Keeping Track Of Your Net Worth
No matter where you are along your financial independence journey, running the numbers by calculating your net worth is an invaluable way to determine your financial health.
By keeping an eye on your finances, you will inherently increase your awareness and money management skills quicker than you think. If you are the type of person that considers themselves a poor money manager, then perhaps it is time to change that skill.
Is it possible that you are bad with money because you don't track it? Do you think you would get better or worse with your finances if you started paying more attention to them?
The basics for calculating net worth are as follows: assets - liabilities = net worth
An asset is anything you can exchange for future monetary or economic value and are assessed at present value to the marketplace.
A liability is a debt or expense that you owe. This is also assessed at present value. Include everything here, no matter how embarrassing the liability might be. People finance everything these days from furniture to pets, so don't be discouraged and include every last outstanding debt.
The reasons you should track your net worth regularly
First and foremost, you need to track it because it provides instant feedback on how well you are doing managing your financial portfolio. Only those saddled with debt and living check to check don't know what a portfolio is. Truth is, I believe all you need for a portfolio is a positive net worth.
Once you attain a positive net worth, by eliminating all of your debts (the mortgage is the only thing that could possibly stay), then you can worry about managing your investments.
The real-time feedback that your net worth provides gives direct insight to the following questions:
Besides gaining insight into your overall financial picture, tracking your net worth allows you to learn something new about yourself or even become a different type of person altogether. As the late Jim Rohn always said (paraphrasing), "Don't do something just for the sake of doing it, but rather do it for what you will become in the process". If you were previously the type of person who is terrible at money management, now you can start to become the type of person who is rather skilled at it. Imagine what you will learn along the way. You certainly don't need to know much more than the difference between an asset and a liability to get started, but I promise you will pick up many more money-related skills along the way.
Another reason to consider tracking your finances (at least annually) is because it helps you stay motivated on your financial journey. Make a game out of it and embrace the milestones along the way. Find economical ways to celebrate when you hit certain savings and net worth goals to keep you motivated. The reality is that far too often I hear of tracking finances as a source of anxiety instead of motivation. Some years you will make large strides and other years will feel like a standstill. Just remember, the path to financial independence is not supposed to be a smooth and linear road.
You will be amazed at what you learn as you practice tracking your net worth every year. For example, just four years ago I had no idea what a 457(b) was. Fast forward four years and my wife and I not only have 457(b) plans, but we have saved over $50,000 in them. I am not gloating but rather illustrating to you my very point in which I started the paragraph: you are going to learn a tremendous amount about money along the way. You will discover things along the way that you never imagined will accelerate your net worth just because you will be searching online and asking questions about terms to which you did not previously know. It is by searching and asking that you will expand your financial knowledge, and almost assuredly your net worth, along the way.
Lastly, you will be able to share with others and help them along their path as well (if you so choose). Use this superpower with caution and do not be condescending when offering others advice. Be helpful and encouraging and share with them that you had little to no knowledge of any of this just a short time ago. Imagine the satisfaction you would have in starting to teach others about personal finance knowing you once were as bad, or maybe worse, at managing money than they are. This last reason is optional, yet I argue one of the most important reasons to stay abreast of your financial snapshot, and therefore stay on top of all the financial education out there.
The morale to the story is that you have the ability to improve your financial situation just by keeping track of it. What gets measured can be improved. If you don't measure something, it is very difficult to know if you are improving it. So quit procrastinating and start tracking. Track your net worth. Track your expenses. Track your investment contributions and savings rates. If it causes you anxiety initially, that's alright and often to be expected. Stay the course and keep going. If you simply cannot get over the stress of managing money, then perhaps it's time to seek the guidance of a financial professional after all.
Leave a comment below. What have you learned by tracking your money over time?
Do you really need to live a life of extreme deprivation?
Extreme deprivation isn't really that much fun. To most folks, the idea of putting on 4 layers in the winter instead of turning on the heat is not that appealing. Standing in the grocery store comparing the cost per ounce of beans is, for many, not a recipe for a good time. The cost savings of single-ply toilet paper is just too abrasive for most (literally).
Don't get me wrong, frugality tends to come with some weird savings hacks that are the centerpiece of your friend's jokes. I have even heard of someone using industrial CO2 containers to make their own seltzer water. Frugal folks tend to be a pretty strange flock.
If you are motivated by cost cutting and frugality on small ticket items, go right ahead, I won't stop you.
But if the idea of penny pinching on the little things drives you crazy then perhaps you need a much needed re-frame on your concept of frugality.
"The Big Three" Expenses
For those of us who cannot tolerate the idea of skipping our latte factor items, there may be bigger fish to fry for you yet.
Saving on housing, transportation, and food is a hell of a good place to start. In fact, it may be the only strategy you will ever need.
Housing. Buy less house than you can afford, nothing more. Married with one kid and no plans for more? Why the hell do you need a 5 bedroom, 3 bathroom house? You don't. Be smart. Warren Buffet still lives in the home he bought for $31,500 in 1958.
Transportation. Don't buy a new car. Ever. It's really that simple. Buffet, one of the wealthiest men alive drives a midsize sedan, a 2014 Cadillac.
Food. Don't eat out. Split meals when you do go out. Cook at home a great majority of the time.
My thoughts on "The Big Three" expenses
Show these guidelines to your mortgage or real estate professional if you have trouble computing a price range off of these numbers.
Rule 1: Always buy less than you can afford
Rule 2: Purchase all necessary insurances - don't skimp on these!
Rule 3: Buy a house with at least 2 bathrooms - the more bathrooms in a home the better the resale value
Rule 4: Always get a termite inspection and order a plan that covers treatment.
Rule 1: When it comes to cars, buy used. Never buy new due to massive depreciation as soon as you drive it off the lot.
Rule 2: Bike or walk more often. If you cannot bike or walk, combine your trips to save gas and mileage on your vehicle.
Rule 3: Shop around for more affordable car insurance.
Rule 1: Drastically reduce, or eliminate, dining out and take out orders.
Rule 2: Cook at home.
Rule 3: Buy in bulk. Especially buying and storing the following:
If you happen to know you need a budget, but cannot see yourself trading in your 2-ply toilet paper for 1-ply to save a few Shekels, then focus your efforts in these three areas.
Comment below on how you have saved in these areas.
Disclosure: This post may contain affiliate links wherein I get a commission if you decide to make a purchase through these links, at no additional cost to you.
The Latte Factor Explained
Frugality does not automatically imply you need to move out of your house, sell your car, ride a bike and live in a tent for the rest of your days. Frugality does not have to mean extreme deprivation.
In the financial independence and frugality community a term referred to as "the latte factor" has arisen. The literal translation of this is if you saved the cost of a latte and instead invested it, that over time you would become rich. I suggest that we can expand this beyond its' literal meaning however. Your "latte" could be any recurring expense, it does not have to be an actual latte.
Note: I believe the term latte factor originated with author David Bach. He even has written an excellent work titled The Latte Factor: Why You Don't Have to Be Rich to Live Rich.
The Long-term Cost of Everyday Expenses
At last, here is our latte factor calculator demonstration. Use the following to plug in your own numbers and expenses to figure out how saving small amounts can generate wealth over time.
First, figure out what your daily "latte" expense is. Perhaps it is literally a flavored morning beverage, but I suspect for many it is something else. Do you buy lunch everyday? A pack of smokes (saving money is another reason to quit)? A donut every morning? Essentially, what is the item that you immediately identify as a regular expense that you purchase at least once every few days, if not everyday?
Figure out how much that item costs you every month. Then take that monthly expense and plug it into this calculator.
Say I purchase a sandwich at work everyday at work. Say that sandwich costs $7. What if, instead, I could make lunch for $2 and bring it to work instead of buying that $7 sandwich? The answer to the riddle is that you would save $5 on lunch. Following me so far?
Such a simple example yields over $100,000 difference over the span of 30 years.
Just assessing your lifestyle habits from a true monetary cost-benefit perspective will change your mindset. It has the potential to train your brain to think differently about seemingly innocent recurring expenses. It might even eventually make you frugal.
Taking this one step further, imagine you are able to find more than one item to save on over a lifetime. Now use the example above to calculate how the recurring expense of a particular item could instead be utilized to harness the power of compound interest.
Deprivation vs. Frugality?
The most common rebuttal to compounded savings is the concern that you will be depriving yourself. Yet that is not the point!
The point is that by choosing to limit yourself for a definitive period of time- like packing your lunch instead of that delicious hoagie for lunch everyday- you can ultimately choose to start purchasing that item again someday. The difference is that by limiting yourself for a defined period of time, when you ultimately choose to start spending that money again, you can restart the original behavior and then some! You can have your sandwich, and a new car, and a boat if you so choose. How? Because you chose to not spend on something for a defined period with the ultimate expectation to gain far more in the long term. This is the classic marshmallow experiment in action!
In 1972, a study was published from a group of researchers out of Stanford which later became know as the "Stanford Marshmallow Experiment". In this aforementioned study, children were given the choice of having one marshmallow immediately, or avoiding eating the first marshmallow until the researcher returned to the room in exchange for receiving two marshmallows.
That's the power of choice. That is the power of delayed gratification.
Ultimately the choice to be frugal now is because you can. Because you will never be younger than you are right now. You can possibly handle more now. Work more now. Cut spending more effectively right now. Delay your gratification. That's what frugality ultimately is!
Leave a comment below. What's your "latte factor" item? How do you anticipate this delayed gratification to benefit you in the long term?
Misleading claims by "Real Estate Gurus"
Many self-proclaimed real estate gurus espouse the idea that you cannot live an asset. By the same meaning, they would therefore declare your primary residence a liability. I believe that this type of thinking is misleading at best and incorrect more often that not.
The reasoning behind the claims that housing is a liability are centered on the argument that as long as you live in your home, it is unable to generate rate of return for you. With the failure to generate a rate of return, the industry "gurus" would likely inform you that your house is disqualified from being an asset.
Rate of returns in real estate involve more than just rental property income however. Just because you do not have positive monthly cash-flow in the form of rental income, does not mean that your primary residence cannot be an investment.
An asset is can technically be classified as anything that has the potential to produce positive economic value. Unless your house became worthless the second after you signed at closing, it cannot possibly be considered anything other than an asset. Whether your home is an appreciating or depreciating asset however, is an article for another day.
What kind of return on investment (ROI) can you expect from real estate in general?
According to data collected by Jorda et. al. (2019) from the time period of 1870 to 2015- over a century's worth of data- equities (stocks) beat real estate returns 8.46 to 6.10% respectively after being adjusted for inflation.
