Building Wealth on a Budget

I find much of the internet fodder with investing strategies to become a millionaire amusing. Most of the millionaire by (insert benchmark here) advice isn’t built on realistic assumptions regarding income and return on investments. The other day I read an article that suggested in order to achieve a million dollar net worth, one simply needed to invest $50 a day for twenty years with an anticipated 10% return. That’s over $18,000 per year, not to mention a constant 10% return over 20 years is pretty ambitious!

According to census.gov, in 2018 the median annual household income was $61,937. That’s the median, meaning half the households in the United States bring home less than $61,937. Investing $50 a day on a typical household income is nearly impossible!

A million dollar net worth isn’t the end all for financial success it used to be. Inflation and consumer spending habits have made the actual value of a million dollars less than the days when “millionaire” was the pinnacle for a financially successful person.  Yet a million dollars is still a lot of money and, depending on which report you read, should place the millionaire within the top 10% of household net worth in the United States. Heck, any financial benchmark that’s included in the title of a game show has got to be a respectable goal!

A million dollar net worth achieved by the early to mid-40’s certainly indicates someone who has their financial life well in hand. If they continue on the positive trend, a 45 year old millionaire will be comfortable in the golden years and leave a legacy for their families.

Unfortunately, many Americans today work hard their whole lives, but still remain out of reach from this laudable financial target. Additionally, in our instant gratification society, some become disheartened when unable to achieve a million dollar net worth in their 20s or 30s. Still others just don’t know where to start in order to get on track towards financial goals.

So how can the average American reach a million dollar net worth in a reasonable amount of time, say 20 to 25 years? There is no secret sauce or get rich quick strategy, building wealth is so much more than making wise investing decisions. Building wealth takes a lifelong commitment to certain financial principles which I like to call truths and over the next several weeks I’d like to tell you a little about them!

Financial truths are remarkably easy in concept, but require much effort in implementation.   So what are they you ask? Financial truths can range from tactics, such as invest early and often, to required personal attributes such as being frugal.

Let’s start by taking a look at a financial truth we’ve already touched on, investing early and often. It’s no secret that to build wealth, one must invest. But beyond the “invest $50 dollars a day for 20 years” strategies, what does it really take to make investing early and often a truth in your financial life?

Well first, you’ve got to establish investment accounts! Close that savings account and open a taxable investment account for those financial needs that are three to five years out. Savings accounts haven’t been good investments for a long time and I haven’t had one for decades!

While you’re at it, if you haven’t done so already, open multiple long term tax advantaged investment accounts which include 529 college savings plan, traditional or Roth IRAs and 401ks. We’ll talk more about long term investing next week, for now let’s focus on the short term, taxable investment accounts.

For a taxable investment account in lieu of savings, you’ll need to consider quite a bit before taking the plunge as mistakes could be costly. First and foremost, how much risk are you willing to accept? The worst case scenario for this approach is to need funds with an account value running low due to a dip in the market.

For this reason, consider more conservative investments. Income producing funds, lower risk dividend paying stock funds and positions weighted in certain commodities are options to consider. Another possibility is a target fund set for a target year about 5 to 10 years out.

I keep about a 70/30 split between low risk positions to moderate risk positions, but that is me. Regardless, even the lowest risk portfolio will outperform a savings account!

Remember, this investment account should not be tapped for routine needs or even unanticipated small expenses, but rather every 3 – 5 years for the major expenditures in life one typically saves for. This could include down payment for a house or car, continuing education expenses or perhaps expenses associated with starting a family.

A key point to remember about using an investment account as your “savings” is that it could take a week or so to access your funds after a sell. For this reason, maintain a cushion in checking account to cover immediate expenses (at least a month) until able to tap the short term investment account.

Fees must also be taken into consideration when selecting positions for a short term investment account. There are a lot of big investment companies out there that have several quality investment products with reasonable fees. Look for mutual funds that don’t include front or back end loads as well as those with minimal annual operating fees. Account fees are another reason, you should only dip into the taxable investment account when absolutely necessary as frequent trades will run up expenses and tax implications. Conveniently, you can usually open these accounts and manage them on line. Automatic investments and trades can be managed easily with the click of a mouse!

Lastly, when selecting positions for your short term investment account, consider tax implications. I say “consider” because that is really all you can do, be aware that income from this account must be reported at tax time. Taxes are not always bad, owing taxes for an investment account means you are making money!

Many people have sworn off savings account and I am solidly in this camp. It takes discipline and some work but will help compound “savings”. Never underestimate the time value of money! Do the research and find the best investment account to open and mutual funds with the right level of risk.

Next week we’ll continue to explore the “invest early and often” financial truth with a look at longer term investment accounts.

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The commentary provided in this blog is for informational purposes only and is not intended to be a source of financial or investing advice.