average of $50,000 a year. He has followed the Drunk Millionaire’s advice and has paid off his student loans and car, and built a comfortable disaster fund. His employer doesn’t offer a retirement plan, so he invests in the S&P 500 Index Fund. We know that that S&P 500 has a 50 year track record of 11.5% average return so we will use this figure as a safe estimate of how it will perform in the future.
Looking at the graph below, we can see that Bill has contributed $7,500/year (15% of his income) with a total of $195,000 invested for 25 years. (Keep in mind that Bill would most likely have pay raises and contribute more, but for simplicity sake we did not factor in any increases in contributions.) Bill started saving at the age of 25 and since he continued to save and started at such an early age, he could retire at the age of 50 if he wanted too!! His wealth has grown to over $1 million dollars by the time he was 50!!
How to Invest. If your company offers a retirement plan, it’s usually beneficial to contribute to it, especially if a company match is offered. A company match is just gravy on the biscuit (hillbilly speak for free money). Many companies offer a 401K or a Roth 401K. Typically the Roth option is the best choice because you are taxed a small amount as you contribute, but when your money has grown to millions, you won’t owe any taxes because you paid them in at the front end. Unfortunately this good deal means companies can’t contribute matched funds into a Roth account.
Unless you are forced to, we recommend staying away from Pension plans. You have no control over your money in a pension plan, and when you die your spouse may get some money but there isn’t any money for the rest of your family. For example if you retire at 60, and die at 70, you will have only received 10 years of retirement payout after contributing into it your whole life. Your spouse may receive 50% of the pension payments but when he/she dies, the pension is gone. When you control where your money goes, you have complete control of your wealth and your money gets passed on to your family after you die.
If you are self-employed, or your employer doesn’t offer retirement plans, the next best option is a Roth IRA (IRA = Individual Retirement Arrangement). Similar to a Roth 401K, a Roth IRA means that you pay a smaller amount on taxes at the front end and don’t pay any taxes when you retire. The government limits how much you can contribute in a Roth account each year. With IRAs we recommend working with an investment professional to pick out mutual funds with a good long term track record with over 10% average growth during that time.
Remember that we recommend saving 15% of your income into a retirement account. If you’ve only invested 10% so far into the IRA or 401K, we recommend putting the remainder of the money into no-load index funds to get you to that 15%. These accounts will be taxed when you pull money out, but they are still a great way to build wealth.
Real estate can also be a good wealth building option. However, now that we are debt free and investing, we don’t want to purchase an investment piece of real estate unless it’s purchased with cash. We recommend chunking some money away into a no-load index fund for a few years until you build up enough money to buy a rental property. Once that first property is purchased, with cash, you’ve basically created a money printing press and soon you will have the means to purchase more (possibly bigger) investment properties.
Now that we’ve covered how to invest like a Drunk Millionaire, it’s time for you to get started. Remember to complete these steps in order. Before building wealth, pay off your debts, budget, and have a solid disaster fund.
The final step after building wealth is to enjoy it. One of the best ways we enjoy wealth is to be generous. Don’t hoard all your money until you die, build wealth so that you can change the world for the better.
For further reading check out our recent post: Investing- The Financial Field Guide.