That 2.36% difference (8.46 vs. 6.10) in returns is actually attributed largely due to the inclusion of rental yields into the equation. The reality is, capital appreciation is much closer to 1% over the long term, according to Shiller (2000).
Many will argue that the measly 1% capital appreciation on homes is bringing down the real number associated with total real estate rental yields. They insist that rental yields are much higher than just 6.1%. The only problem is, there is insufficient data to support those claims. The reality is that rental real estate yields are very wide ranging and extremely difficult to predict ahead of time due to known long-term costs associated with the property.
Why are the costs of rental real estate relatively unknown and difficult to predict?
The expenses associated with owning this property are variable and largely unknown throughout the lifetime holding of any given property.
Consider just some of these unexpected expenses associated with ownership in real estate:
I digress, because we are talking home ownership as an investment, not rental real estate. To evaluate a home as an investment, we will need to know how much a house appreciates over time. This will allow us to measure it's monetary value as an investment.
How much does a typical home appreciate in value?
To find the best answer to this multi-factorial question, we can take a look at the Case-Shiller Home Price Index. This appears to be the best index associated with the national home price index. Keep in mind, the Case-Shiller index excludes new home construction (there is a separate index for that) and focused primarily on resale of existing homes within a given time period. This is good news because most of us in the FI community focus on used real estate for purchase and ownerhsip.
When digging through Shiller's website data (available on his website for free), I found historical data---measured with a 3 month moving average---since 1953 (I chose 1953 as a starting point because that appears to be the year they began updating the index on a monthly basis).
Now, the data is broken into real and nominal values. The difference is crucial. The real home price index is adjusted for inflation and is updated for "today's dollars". The nominal price index does not adjust for inflation.
What's the difference between real and nominal home value?
The real home price index from 1953-2019 increased by 54.16%
So why is there such a difference between real and nominal home prices?
Again, the nominal home price increase is much larger in the example above because it fails to account for the fact that the market value of $1 in 1953 is not the same as the market value of $1 in 2019. This is primarily due to inflation.
In other words, a single dollar went "much further" in 1953 than it does today. Plain and simple.
That is why the real home price index is a more useful tool in calculating the expected annual rate of return of housing. The index essentially equates yesterday's dollars with today's dollars by adjusting for inflation.
By evaluating the change in real home price index figures from 1953-2019, I calculated an annualized rate of return of 0.81% per year of capital appreciation of a typical home over that 67 year period
Admittedly, I will occasionally round up and use a full one percent per year figure in my articles since many market critics will recognize a full percentage point as an accurate figure.
Now that we have calculated the expected annual rate of appreciation of your home, let's dive into the discussion of seeing your home as an investment.
Plenty of confusion surrounding the word investment
Most people simply do not even understand the basics of what is considered an investment. An investment is something that you attain now with the prospects of benefit in the future.
Typically, this is referred to in terms of financial gain. However, this is entirely misleading due to the fact that there are many types of investments don't even generate a positive return.
Some examples of investments that fail to generate positive returns over the long-term:
These are all acknowledged as investments, yet they lose money. So sure, your house can still "lose money" if you sell it at the wrong time, but it's still worth something.
Technically speaking, an investment is simply something that you anticipate will be worth something in the future. You hope it will be worth something in the future that is of benefit to you. But remember, beauty is in the eye of the beholder. Your definition of "benefit" is not a universal definition, it is unique to you only. Many would simply be happy knowing that their house will be worth something someday, regardless of how it compares to the original purchase price--especially if it's paid for.
Can Your House Make You Rich?
Perhaps, indirectly. One of the best write-ups I have seen on this conversation is found here, written by Michael Bluejay. He analyzes the difference over the long-term of renting versus buying and breaks down a unique "Rent we didn't have to pay" line item in expenses.
Rather than reinventing the wheel, Bluejay discusses how the average person will have to pay hundreds of thousands of dollars in rent over a 30 year period---which is also the length of the average mortgage.
He breaks down the difference in value of two scenarios:
The math is quite interesting and the numbers are very practical. Check them out for yourself in Bluejay's article here.
A Case for Home Ownership as an Investment
Home ownership, subjectively, is:
You get the idea. A home is a chance to actually have a stake in something in the world. Your own plot of land (be careful though, it's not really yours until you pay off that mortgage).
Financially, home ownership is a net wash at only 0.81% per year. It's certainly true that you "have to live somewhere" and paying rent feels like you are giving money away without the hopes of return. So yes, your home is definitely an investment. Although it does not return as much as other types of investments, it provides many intangibles (highlighted above) that are irreplaceable.
1. Shiller, Robert J. 2000. Irrational Exuberance. Princeton, N.J.: Princeton University Press.
Index Funds vs Managed Funds (Mutual Funds)
Today we assess the difference between index funds and mutual funds. The overall investment objective varies greatly between these two types of funds.
Index funds are actually a type of mutual fund. An index fund is a passively managed that seeks to match a given market index. The Dow Jones or S&P 500 are two of the most common indices of the overall stock market. An S&P 500 index fund is a very common method of investing in the stock market.
Mutual funds are professionally managed investment portfolios. The fund manager will buy and sell stocks quite frequently, leading to higher turnover, higher taxes, and higher expenses than the average passive index fund. Mutual funds are funded primarily by the shareholders (investors) like you and I. Typically, their goal is to generate the highest rate of return annually for the shareholders of the portfolio which is why they do so much buying and selling. This is why they are referred to as actively managed funds. The way these funds are marketed to the public is usually by comparing returns to general stock market indexes such as the Dow Jones or the S&P 500.
So why is there so much confusion out there about mutual funds vs. index funds?
Although index funds are technically a type of mutual fund, they differ significantly in almost every other way. For the sake of clarity, it helps to divide the entire category of mutual funds into actively managed and passively managed. Therefore,
What's the difference between mutual funds & index funds?
Fees and management style.
The typical fees of a mutual fund are in excess of 2%. The typical fees of an index fund are often less than 0.1%. Doesn't sound like much? Well, it is!
Let's look at an example headline from our friends over at NerdWallet:
Millennials have decades to save for retirement, but also decades of exposure to avoidable investment fees. NerdWallet analyzed a variety of scenarios and in one case found that paying just 1% in fees could cost a millennial more than $590,000 in sacrificed returns over 40 years of saving.
What is even worse is that this only looked at a 1% fee. Compounded over time, the loss of that measly 1% fee is extraordinary as outlined above. Remember, the average active mutual fund fee is well over 2%.
To make matters worse, if you happen to hold an actively managed mutual fund in a taxable brokerage account, you would need to beat the passive fund by 4.3% just to match the return of the passive fund. Why 4.3%? Professor Mark Kritzman of M.I.T. conducted a study reported in The New York Times.
So if your so-called "index beating" mutual fund was held in an taxable brokerage account.
If you held this actively managed fund in a tax-advantaged retirement account, you would still need to generate at least 2% higher returns just to break even with the passive index fund.
The average actively managed mutual fund consists of the following fees:
Why choosing actively managed mutual funds is a mistake
There are professional money managers who spend their whole entire life's work trying to time the market and, guess what... 92% of actively managed funds fail to match the returns of the market (i.e. S&P 500 index) over a 15 year period.
If your investment horizon is 15 years or greater- which includes you unless you plan on dying in the next 15 years- you stand practically no chance of picking the 8% of actively managed funds that will outperform the market. What's worse is that not only would the actively managed fund you chose have to beat the market, but it would need to beat it by at least 1.5 to 2.0%.
Why would it need to beat it by at least 1.5%? Fees and expenses. The average index fund has less than 0.1% in fees compared to the 2 plus percent fees of active funds.
See why you are better off choosing index funds instead.
I know many are thinking that 1 or 2% in fees doesn't sound like a lot, but trust me, it is. For example, saving even just 1% on fees could result in big differences compounded over time. Remember, the cost of a 1% fee could cost you $590,000 over 40 years, which is a very typical investment horizon.
WARNING: Your Financial Advisor Will Sound Very Convincing!
Remember, index funds- passively managed funds- do not generate revenue for your advisor's company. The index funds simply don't make money for your advisor because they do not have all of the above fees associated with them. Beware, your advisor might still charge an "advisor fee" or an "administration fee" which is why I am a firm believer in the DIY method of investing in index funds.
I promise that your current advisor will pitch you something like this:
Our advisement provides you expertly managed portfolios with industry leading research tools that often outperform index funds. We have an experienced staff dedicated to selecting blue chip funds that have demonstrated superior returns in recent market conditions.
This is literally what my advisor emailed me when I exited a high-cost fund through a previous employer's 401(k) program.
It's bullshit. Complete nonsense. Even if they do generate higher returns, it does not last. Never has. Likely never will.
I am certain you will be able to find funds that outperform the market over 1-, 3-, or even 5-year periods. But outperforming index funds over your entire investment lifetime? Outperform for 30 or more years, in a row? They don't exist. Not one ever has.
Perhaps some of you are in a position to require a financial advisor. Some might need to receive tax advice. There are even some of you who are not willing to take just a few minutes to open your own account or call your advisor and inquire about fees and how to lower them by switching to passively managed index funds in your portfolio.
To those of you which this applies, I encourage you to seek the professional help that you require. Do not do so blindly however. Ask. Pick up the phone and have a few conversations with money managers and financial advisors. Be up front with them and ask immediately if this conversation will cost anything. Ask for free consultations as most money managers will be happy to provide a free initial chat.
Ask about fees. Ask about expenses. Ask about commissions. Be inquisitive and remember it is their job to answer all of your questions, even if most of them are about how the advisor gets paid. It's your money and to them, it's a job, so ask them about the costs associated with their account.
Your failure to ask could result in hundreds of thousands of dollars of expenses over a lifetime.
It's not unreasonable to think that if you start investing in your twenty's, and you live to be 90, you may be invested in the market for 70 years! Now imaging what those 2% fees will do to you compounded over 70 years.
Be smart. Be curious. Don't be shy and don't be afraid to ask some questions. Even if you were able to save 1% in fees just by switching to passively managed funds, it could result in you retiring much earlier with a lot more money someday. It's worth it.
Until next time...
Comment below with your experiences with active vs. passive funds. Index funds vs. mutual funds. Run-ins with your advisors commissions. Please share with your community.
Disclosure: This post may contain affiliate links wherein I get a commission if you decide to make a purchase through these links, at no additional cost to you
The Financial Independence, Retire Early Movement (FIRE)
Personal finance seems to be making a comeback. Books are written, podcasts recorded, and Youtube videos are increasing in abundance, all centered around the topic of financial independence. The theme continues by extending the conversation into a concept known as early retirement. Early retirement is predicated on demonstrating discipline and consistency with your finances, all in an effort to quit working as quickly as possible. Could it really be that simple? Has everybody been missing the bus on finances? Will this financial independence retire early (FIRE) movement last?
Why the "FIRE" movement can be misleading
I must admit, I am fairly skeptical when it comes to large groups with common agendas (this stuff sounds cult leadership to me). Don't get me wrong, I do believe the FIRE community has produced many positive outcomes, but my concern is that there is no platform to host the individuals who failed. We only ever hear about the success stories in this community.
Focusing on early retirement, as a sole motivator to get your financial house in order, is a rather dangerous game to play. When pursuing finances as a means to an end, one has a tendency to lose sight of the joys of life, or even stop pursuing them altogether. I am certainly not advocating for the collection of material possessions but rather restarting the search for meaning and happiness in life. There is a level of diversion that is difficult to quantify when we take a myopic view towards any one particular outcome - in this case, early retirement.
Author Ramit Sethi encourages his readers to "automate and live outside of the spreadsheet" in his book I Will Teach You To Be Rich.
What concerns me the most about general guidelines and universal advice on finances is the notion that personal finance is inherently personal. It is unique to your own individual needs. Your path to financial freedom and financial independence does not have to be based on retiring early, although it certainly can be.
Most of us want to work. Some of us even enjoy some of our current work. Yet it is not enough to keep us from wanting something more. That something more is a definitive purpose which our day job presently interferes with.
The FIRE community tends to focus too heavily on residual income strategies, passive income development, and advanced blueprints for access to retirement funds through Roth conversion ladders. These strategies are aimed at using money as a means to an end and using money as a means to an end is a slippery slope worth investigating further.
The fact is, money is a necessary medium of exchange for goods and services, especially in the United States. We find truth and solace in adages like "no free lunches" as most things in life are not without monetary cost. The simple truth is that the less that you have in savings and the more you have in debt, the greater difficulty you will likely have navigating through life.
Accumulating wealth and eliminating debt will certainly open up opportunities and breathing room necessary to explore and pursue your passions. On the contrary, I am not convinced that you need as much as they say you need before pursuing your passions. Going well beyond debt elimination and attaining positive net worth of 3-5 times your annual expenses seems to provide diminishing returns and takes too long for most people to stay with. I believe that saving and investing anything beyond 5 times your annual expenses might be completely unnecessary and a source of undue stress for many of us. There is not a huge difference, in my mind, between 5x annual savings and 25x annual savings (a popular FIRE milestone) when considering your freedom to pursue alternative occupations. Most of us cannot even fully quantify what it is like to have 5 years worth of expenses saved, let alone 25 years worth. The trick is learning when enough is enough.
Consider the difference between having a financial buffer of 5 years of expenses compared to 25 years of expenses. Obviously, the answer is there is 20 years difference. However, getting to the 25 years mark still does not address the underlying problem (neither does 5 years). Your overall lack of a definitive purpose in life.
I have little confidence that an aggressive pursuit to save 25 times your annual expenses to achieve a FIRE milestone will actually contribute in any way, shape, or form to your ability to discover meaning and purpose. Certainly you will become an excellent savor and a savvy investor along the way. But will you become a better person? Will you generate value for others along the way?
Of course you could just wait to save the requisite amount and then begin your pursuit but you need to ask yourself one serious question: Are you willing to wait that long?
The infamous post by Mr. Money Mustache suggests that finding out how many years before your can enter early retirement is much easier than you think. This is an excellent post and has been life changing for many folks. If you have not read his post, go do it now and then come right back here. If you are already familiar with it, keep reading.
I do not want to ruin the moment for anyone but after assessing the numbers highlighted in table and graphical format on his pillar post, I could not help but wonder if everybody is willing and able to wait that long. For example, consider that it still takes 17 years to achieve early retirement by saving 50% of your take-home pay. That's a long time. If you can bump your savings rate up to 65%, you can do achieve FIRE at just over 10 years.
The math above assumes a starting point of zero net worth. Many are already ahead of that and many are well below zero, in the negative net worth category. If you are close to early retirement, already have a significant positive net worth with no debt, by all means finish your pursuit of FIRE. For those of you who are much further away (most of you are), I urge you to consider much more attainable and realistic milestones for your medium to long-term goals.
Debt elimination is huge. If you are not there yet, this is one of the best places to start.
If you have finally broke even and said goodbye to toxic debt like car loans and student loans, it is time to start building a positive net worth. I don't know about you but starting at zero and saving 50% of my take-home pay for 17 consecutive years (204 months) seems like a very long way off and would be nearly impossible to stay motivated for.
Contemplate some important questions when considering if 25x annual expenses is really worthwhile:
My concern with the FIRE movement is that it causes a lot of individuals unnecessary levels of suffering along the journey. Sure, we hear about all the folks whose lives were "changed" the moment they reached the coveted quarter century savings mark. How many are we not hearing about that this advice caused obsessive or pathological levels of focus around money and savings? The truth is, I was one of them.
My personal truth about early retirement
When I first began learning about personal finance and discovering the concept of early retirement, I was all in. Along the way I listened to the ChooseFI podcast, read many personal finance books, and listened to the latest advice from "influencers" about how to attain financial freedom. It was great, while it lasted.
Then I started accumulating a positive net worth. Six figures. A quarter of a million. $400k. My wife and I kept hitting these milestones but, admittedly, felt diminishing returns and satisfaction along the way. We had to stop and take a moment to consider whether we needed to keep pursuing the 25 times annual expenses mark, or whether we actually already had enough.
Forgive me but I am just not convinced that we truly need much more than a few years worth of expenses saved up before we can take a giant leap of progress towards pursuing our passions in life.
Early retirement does not seem to encourage the pursuit of purpose in life, until after you reach early retirement. What if that is not soon enough for most people? What if we are only really hearing about the success stories, and there are many more failures that go unknown? We all need purpose. Dr. Viktor Frankl famously discussed the importance of purpose in his personal memoir about surviving the holocaust, Man's Search for Meaning.
The FIRE movement is centered on the concept of achieving your number, the target net worth and savings so that you can have "F-you" money and walk away from your present job. I agree, having F-you money is very valuable in life. But the real value is in attaining that number so that you can do the things you really want to do in life. Does it really need to be a full 25 times your annual expenses? For some it might. For many others, we can get to work on pursuing our passions on much less.
Trust me, as badly as you think you want to, you may not really be seeking to retire. You may be convinced this is the solution to your problems but I would suggest that your lack of definitive purpose is the real tragedy at work here.
Remember, retirement means doing nothing for work. Consider the Oxford definition of retirement quoted below:
Retirement - "the action or fact of leaving one's job and ceasing to work"
Now that we know the true definition of retirement, is that really what you are looking for? I enjoy working when the tasks I do are meaningful, purposeful, and impactful to others or myself. I like the notion that somebody else is willing to pay me for my time. Are you really hoping for that to end completely? Or do you just want to be paid for your time to do something else? Perhaps something you enjoy much more that provides much greater purpose and service to your community.
Using money as a means to an end is the enemy of happiness. Really, using anything as a means to an end is the enemy of happiness. Do the things you do in life because you want to, not because you expect something in return. This concept is hashed out in best-selling author Mark Manson's work Everything is F*cked: A Book About Hope. If you are the type of person who would not do the current job you are doing if it did not pay, then I encourage you to get your financial house in order so that you can pursue something else.
What society certainly does not need is a bunch of retired 30 and 40 year-olds not contributing positively to society and the workforce. Society does need more people pursuing purposeful work.
Reaching financial independence, for me, is about permitting myself to do the type of work and choosing my own suffering in exchange for long-term benefit. In his book, Manson introduces the concept of choosing your own suffering as a form of "self-limitation". The example he provides to the reader is that the ability to choose your pain in life is the real magic. Take physical exercise for example. You choose to suffer through the short-term pain of exercise in exchange for the long-term benefits of greater strength, endurance, mobility and improved health. That is the power of choosing your own suffering in life.
So What Are We Doing Instead of FIRE'ing Ourselves?
We are setting ourselves up to choose our own suffering. Picking our pain in life, not trying to avoid it. Life will be filled with pain and suffering regardless of whether we try to avoid it, therefore quit trying to avoid it. Rather, set yourself up so that you can choose your pain points in life such as physical exercise, financial planning, sauna bathing, cold showers, proper nutrition, meditation, and whatever other hormetic stressors you can devise that will benefit you in the long-term.
When you are paycheck to paycheck, saddled with debt, you are not in a position to choose your suffering. You need your current job with the long hours, arbitrary rules, and tedious demands that come along with it. You rarely can afford to step away and fully pursue your passion. You're stuck. Many of us are there. Many of us have been there for decades. Even I was there. It wasn't pretty.
"25x annual expenses"
"4% withdrawal rates"
"Passive income strategies"
The above are all common terminology of FIRE community. You may certainly use some, or all of them as you so choose, but make sure you are using them for the right reasons. Make sure you have assessed whether you really need a full 25x annual expenses, or whether you can take a leap of faith much sooner in life. An emerging, and increasingly popular, pivot on FIRE is instead referring to attaining a "work optional" status. When you hit work optional, you have many months, and hopefully years, worth of savings and investing accumulated so your reliance on your present job is minimal.
I encourage you to separate the "FI" from "FIRE". Focus solely on financial independence (FI) aspect and move towards a position of financial strength to allow yourself to pursue your passions in life sooner rather than later. Financial Independence permits many opportunities for you to no longer be beholden to your present job, especially if you dislike it greatly and do not find purpose in your work.
The biggest problem in the FIRE community is the underlying concept that we should eventually be able to attain a life with freedom to recline in a hammock everyday if we so choose. The major flaw of this underlying ideology is that there will always be a part of your life that will suck. Always. Therefore trying to avoid it altogether is a fruitless endeavor.
Assuming that we can eliminate hardship and suffering in life is completely impractical and ironically tends to lead to greater suffering and unhappiness.
The real power is when you are in control of choosing your suffering. As mentioned above, physical exercise is a great example of choosing your suffering. The short-term costs are certainly worth the long-term benefits. Me sitting down and writing this post when I would rather do just about anything else, is another example of choosing your suffering. I am choosing to do this, rather than something else, with the concept that there will be some future return.
I encourage you to move forward and pursue your passions as quickly as possible. Plan, save, and invest along the way and assure your financial house is in order before doing so. Eliminate your debt and attain a positive net worth and then quickly move onto more meaningful aspects of life, such as defining your purpose.
As always, leave your comment below on how you felt about today's article. Love it or hate it, life is not about retiring. Going through your entire life with one goal, to retire, seems like just about the worst form of hell on earth. I challenge you to look further and realize that your problem is not that you are not retired, your problem is that you just haven't yet found out why you are important to the world, however big or small that importance may be.
Disclosure: This post may contain affiliate links wherein I get a commission if you decide to make a purchase through these links, at no additional cost to you.
How small purchases could add up to big savings
I read and hear about too many cost-saving methods that are impractical and simply do not produce quite the return they promise.
First, figure out why you want to save money.
Are you saving for a house? Saving for college education? Saving for an investment? Saving for anticipated expenses such as repairs or maintenance?
Second, please realize that saving money does not have to be difficult. It also does not need to lead to massive deprivation where you use candles instead of lights (plus candles are a fire hazard).
To prove my point, here are 3 stupid items that I save real money on every single year. Results may vary.
3 Simple Ways to Save Money Every Year
1. Eat Almonds
Almonds, my number one snack food item.
I buy a ton of them. Not literally a ton, but damn close. I buy a 40 oz. bag of whole raw almonds online for less than $13.
A typical 16 oz. bag of almonds at the store is $8. The bag I buy online is 2.5x larger but costs less than twice as much. 40 ounces of almonds would cost me over $20 at the store therefore I save about $7 per 40 ounces. I go through a full 40 ounce bag every week which means I save $7 every single week. This adds up to over $350 of savings every single year.
2. Single-Ply Toilet Paper
Actually there are two paper products to be aware of here: single-ply toilet paper and half-sheet paper towels are two game changers.
I can buy a 1000 sheet single ply toilet paper that lasts for 6 months for less than $7 at the store. Supposedly the average American uses $10 worth of toilet paper per month. By switching to single-ply TP I have been able to spend only $14 per year, per person in our household. This comes out to a little over $1 per month of TP usage. This equates to a savings of over $100 per year compared to the average American 2-ply user!
Half-sheet paper towels allows me to be significantly more mindful of how much paper towel I was using. Full sheets are bullshit. Rarely do you ever need a full sheet. I cut my paper towel usage in half my first year using half-sheets. How much could this switch realistically save? I use two less rolls per week at which saves me over $150 per year.
3. Filtered instead of bottled water
Using a water filter could potentially save you big money every year. If the typical household purchases a case of water every week, and bottled water is approximately $5 per case of 24 (depending on where you live), you could save $250 in bottled water every year. If you buy two cases per week, you might be able to save over $500 per year.
Some of these companies even claim you can save up to $1000/yr, but that's a pipe-dream in my opinion.
There are two popular options depending on how often you want to change the filter and how easy you want your experience to be:
Saving Money is Easier Than You Think
Here is proof that even these 3 ridiculous ideas can save you serious money every year without effecting your quality of life via deprivation.
These don't involve turning the thermostat to 45 in the winter or 90 in the summer. They don't involve biking 30 miles to work. They sure as hell don't include eating noodles everyday (just almonds).
What are 3 things that save you real money every year that might surprise fellow readers? Comment below with your answer.
Understanding what a mortgage actually is
A mortgage is a loan used for the purchase or refinancing of a home. Practically speaking, it is the amount of money given to you by a lender for the financing of a home.
The mortgage loan has many parameters including, but not limited to:
Mortgages are typically used when you do not have all of the money upfront for the sale of a home. If you do happen to have the entire upfront cost, you might still choose to mortgage the property if you do not want to give up such a large sum of money, all at once.
Is a mortgage the same as any other type of loan?
Yes and no.
A mortgage is specifically a loan given as financing for a home purchase, or refinancing. As collateral for such a large amount, the home is typically put up against the value of the home just in case you stop making payments to them. If payments should stop, the home could then be used as collateral for "repayment" of the loan. I use the term "repayment" very loosely because you lose more than just a home in this process. In the process of losing a home due to missed mortgage payments (essentially a foreclosure), your credit score will be ruined.
Keep in mind that this black mark (i.e. foreclosure) stays on your record for 10 years. Avoid this at all costs if you ever hope to receive any other loans or favorable terms on lines of credit.
Lenders typically get into business to lend money, not to own homes. They want your money, not the house. I have heard of many people getting away with up to a year's worth of missed payments prior to the lender foreclosing on the property. This is proof of concept that lenders really don't want to be homeowners.
What is a mortgage "pre-approval" or "pre-qualification"
The initial process of obtaining a mortgage is to receive a pre-approval or a pre-qualification. Be advised, these are not the same thing. These two terms are often used interchangeably, but they differ in some important ways.
A pre-qualification is solely based on information that you provide to the lender. This is simply a way to help you "ballpark" the amount of money you can hope to spend on a home. This is by no means a commitment nor is it a hard number to use when making home buying decisions.
A pre-approval is a much deeper dive into your history including, but not limited to:
The pre-approval is a much firmer commitment to lend you a given amount of money. Essentially, a pre-approval is a mortgage loan application without a specific property affixed to the loan application.
How does the rest of the mortgage process work?
After obtaining a pre-approval letter (highlighted above), the potential buyer includes this in an offer on a particular home. If the offer is accepted, the potential buyer typically has a period of less than 10 days to officially apply for a loan with a lender. This is the time where most people "shop" around for the best quotes before submitting a formalized application. Beware however, you really do not have a ton of time to do your shopping so move forward wisely.
Around the same time as you are gathering documents for your mortgage application, you will be arranging to have the property inspected (if you choose) and place "earnest money" in an account based on the terms of your contract.
As for the application process itself, the lender will now perform any final verification of employment, income, and assets. The lender will also attain details on the specific property for which you intend to purchase following the seller's acceptance of your offer. The lender will look to have the following done prior to fully approving your loan:
If everything checks out and terms are acceptable (interest rates, loan duration, loan type, etc.), you will move towards closing on your mortgage.
Closing on your mortgage involves meeting with the lender and your real estate agent (and any other necessary parties depending on your state's rules/regulations). This is where you will sign your mortgage papers. This is also typically when your down payment and closing costs are due, in full.
As always, this is not to be interpreted as financial advice. Check your local rules and regulations as some of the information will ultimately differ according to where you live or desire to live.
Above is a summary of the basic "moving parts" surrounding mortgages. It is important to understand the nuts and bolts of a mortgage since it will likely be the largest financial transaction of your life.
The creation of mortgages permits many to attain home-ownership where it would otherwise be impossible due to limited income and finances.
There are many more things to know about mortgages. Learn everything you can. Knowledge is power.
Best of luck.
Can Credit Cards Be Effective for F.I.?
The financial independence community often demonizes the use of credit cards. The words of advice that are commonplace in the personal finance realm suggests you pay for everything in cash. Guys like Dave Ramsey even go so far as to encourage that you cut up your credit card.
But wait, this cannot be the only way. We should not have to carry pockets full of cash around just to fit in with the financial freedom crowd. Why do I have such a problem with this "cutting up the card" advice? I will tell you why. Cutting up your credit card to avoid spending does not correct the actual behavior of overspending.
I agree, it adds friction to the process which many psychologists believe will interfere with the participation in an undesired behavior. In this illusion of self-control, you would add friction to your undesired habit as a means to decreasing the likelihood you will participate in said habit. A smoker would lock their cigarettes in a cabinet and hide the key down the block as a method for increasing friction between them and their undesired behavior. Cutting up the card is like hiding the cigarettes. It fails to address the poor habit head on.
Credit Card Rules To Abide By
Where credit cards shine
First up is credit card rewards. The fellas over at ChooseFI have a great section on their site about travel rewards and credit card rewards. Cash back, bonus points, airline miles, travel rewards and hotel credits are some of the many perks that certain cardholders can participate in with disciplined use. Without a credit card you cannot participate in these rewards. Remember however, these credit card rewards are not actually for your benefit (at least they are not supposed to be). These rewards exist to encourage spending behavior. Period. You are lying to yourself if you say that rewards will not encourage you to spend more. It will, unless you are hardcore about recognizing your spending habits and budgeting. This is why you have to "game-out" rewards and turn the tides in your favor so that you can benefit from something that was originally intended to cause you harm (in the form of overspending).
Next up, cards can help build your credit score. To do this, you need to pay particular attention to some important factors in order to build your score:
Why is building a credit score important?
The benefits of a high credit score (720+) include:
The final credit card benefit worth mentioning is the added safeguards of carrying a credit card vs. carrying cash all the time. If you think this doesn't apply to you, think again. Lost your wallet? Just immediately call and freeze your credit card. If there was cash in your wallet, likely forget you ever had it.
Pulling out your wallet or money clip and revealing some serious paper is asking for trouble. Remember, criminals are looking for targets. If they see you at the checkout shuffling through your $100 bills to pay for a light bulb you might have an expected encounter on your way out to your car in the parking lot.
Yes, you can be both frugal and have a credit card. Just manage it responsibly and it can be an asset instead of a hindrance. Spend wisely and continue to find ways to improve your saving habits and spending behavior.
Let me know your thoughts in the comments below.
Why panicking is the worst thing to do in a financial downturn
During a period of decline in the market, many individuals feel like they are losing their shirts (and possibly much more).
Remember, corrections happen often. Technically, so do recessions. We typically have a correction once every couple of years and a recession every 5 years or so. That said, the overall equity market still returns just under 10% over the last 200 plus years.
So what might one do amidst a significant financial downturn? Suggestion: hold on tight!
How often do these "market crashes" happen exactly?
According to USnews, corrections happen at least once every 2 years. Sometimes they happen annually. When corrections do occur, they typically only last a couple of months and drop less than 20%.
Bear markets (recessions) occur every 4-5 years. They typically drop 20% or greater and last for a duration of one year, give or take a few months.
The worst meltdowns or recessions in recent memory was "The Great Recession". That sucker lasted 18 months and was the worst meltdown since World War II. During that period, the S&P 500 lost approximately 50% of it's total value. Now that's scary stuff!
How long does it take to recover from a typical market dip?
The single most significant factor of a recovery whether or not you stayed invested throughout the entire downturn.
As history has shown repeatedly, if you choose to try and time the market and you get out while it's on the way down, you technically have to time the market correctly twice- once on the way down, and then once on the way back up when you "re-enter" the market. Market timing is a fool's errand.
There are professional money managers who spend their whole entire life's work trying to time the market and, guess what... 92% of actively managed funds fail to match the returns of the market (i.e. S&P 500 index) over a 15 year period.
That means if they cannot do it, why would you even try? You don't have the time to sit around and read financials all day like these guys do.
As for how long the typical recovery takes.
In a correction, you should be back to even within a couple of months. For recessions, you usually get back to square within 18 months, give or take. Regardless, the markets have always climbed back and resumed breaking records. This is no guarantee but it seems highly likely given that we have two centuries of market data to rely on.
What to do when things get scary
My personal philosophy, as well as the philosophy of many seasoned investors, is to sit tight. Selling when the market is falling is one way to guarantee a financial loss and give yourself a lasting bad experience with investing in the market.
For the bravest of the brave, you could take this one step further and actually invest during a downturn. This is what I personally do. I take advantage of funds going "on sale" and purchase shares of the index funds that I already usually invest in at a drastically lower price than I would have gotten if the market continued to climb. See my thoughts on low cost index funds if you are unsure what these are.
It was the infamous Warren Buffet who said when the sky is raining gold do not go outside with anything less than a washtub. This is the very basis of the saying "buy low".
If you happen to be an individual stock picker, and not a typical index fund investor, then I suggest you go elsewhere for information because this is not a game I like to play.
When you invest in index funds like the S&P 500, you are betting on the entire US economy. Realistically, in order to lose ALL of your money, the entire country would nearly have to "go out of business" and I just would not bet on that happening anytime soon. Beside, even if the U.S. economy completely tanked and all businesses closed up shop, there will be much bigger problems going on in society that will quickly overshadow your worries about how much money is in your account.
If you are invested in broad based, low-cost index funds, then I would plan to stay the course and avoid selling in a downturn. You lose money when you sell or when a company goes out of business. If you stay invested, particularly in these broad index funds, the likelihood of never returning to baseline is slim to none.
If you had a crystal ball and could see things coming, perhaps you could adjust your asset allocation (i.e. more bonds and less stocks) prior to or immediately after the beginning of a downturn. The problem is, nobody is able to time this. Most of the corrections and recessions have no consistent way to assess when another one is coming. The best you can do is decide whether you think major market fluctuations are ahead based on national news - think politics and pandemics.
For example, take the onset of the coronavirus (COVID-19). If you had first heard of the potential outbreak on the news January of 2020, perhaps you could have adjusted your allocation more towards less-volatile bonds to soften the blow. Nevertheless, things were able to return despite the fact it seemed the downward spiral would never end. If you are considering yourself a long-term investor (which I hope you are), perhaps ignoring these events altogether is your best bet. Ask your financial pro if you don't believe me and if he disagrees, find out why (it usually revolves around him or her making an extra commission to manage your funds).
In the end, no results are guaranteed. Past history does not indicate future returns. Besides, none of this is investment advice and I am not a financial professional. You have to take the good with the bad. The overall average returns of the market of just under 10% per year include years where the market dips greater than 50%-such as what happened in 2008. You truly do have to take the good with the bad when it comes to investing.
In closing, corrections happen all the time. Further, we are never that far away from a full recession. They are coming. They will continue to come. Be prepared. Be ready to see your accounts lose massive value. This are the harsh realities. If you cannot handle it, maybe you should go bury that money under the shed and let the worms get it.
Understanding life insurance policies
Insurance is often a very important component of a sound financial portfolio. However, the needs of each person is unique, especially when it comes to life insurance.
When deciding on life insurance policies, there are several important things to consider.
First, you need to consider your current debt to income ratio. If you are the high earner in the household, and carry a lot of debt, taking out a larger policy on yourself is probably justified. Even if you are a low earner, but carry a large amount of debt, considering a medium to large policy is definitely warranted.
It is also important to consider where you estimate you will be in the future regarding your financial situation. If you are a habitual saver, perhaps taking out a larger policy now and shifting to a smaller, more affordable policy later would be justified.
If you are already financially independent, saved 5 or more years worth of expenses, and carry no significant debt, life insurance may not be needed at all. It is definitely a conversation worth having with your financial professional.
What is Life Insurance?
Basically, it is a contract. The payer (insured) is in contract with the insurance company. The exchange is a monthly premium for a "potential" lump-sum payout. To remain under contract, the insured pays a monthly premium to remain eligible for a "death benefit", which is often the lump-sum payout.
If you ever wanted to discontinue your policy, you could just simply stop paying the premiums and your coverage would cease. I would check with your provider first however.
Common Types of Life Insurance
Basically, there are two types of life insurance. There are fixed term policies and there are lifetime policies.
Fixed term policies are often referred to as term policies, or term life insurance. This type of policy provides coverage for a fixed period of time, most often 25-30 years. Term insurance is the most popular type of insurance chosen by followers of the financial independence and financial freedom movements as it is typically the more cost effective form of life insurance.
Lifetime policies typically come in the form of whole and universal life insurance. These policies typically carry a much higher premium, however they are payable for the lifetime of the insured instead of expiring after a pre-determined period like a term insurance policy.
Essentially, for a higher monthly premium you stay eligible for a "death benefit" payout under a lifetime policy. In a term policy, if you are not deceased prior to the policy expiration date, there is no "death benefit".
Why I Chose Term Life Insurance
My thought process, like many F.I. followers, is that I chose the policy with the greatest amount of value.
Term insurance affords a much lower monthly premium than a lifetime policy. This allows me to instead invest the difference in cost between the two policies, month after month, compounded over time.
By investing the amount I am saving with a term policy, compared to a lifetime policy, I will take advantage of the effects of compound interest. While taking advantage of this investing strategy, I do not leave myself "exposed" to significant losses of income that my family would incur should I meet an untimely demise. This is because I still have a substantial "death benefit" payout with my term life insurance policy.
I chose to avoid a lifetime (universal or whole life insurance) policy because I anticipate reaching a significant amount of net worth and savings by the time my term life insurance expires.
In other words, if you anticipate saving and investing for the next 30 years, you will likely have a significant amount of money at the end of that term. The need for continued coverage beyond this point, like you would receive with a whole or universal life insurance policy, is unnecessary and very expensive.
Overall, everybody is different
Assess your needs on an individual basis. Consult with a financial professional.
Not everyone will benefit from a term policy over a lifetime policy. Your circumstance may be unique. Consider your overall picture (time horizon, investing strategies, savings rate, anticipated expenses, etc.) when determining what type of life insurance policy will best meet your needs.
In the end, whichever policy you choose, I do feel that life insurance in general is an excellent thing to consider for anyone with a spouse or dependents that will be deeply impacted by your loss of earnings upon the event of your death.
Getting "smarter" about money is a proven road to riches
I am not referring specifically to college education either. I am referring to "getting to know money".
You see, most wealthy people (people with a high net worth) seem to know money pretty well. They know where and how to save it. They certainly know how to make more of it. Perhaps most importantly, they know how to invest it. There are very few millionaires who do not have an excellent education on "how money works" as a medium of exchange.
There are some popular exceptions to this rule such as professional athletes, divorcees, trust-fund babies, and celebrities. Consider how many stories of celebrities and athletes going bankrupt or having significant amounts of debt that we are aware of. It seems that the only difference between those who have received a windfall due to celebrity status or otherwise, and those who remain millionaires for decades, is the level of education they have about their money.
Most of the wealthy got their status because of their desire to study riches. Take some of the wealthiest investors in America as an example:
What all these men have in common is they have dedicated their lives to learning about money!
Buffet is said to read some 500 pages of financial statements per day. This is taking learning about money to a new extreme. Any coincidence that his passion and desire for learning about money and value has led him to be one of the richest men in America? I think not.
Icahn is a ruthless investor and seeks undervalued assets to turn a profit. He has developed an incredible ability to remain patient and concentrate his bets and investments in definitive assets. He has consistently beaten the returns on Buffet by nearly 10% over the last 30 years. How could he possibly have developed these skills? He learned about money and value investing by educating himself on how to read and interpret financial statements.
For Dalio, it has long been said that he had an innate ability to find a way to learn from anyone who had something to teach. He is reported to have even listed to his barber or somebody that he caddied for to pick up valuable long-term investing tips. This should all come as no surprise that he made his money by learning about money.
These are some extreme examples of how learning about money typically leads to generation of assets and accumulation of net worth. However, it can be true for all of us as well.
How can "everyday folks" become wealthy?
Same answer as before: improving your education and understanding of money.
For example, try to predict whether learning about any of the following would increase or decrease your net worth"
My guess would be that your net worth would increase if you learned any, or all, of the above! What do you think?
Where You Can Start Learning About Money
Picking one of the items listed above and searching the library or the internet for reputable sources would be a great place to start. Your goal should be to learn slowly and consistently over time. This information and knowledge will not be an overnight success, but I think you will be surprised at how quickly you see measurable differences when you start teaching yourself about money management.
I have a resource page on this site that lists my favorite and most highly recommended books that I have read which have made profound improvements on my understanding of money management and contributed to substantial improvements in my net worth.
Over time, you will develop the skills necessary to be a dependable money manager which is the most reliable method to increasing your wealth.
Please comment below which area of money you plan to learn about first.
Increasing Your Net Worth Is Simpler Than You Think
How to Increase Overall Net Worth
These steps are for anyone interested in increasing net worth and savings.
Whether helping you get started with saving your first dollar, or guiding you to remain motivated as you cross another financial milestone, these 3 steps are the building blocks of increasing your overall net worth.
My advice: revisit these 3 step early and often.
Saving money does NOT have to be difficult
Saving money does not have to be a difficult endeavor. Yet for many of us, we find it nearly impossible. Most of us suffer from "too much month at the end of the money" which essentially means the average American is living paycheck-to-paycheck.
In the United States, it is a sad state of affairs when examining our average net worth by age.
The chart below highlights, by age, the average net worth inclusive vs. exclusive of the equity in their own home:
Summary of Average U.S. Household Net Worth by Age
Average Net Worth in the United States by Age:
Summary of Average U.S. Household Net Worth by Age less Home Equity
Average Net Worth in the United States by Age minus Personal Home Equity:
The Average U.S. Household Net Worth
As you can see, the average American under the age of 35 is only worth less than $7,000. You would hope that by the age of 50, that number would go up dramatically.
Well, guess what, it doesn't. According to the chart, by 50 years old, you can expect a net worth of less than $90,000. By the age of 65, Americans are only worth about $170,000.
That means that after 30 plus years, the average American only increases their net worth by $160,000.
Sound like a lot? It isn't! So how can we kick these savings into overdrive and take advantage of the power of compound interest?
Easy ways to increase your overall net worth
1. Learn about money
Seems simple right? This one seems straightforward but many readers ask why this is important.
Think about it this way: you would not perform heart surgery without going through undergraduate studies, med school, fellowships and residency training first. That's a lot of preparation.
So why would preparing to increase your net worth be any different. You need to learn about it. What is the primary driver of net worth... money!
Here is a list of the most meaningful books that I read when I first started my financial independence journey.
2. Track your money
I don't really care how you do this but it is unavoidable. You do not need a full blown budget but you do need to be aware of where your money is going. If you have no idea where an entire months worth of earnings or paychecks are going, you have very little chance of increasing your overall net worth.
If this intimidates you, take this on incrementally. For example, if last year you had an extra $200 every month in your checking account after expenses, and now you only have $50, investigate where that extra $150 went.
This is a great place to start. This is where you can identify extra savings very quickly.
Some ideas and quick tips for where to look for extra money each month:
3. 'Automate' or 'Normalize' your savings
I purposefully used BOTH automate and normalize for #3. Why? The fear factor associated with "automation".
Some of you are going to be scared off by the "automate" verbiage. You do not like the rules of needing to link accounts and automate savings in regular intervals directly to your 401k, 403(b), 457 (b), etc. I am certainly aware that this is very common advice in the common wisdom of pay yourself first.
The problem with automation is that it becomes another point of friction, or sticking point. Many of us do not like the rigidity of automatic deposits.
For others, automation is great advice. If your company gives you a "match" into your retirement account, you need to take advantage of this up to the maximum amount they will match. Otherwise, this is free money being left on the table each month.
To get started with automation, simply set up an automatic deposit on a weekly, bi-weekly, or monthly basis. Direct it to your 401k, 403(b), 457 (b), IRA, brokerage, etc.
I personally prefer sending it to a taxable brokerage account or IRA which gives me access to low cost index funds (although volatile, over a 210 year history they typically yield an 8% return, give or take). Please consider the fees of your retirement accounts. Make sure to ask for all types of fees. Be sure to ask about:
If you need a little extra motivation, consider that Tony Robbins - in his book Unshakeable - tells a story of what happens if the government imposes a tax on you.
To paraphrase Tony: if you had a tax imposed on you suddenly, you would initially complain and kick dirt, but you would still eventually pay it. Think of your automated savings like a self-imposed tax. You might complain about saving a pre-determined percentage of your pay initially, but eventually you would find a way to "pay it". Consider the added benefit, in this case, that this self-imposed tax is actually just you "paying" yourself.
If you still cannot get over the idea and rigidity behind automation, do not give up. I believe there is an alternative option.
It is something that I personally do. It typically is not as consistent and it does require some discipline.
I call it normalization of savings.
What I mean by normalization of savings is find a way to make savings a normal part of your life and money management.
How would you do this? With repetition and practice.
For example, if you never saved before and you anticipated finally starting to save, that first $100 deposit is going to seem monumental. While it certainly is monumental, it only is so because you have never done it before.
Over time, as you continue to deposit $100, month after month, year after year, each individual deposit will not have the same psychological impact as the very first $100.
This habituation effect is actually what we are looking for! It is the normalization of savings.
If a deposit into your accounts seems like a big deal, it is probably because you have never done it before (or at least not in that amount). This psychological "wow factor" adds yet another layer of friction which will prevent you from saving it in the first place.
Put your money where your mouth is.
Write these 3 steps on a whiteboard, paint them on the wall, whatever. I do not care how you do it, just remember to revisit these 3 steps no matter where you are on your path to financial independence.
They can serve as a great motivator for beginners or a "back to basics" course for those well seasoned pros already along the journey.
Be sure to leave us a comment below on how these strategies gave you a kick in the ass to get started or helped orient you somewhere down the road...
Disclosure: This post may contain affiliate links wherein I get a commission if you decide to make a purchase through these links, at no additional cost to you.
A Story of Six-figure Debt Payoff
Debt payoff typically isn't easy. Many times, the first step is to take a cold hard look at your financial situation which is more than most can tolerate. In the end, however, you will be glad that you did.
Debt payoff is often a thankless endeavor because it mostly revolves around undoing a mistake. Being in debt means that the money was already spent. The bad decision was already made.
Contemporary American culture informs us that we all should strive for the "American Dream". Yet most of our understanding of the American dream is violated by the pervasive images of cars, clothes, and material possessions from films and TV shows. Folks, this is not reality.
America is about freedom. Freedom cannot possibly be pursued to its' fullest if you are under a mountain of debt and financial obligations. Debt keeps you in jobs you hate. Debt is one of the leading causes of stress. Debt breaks up families and creates marital divide.
For Millennials, student loans are the spearhead of our credit crisis. Unaffordable rates for college tuition is readily subsidized by eager lenders preying on the young and innocent. Millennials were led to believe that the only way to "succeed" was by going to school. How well is that paying off for us?
We are left to watch those who have elected to go into trades and forego college beginning their lives with significantly higher levels of financial strength. They start families much earlier than college-goers. With a smart first time home purchase, they are able to avoid debt to an extent most academically-inclined students will never know. Those who avoid student loan debt have essentially given themselves many advantages that otherwise are unattainable for those who have received higher education.
Don't get me wrong, college education typically equates to higher salary and lifetime earnings (provided you find a job). But it is about what you trade in your 20's and 30's that is not easy to recover. If you spend most of your 20's and 30's paying off student loan debt-which is what most people are doing-you will have little energy and capital to allocate elsewhere.
Student loans are a difficult situation that is wreaking havoc on Millennials, as well as younger generations. This crisis can be averted however, even if you already have accrued a significant amount of debt. I must admit, it will take tremendous discipline and consistency to get yourself out from under your student loans.
Nearly $100,000 In Debt to Break-even
The three biggest tips I followed for six-figure debt payoff:
Be creative with housing:
The way I was able to avoid housing payments is I stayed with my parents for 2 of the 3 years in graduate school. In the third year of PT school, I moved into an apartment where I negotiated an agreement to trade labor/maintenance on the building itself as a rent payment.
Limit transportation expenses:
The way I avoided toxic car debt was I drove a '96 Toyota Camry with 200,000 miles that I paid for in cash. Get a grip. Unless you have extreme concerns about safety ratings for a family of 5, swallow your pride and drive a cheap used car. Period.
Keep recurring costs low and aggressively use the savings for debt payoff:
I took a look at all my bills like cable/internet, utilities, and insurances. I called each of the companies or researched competitive quotes to cut recurring costs. Each dollar I saved went into aggressively paying the debt.
Focus on earning more through increased skills (or increased hours):
I quickly stepped into a lucrative field, but also maintained a part-time job in the evenings during my three year debt payoff period. It felt arduous at times, but in the end, it was well worth it. I also took some time to learn some management lingo by reading business journals and was able to land a management job at a private outpatient practice which is quite rare for my field.
The Truth Of Debt Payoff Strategies
If you have a significant amount of debt, especially student loan debt, I suggest you get serious about it and turn it into somewhat of a "game" because there will likely be a significant amount of strategy involved. You will need to get focused. Do the math. Find out where your money is going. Calculate your life energy and where it all goes.
If you want a very detailed, impossible to beat formula for how to calculate your real hourly wage, you need to read Your Money or Your Life immediately! This will help put your hours and dollars into perspective.
MANY have had success eliminating debt by following Dave Ramsey's Total Money Makeover book (myself included).
After reading this book I understood how to become focused on the objective. The only thing that mattered was freeing up as much money as possible so that it could all be used to aggressively pay down debt. Every extra dollar, whether it be cost cutting or selling shoes on Craigslist, needs to be contributed to getting this toxic debt out of your life once and for all.
Share your story in the comments below. What are your tips for aggressive debt payoff for our community?
Until next time...
“Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it.” - Albert Einstein
How dramatic is the effect of compounding?
For finances, and most other objective measured, the value of compounding grows in logarithmic fashion. This means that as you move along the horizontal (x) axis, the growth on the vertical (y) axis grows exponentially. More simply put, the line curves upwards (or downwards if in debt) instead of increasing in a straight line -see below.
Frequently, in the personal finance community, we use money on the horizontal (x) axis, and net worth on the vertical (y) axis as follows:
Examples of the effects of compound interest using $10,000 initially and never adding another dime!
After 10 years, your initial $10,000 (assuming you added nothing else), grows to only $19,990. Not bad, but this will not get you rich.
After 20 years, your initial $10,000 (again assuming you add nothing), grows to $43, 157. Again, not too bad considering you never added another dime - which is typically very unrealistic for those interested in saving and investing.
Fast forward to the 50 years mark, your initial $10,000 investment turned into a whopping $434,274. Again, this does not adjust for inflation and just shows you what your initial dollar amount will potentially turn into after 50 years of passive index fund investing.
Initial investment of $10,000 plus adding another $500/yr to your investment
You may feel somewhat underwhelmed after that first example. That is fine. The power of compounding is quite dramatic, however some folks argue and become upset when they hear about 50 plus years of investing. It might just be too far out for most people to imagine and remain motivated on the path to F.I.
This is where demonstrating the power of saving plus compound interest comes into play.
Take our initial investment of $10,000, use the same parameters of hypothetical growth at 8% compounded annually, and add $500 a year.
This time it only takes 43 years to cross the $400,000 mark. At the end of 50 years, your initial investment of $10,000 plus an additional $500/yr, compounded at 8% annually, turns into $720,000.
Initial investment of $10,000 plus an additional $5,000/yr in an IRA
Now what if you simply take your initial investment of $10,000, and add $5,000 per year to an IRA, compounded annually at 8%. Essentially this would be nearly maxing out an IRA every year ($6,000 contribution limit as of 2020).
Following this process of $10,000 initial investment, plus $5,000 contribution annually to an IRA, compounded at a hypothetical rate of 8% annually - you would be a millionaire in 36 years with your investments growing to $1,078,364.
At the 50 year mark, you'd have potentially $3.3 million in the bank. Not too shabby.
There is significant potential waiting for you in the form of "compound interest"
As you can see, compound interest takes time to reveal its' magic. The earlier you start, the longer you have for compound interest to work in dramatic fashion.
When evaluating the role of compound interest most folks refer to the rule of 72. The rule of 72 helps you learn how long it will take to double your initial investment. You discover this by dividing 72 by your expected annual interest rate (8% in our example).
The Rule: 72 / expected annual interest rate = years until initial investment doubles.
In our example: 72/8 = 10.3 years. In other words, every 10 years our money would double.
How do I make compounding more powerful?
As you can see, each of our models demonstrates-after a hypothetical return-a "hockey stick" growth curve. This means your money compounds and grows exponentially upward instead of a straight line.
Of course, this does not happen consistently. Here is a caveat: Actual stock market returns look nothing like a smooth line the way our model shows. It takes many scary nosedives in a few months to high altitude climbs over many years. These fluctuations occur due to many reasons such as investor behavior, consumer sentiment, inflation, pricing, GDP, etc. Many factors determine market returns.
However, according to over 200 years worth of data, the average return of the stock market is in the 8-10% range. Remember, this is just an average. Do not expect these returns on a reliable and consistent basis. Some years will be higher, and some years will be much, much lower. Overall, unless America "goes out of business", you are likely to see a positive return with longer time horizons of 20 years or more.
How To Increase the Power of Compound Interest
There is a very simple, yet often overlooked method of increasing the power of compound interest. How? START WITH A HIGHER INITIAL INVESTMENT.
To illustrate my point, say you start with an initial investment of $100,000, instead of $10,000. Do not add another dime to that $100,000. Ever.
In 50 years, after an 8% return compounded annually, you'd see your initial investment grow to...
This is approximately $1.4 million more than what you would have compared to if you initially invested $10,000 plus $5,000 a year compounded at 8%.
To illustrate this point further, in the model representing a $10,000 initial investment plus $5,000 annually, you will have contributed a total of $260,000 of capital with a final worth of $3.3 million.
By starting with a greater initial investment, not only will you be worth $1.4 million more - at a total of $4.7 million - but you will contribute $160,000 less of your own capital.
The power of compound interest is one of the primary motivators that keeps me steady on the path to F.I.
Consider visiting a compound interest calculator and plugging in your own numbers.
Remember, our models and examples are completely hypothetical and do not represent real returns, nor are they adjusted for inflation. In no way is this a guarantee of returns. Please seek guidance from a financial professional, of which I am not.
Still, the point remains. The dramatic effects of compound interest are on display.
The ideal recipe would be to start with a big lump sum as soon as possible. However, if you are unable to do this, the next best method would simply be to start as soon as possible.
Enjoying our content? Please leave a comment below.
Further, take a look at our favorite resources that built the foundation for our awareness of financial independence, frugality, and investing.
Cutting monetary costs are not the only benefit of these thrifty habits
Some folks need more incentive than simply a lower price tag to practice frugality. Thrifty habits often come with additional benefits, aside from lower cost.
Below you will find some of the dual benefits of common cost cutting techniques. Use this as a means to continue to motivate yourself on why you chose the financial independence lifestyle.
1. Cutting Cable... or just reducing the monthly services
The cost implications of this are obvious. Paying $160 per month just to watch a few games or occasionally flip on the hunting channel? Why not see if you can reduce how much TV you watch by eliminating the channels you barely watch, or even cutting cable altogether.
Some will make an argument that they get great benefit from watching a certain sports team or having access to a certain movie channel. That is entirely your business, not mine.
What I am suggesting is seeing if truly assessing this habit from more than just a monetary cost perspective really yields a positive return on your happiness.
Remember, time is life's most precious commodity. As far as we can tell, it is a fixed commodity for all of us. Consider that, according to the BLS, the average full-time employed American still finds enough time to watch approximately 2 hours of TV per day! Unemployed Americans watch nearly twice that at 3.8 hours per day. This is alarming! Think of all you could be doing if you reduced, or even eliminated, the TV watching habit.
Consider the following additional benefits of cutting/reducing cable, aside from cost savings:
2. Joining a public library
Save money on books and movies. This one actually lends back to our first idea, cutting cable. Stacking these habits would be an excellent idea for maximum benefits of the frugal lifestyle.
There are many free events at the library. Some events at our local library include, but are not limited to:
For those with a family, most public libraries have dedicated areas for children. This can be a great alternative for children to learn and socialize instead of watching TV or playing games on a device.
3. Learn how to DIY
You control the costs because control the inputs.
Aside from controlling costs, think about how DIY might further impact you in the following ways:
Frugality is often about Dual Benefits
Again, as we highlight in "what is frugality", being thrifty is often of great value to those of us leading a life aimed at financial independence.
These dual benefits are an excellent way to continue to properly value our cost saving efforts beyond dollars and cents.
The more you understand about why you have chosen frugality, the easier it will be to stay on track over the long term.
If you have anything further to add to this article, please place it in the comments below.
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Should you believe everything you hear about Financial Independence?
Most of the folks of the FI and FIRE community have very good intentions. As with any group, there are certainly some outliers. In my reading and research over the years, I have found some common myths that often dishearten the community and the people of the financial independence community.
Let us outline 3 common myths I see continuously emerge and break the spirits of our community members.
The 3 Biggest F.I. Myths
1. Financial independence is as easy as increasing your savings rate and investing
This is only partially true for some of us.
However, don't be discouraged if you find yourself saying "maybe for them" or "well that's not for me". Everyone has a different starting point. Even siblings can have different degrees of support. These are just the facts of life.
Your friend who retired at 30 because they hit it big on cryptocurrency or another couple who moved their family to the woods after starting a blog, I guarantee they had a different starting point than you did! If you press them on it, I am sure they will admit it. I wouldn't expect that you guys become friends afterwards however. Finances are one of the greatest fight promoters known to mankind.
Perhaps any one of the following is true about your current situation:
Your situation is unique to you. There are many things that will affect your so called "savings rate" and all you can do is strive to improve your situation relative to you. That's it. This is not a competition unless you want it to be and you enjoy competition, in a healthy manner of course.
Besides, maybe your version of "financial independence" is being debt-free and living paycheck to paycheck. If that's your goal and you are fully aware of the risks of living that close to the edge and are content with it, then who cares about a savings rate!
2. Everyone will understand why you practice frugality and will support you in your goals
Mostly false and very, very rarely true.
Most people do not even have an idea of what frugality even is. You will often be called "cheap", albeit mistakenly. You may even have one of the following condemnations thrown your way:
All of these are aimed at indicating that you should just spend more money. Basically, all of these condemnations are aimed at why you shouldn't be frugal.
This is utter nonsense. Again, frugality - to most of us who practice it- adds tremendous value and meaning to our lives. We actually like being frugal (some of us).
A word of caution: try not to spend too much time, or any at all, explaining frugality and your purpose to somebody who is clearly unwilling or unable to understand this way of life. Just nod, smile, and purchase more shares of your favorite index fund with your savings.
3. Real Estate is the quickest path to F.I.
Depends. I mean really, truly, depends.
Transaction costs are typically very, very high when it comes to real estate. Obtaining financing, costs of upkeep, finding tenants, drafting leases, commissions to realtors. Please be sure that you are able to calculate your real rate of return in real estate. Check out road #9 in Ken Fisher's book The Ten Roads to Riches to find out the hard truth of real estate investing, and learn how to do it right.
Sure you can have investors or use other people's money. Leverage is your friend. Be a friend of borrowing to rapidly increase your wealth. Whatever.
Honestly, most of us are coming from significant financial burden and debt. The last thing most of us want is more debt and more borrowing. Perhaps someday I can be convinced otherwise but real estate is not a great investment.
Consider that according to data collected by Jorda et. al. (2019) from the time period of 1870 to 2015, over a century's worth of data, equities beat real estate returns 8.46 to 6.10% respectively after being adjusted for inflation. Although the figure 6.10% does include home capital appreciation--which lowers the total yield of housing return since capital appreciation is less than 1% annually when adjusted for inflation--residential real estate is not the blow-out winning investment it is often claimed to be.
Be wary about real estate. Costs of home ownership are very variable and it's hard to give a true estimate as to your expected rate of return due to the extreme variability in the cost of ownership.
Leave us a comment below on how you feel about the 3 common myths of financial independence.
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If you find yourself frustrated on your path to F.I., remember the 3 common myths of Financial Independence
Finding motivation on the path to F.I.
Many of the authors and content creators I follow in the financial independence space have transitioned their content to an interesting phase. Often I hear them, at their present net worth, going on and on about how great financial independence is.
Undoubtedly, I am truly happy for them. But how does this affect those of us in pursuit? How does it affect the person who is still 5, 10, or 20 plus years away from financial independence?
For many readers and community members, it can be frustrating. It is hard not to compare yourself to another when it comes to finances. The number one thing that knocks people off track and destroys their motivation is comparison. Comparison to others. Comparison to where you thought you'd be at 30. at 40. at 50, and beyond.
First things first, we should strive to eliminate our comparisons.
1. Eliminate Comparisons
There are two exceptions worth mentioning regarding eliminating comparison behavior:
That said, comparisons are the enemy of happiness in most cases. It can often lead to a path of envy and resentment. Further, it typically only serves negative energy. You will not find a more competitive person on the planet than myself, but even I have had to step away from this one.
This is your path. Not anyone else's.
2. Keep track of your net worth
You can do this on high-end software such as Personal Capital, or use a simple Excel sheet. Totally up to you (I prefer to use an Excel sheet).
This can be a great way to remain focused on your individual situation. It also motivates you to keep track of your income and expenses because your savings rate ultimately helps determine how quickly your net worth can grow. It is often said that the only way to improve something is to measure it.
3. Evaluate if you need to give yourself a break
This needs to be earned however. Take inventory of where you are by assessing your progress thus far and assess whether you need to allow yourself an increased budget for a few months prior to returning to a more aggressive approach. I would put a definitive end date on this inflated spending, however.
If pursuing financial independence has given you a great deal of stress and you find it difficult to consistently maintain this furious pace, consider having planned periods off from this extreme frugality behavior. Perhaps take two weeks to spend as much money as you want. Try on an inflated lifestyle if you are so brave (just be ready to hate it). See how it feels to let the dollars slip away from you a little more freely. Hey, who knows, you might actually enjoy debt and keeping up with the Joneses. If you do, quit reading now because this is probably not your type of community (you are welcome back anytime however).
If you are worried about FOMO (fear of missing out), try "test-driving" a few atypical spending habits to see if the consumer culture life actually is your calling. If you take this route, I just suggest finding out what the return policy is for whatever you are purchasing.
If you choose to take a break, definitely have an exit plan for when you aim to jump back into frugality or the pursuit of financial independence. This obviously includes not making any purchasing decisions that indefinitely ruin your net worth and personal finances, especially if the cost is high and recurring (think boats, cars, couch payments, etc.).
4. Remind yourself why you joined this community
Don't like your current job? Most people don't and yet do nothing about it. But you are!
Love your job but want more free time? I am happy for you as this is a good problem to have. Your time is more precious than anything. Loving your job and what you do for 40 plus hours per week is a rare bird. If you have it, consider the strategies you learn in this community to negotiate more PTO, remote work, atypical schedules, 4 day work weeks, transitioning to part time, etc.
Do you resent debt and do not like to be a slave to the lender? I can certainly relate to this one. Eliminating debt is often an excellent way to remove your burden to work or at least eliminate your need to be a prisoner to a higher paycheck. Eliminating most debt from your life often allows you to choose work you love and enjoy since the pay rate is less meaningful.
Do you just want to be part of a frugality movement as a sure way to be a millionaire someday? Do not be ashamed. As the late Jim Rohn would say, think of what you will become in the process of becoming a millionaire. Unfortunately, money is one of life's greatest motivators for many of us. Admittedly, most of us are driven by attaining a large net worth (or at least the appearance of high net worth). Saving and investing is one of the most tried and true ways to become a millionaire, as long as you remain invested for the long term and practice a fair bit of industriousness and frugality.
How I, personally, stay motivated for the long-term
I remind myself the importance of stay the course. Being consistent and displaying discipline. I look forward to learning more, saving more, investing more. I have learned to truly value the ultimate commodity in life, time.
I continue to assess my current income streams. This helps keep me motivated to make them bigger or add one or two more along the way. Consider most millionaires have multiple sources of income. When assessing your income streams, I like to try and diversify.
The concept is to save as much money as possible as early as possible, regardless of when and where you start. Remember, your situation is unique and all you are looking to do is improve upon your current situation.
Consider that if you find a way to earn an extra $20 a month every month for 25 years, and invest it in an index fund you could wind up with $17,543 (assuming an 8% annual return).
An extra $50 a month invested over 25 years could be $43,863.
$100 extra a month, could turn into $87,727 after 25 years.
$1,000 extra a month, in 25 years, could be worth $877,271.
Start small, aim high, and be consistent and disciplined along your path. Consider searching along the way for things that can upgrade your present level of happiness. Things to aim for over time that typically are correlated with increased happiness are:
And yes, enjoy the ride. This is not about a life of deprivation. It is about a life packed with value.
Remember to celebrate victories along the way. Celebrate paying off a car or student loan. Hit a certain number for your net worth, do something you enjoy, even if it costs money. Do not be ashamed to celebrate.
Before we begin, this is absolutely not investment advice and I am certainly not a financial professional. Please understand this is entirely for informational purposes only and in no way are we making any claims about this style of investing. Use your head people, this is a blog, not a financial consultation.
How to Begin Investing
How do you actually become an "investor"? This is a common question to which the answer is actually quite a bit simpler than you think.
First and foremost, to be an investor, it takes having a little extra pocket change for which to invest. Remember, it takes money to make money.
What does this mean for you? It means you need to start saving some extra money.
Previously we discussed what it means to have a margin of potential for savings. Your margin of potential is calculated by subtracting your expenses from your income (margin of potential = income - expenses).
Without having a positive margin of potential, you will lack the most sufficient tool required for investing, money. I am not interested in discussing using other people's money or marginal investing because that is not what this community is about.
You can increase your margin of potential two ways:
I do have a basic tenant that I believe all should follow. I believe that you should eliminate your debt first before worrying about becoming an investor. The only debt I believe that you can keep around is a mortgage, provided that you have at least 20 percent equity in your home.
This is a community filled with people searching for financial strength. You do not get to a financially fit position by borrowing. End of story. If you do believe that you can borrow your way to wealth, stop reading right now and find something else to do with your time (like read a personal finance book or two). This community is the type that pays off their credit card bills, in full, every month. That's what brings us security.
Deciding where to save it
Once you've broken free from spending every single dollar you earn, and you have eliminated debt, you have some choices.
Where can you begin investing?
Here are some of the primary investment vehicles where you can save your money and have access to investing in "the market" (not supposed to be an exhaustive list, just the most common):
I just happen to use Fidelity and Vanguard because I have found they offer the lowest account fees and best customer support around. I have tried MANY other investment companies for various accounts without much success. They will remain nameless.
To open an account in order to begin investing, just visit the company site or call the company directly, and seek advisement for how to open any of the following accounts - or even ask about one's I haven't listed such as a 457 plan, etc.
I do not use a financial professional and choose to pick the funds myself. I do this for the lowest possible cost and the greatest potential return. Read the two books below if you think that you cannot do it yourself when it comes to investing.
How To Start Investing (once you have eliminated your debt)
The simplest way to break into the investing circles is through low cost index funds.
If you are uncertain about investing and you need more confidence built up before enbtering the stock market, here are two must-read books for you:
How to Start Investing (steps)
Step 1. Choose which type of account you will begin investing in from above (Roth IRA, Traditional IRA, Brokerage Account, 401(k), 403(b), etc.)
Step 2. Choose your Financial Service Provider (Fidelity and Vanguard are my favorites - however your 401(k) and 403(b) plans might not offer these companies)
Note: I primarily use Fidelity and Vanguard due to the low cost nature of their funds and little to no fees associated with their accounts.
Step 3. Link your checking account to whichever account you opened after following steps 1 & 2 above. Start depositing money into this account.
Step 4. Choose your investments (by searching the following "ticker symbols"):
My belief is that the younger you are, the greater the percentage of equity index funds you should have in your overall investing portfolio. My preferred choice is low cost index funds that track the total market or a major index.
Step 5. Keep investing in this account and buying shares of the above for years and years to come to take advantage of compound interest.
That is it. Be advised, there are some limits for the types of accounts listed above for how much you can deposit into your account each year. To find up to date contribution limits, visit the IRS website here.
Leave us a comment based on what you learned from this article. Please let us know what you would like us to post on in the future.
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The Definition of Frugal
Frugality is a term often used synonymous with being "cheap". However, is that really a fair comparison?
What is frugality really?
1. Frugality arranges itself with value as the central tenet.
So what should we value? Value your time, because there is no amount of money that buys more of it. Value your life energy, it is not an infinitely renewable resource. Value your freedom, the freedom of choice (yes, you always have a choice). Value your relationships, because this is really all that you have in this world. Value your beliefs, because nobody can take them away from you.
I admit, most of the above is more from a philosophical life perspective. Most of you are looking for the secrets to money and wealth. So what should we value from a financial perspective? From a financial perspective you should value:
Saving money is one of the most important values of frugality. Frugal people differ from "cheap people" in that frugal living takes a long term view on spending money rather than a short term perspective. A cheap person has a tendency to assess the cost in a short term horizon and miss the benefits of how extra money can accumulate into significant wealth over time.
For example, avoiding the more expensive organic produce at the grocery store solely based on price is a characteristic of the cheap. A frugal individual will consider the long term potential reductions in healthcare spending of eating healthier organic produce with lower pesticide and herbicide contaminants as part of a thorough cost-benefit analysis.
2. Frugality is also the act of gaining awareness.
Become aware of your daily routines. Assess your spending habits and scrutinize your budget. Do you have a list of things that really make you happy? If not, sit down right now and list the top five things that have the potential to make you smile everyday (do not read another word on this site if you are not willing to sit down and literally write down your five sources of potential happiness).
To become aware you need to become present in life. Become conscious about where you are directing a majority of your time and energy. This is about efficiency, not goal setting. I am not a firm believer on the traditional concepts of goal setting (which you will notice in future posts). Gaining awareness and becoming present, avoiding the torment of merely existing through life, is actually a potent wealth generator throughout life.
3. Frugality is about gaining back your freedom.
We all had it after birth, but lost it shortly thereafter. I am of course referring to our freedom. Freedom to choose and freedom to live your life according to your standards, not others.
Let us be honest, there is very little you can do in life without money. Period. At the end of the day, most people would be much better off in life with more savings and less debt. I suspect quite a bit of mental health issues would be drastically improved if just those two numbers were adjusted, meaning less debt and more savings.
Consider the correlation drawn between mental health status and money problems according to a Money and Mental Health survey:
Remember however, correlation does not equal causation. The survey above could just as easily mean that these folks had mental health problems long before they had money problems. Nevertheless, there is a strong correlation between mental health problems and financial difficulties, regardless of which one happened first.
Using the above findings, I would suggest that most folks who would like to improve there overall well-being take a look at their finances. If you happen to also find yourself in problem debt or financial struggles, perhaps consider if improving your financial health would make life much more tolerable.
Personally, I believe that improving debt to savings ratio- amount of debt relative to your savings- is a forceful method towards gaining back your freedom in life.
Think about what life would be like if you did not have to spend your 40's and 50's sprinting towards retirement savings. Think about how much freedom you would have if, by age 40 (or 50 - if you are older than this my statement likely will not apply), you no longer needed to save another dime for retirement because you were saving aggressively towards retirement when you were younger. You could spend these years traveling with your family, embarking on new experiences, all while likely enjoying some of your best earning years. Your children (if you have any) would like be of the age where they can also benefit from these experiences and memories as well.
So how do I gain back some freedom in my life? By examining your "Margin of Potential" against your income and your expenses. Quite simply, Margin of Potential = Income - Expenses
How to Assess Your "Margin of Potential"
Everyone has a "Margin of Potential" equation. Whether your are on public assistance, or make over six figures, this equation applies to you.
However, I frequently find that most folks just take the difference between their income and expenses, and turn around and spend it anyway. That is why I call it the margin of potential. The difference between income and expenses is not saving unless you do something with it!
After calculating your margin of potential, write down the top three things that you do with that number. If saving and investing are not in the top three, we have a problem.
If you do not have a positive number when assessing your margin of potential you will likely find yourself amidst significant financial troubles. One might ask, "How could I possibly have a negative number?". Answer: credit. You can borrow your way right into misery and allow your expenses to be greater than your income (the "American Dream").
The truth is, frugality is really about making your margin of potential a positive number. Of course, one way to make this number positive is simply make more money. However, for many, increasing income is quite a bit more difficult than decreasing expenses. Decreasing expenses is where frugality truly shines. By lowering your own cost of living and decreasing the inflation of your lifestyle, you will lower your expenses and give yourself the opportunity to have a positive margin of potential.
So what will you do next after establishing a positive margin of potential? My hopes is that you will begin to investigate what using this margin can truly do for your happiness.