Inspired by one of the greatest minds in history, Benjamin Franklin, I’m enthralled with the idea of becoming “healthy, wealthy, and wise.” This post is about the wealth aspect, and moreover, the goal of becoming financially independent. I’m particularly interested in discovering what philosophies I can borrow from wealthy and successful people that will enable me to live a rich life by my own definition. I think too many people talk about building wealth in the context of making a ton of money, but you only really need enough money to support the lifestyle you seek and endeavors you wish to pursue. Do the math, you might be surprised to find it may be less than you think. Focus on living well over just making money.
While I certainly don’t have the financial fortune of those I’m inspired by, I have found the general good fortune that enables me to live the lifestyle I choose. While my journey is still a work in progress, I have discovered some guiding principles and strategies to plan for the future. This post is intended to distill, demystify, and empower anyone who’s overwhelmed by the idea of managing money from what I’ve learned on the road to financial independence. Choose the life you want, don’t let it be chosen for you out of fear or lack of understanding when it comes to money. And while it’s important to save for the future, it should not come at the expense of enjoying the present.
Preamble
I have been heavily influenced by reading about minimalist lifestyles and seeking life fulfillment, for which finances are a key enabler. I’m certainly not alone. From the 4-Hour Workweek to the FIRE movement, younger generations search for meaningful work, challenging opportunities, and experiences over things. Why wait to retire towards the end of your life when you’re on your physical (and perhaps mental) decline. Why not take multiple retirements and do so while you’re more able. Keep things simple to increase your chances of taking action and don’t beat yourself up about where you are versus where you think you “should” be. Anything is better than nothing. You have to start somewhere. Everyone is different.
Disclaimer: I am not, nor have I ever been, nor do I pretend to be, nor do I ever aspire to be, an investment or tax advisor. These are just my opinions based on my own research and experiences that I hoped to share. I’m not advising you what to do. Investment performance is entirely dependent on the market. Now read on and enjoy!
Questions to Ponder
I think it’s important to start by asking a few key questions around what you need and why. It’s much more helpful than thinking in the abstract.
What’s your minimum comfort level? What’s your desired comfort level? How much do each cost (approximately)? If you’re not sure, do an experiment!
On my first mini-retirement, I traveled both domestically and internationally, the bulk of my possessions in storage and that which I would use for the next 18 months either on my back or in the trunk of my car. I was curious to know what it felt like to live nomadically. Part of this included a summer spent in a small, unfurnished cottage not that much bigger than my tiny house located in someone’s backyard. It was an experiment to find my minimum comfort level. A folding stool, couple end tables, minimal cookware, inflatable mattress, and a lamp. I did this for a month and it was fine. It helped me discover a close to minimum comfort level and learned that my needs were less than I thought. This experiment heavily influenced my decision to go tiny as well as the design of my tiny house.
Do you want to retire “early,” i.e. before 65? What does that actually mean to you and how will you spend your time? For example, maybe retirement really means being able to pick your projects and how you spend your time. Maybe it means traveling and not working at all.
To me retirement means being able to choose how I spend my time and who I spend it with. I don’t think I’ll ever truly “sit still” and why should you when there is so much to learn, see, and do in the world. I love to learn, explore, and experiment. My goal is to be in a financial position where money isn’t a factor in choosing where to spend my time, projects to pursue, or trips to take, all towards the ultimate nirvana of finding fulfillment, pursuing your purpose, and living up to your potential. I personally would like to travel periodically, experience living in different places throughout the year, and working on social mission oriented projects.
Do you want to build wealth and if so how much? What do you need the money for or are you just looking to accumulate wealth? What will you put the money towards?
I oscillate back and forth between wanting to build wealth to do good in the world vs. living minimally and simply enjoying the present moment. This is something I continue to ponder.
A Model to Consider
This is an amalgamation of a model I constructed from my own experimentation and wisdom of others, in particular Ramit Sethi. I was pleasantly surprised that after reading I Will Teach You To Be Rich, I already had a similar approach in place. When it comes to money, there’s no one size fits all solution, as everyone’s situation is different. This is primarily geared towards those who are looking for a place to start, simple levels to achieve, and work for an employer with a focus on common structures for retirement saving. Some of the principles hold true for anyone and can be extended to the self-employed or those who take mini-retirements such as myself, but you should reflect on this model and apply what suits your own circumstances.
Manage spending
I believe it’s crucial to first focus on spending. If you don’t have control over your spending, everything else falls by the wayside. This is the foundation on which building and maintaining financial independence relies. It’s shocking more emphasis isn’t put on this point before talking about investing. After all, you only need as much money as you spend, which essentially includes required expenses and discretionary spending. Living below your means will always ensure you have enough to live on to meet your basic needs. Save what’s left over, build a safety net (emergency fund), and invest the rest. You’ll want to think about what a safety net looks like to you. For example, having enough money in the bank (liquid) to support yourself for six months to a year if you aren’t working or for unexpected emergencies. If you only take away one thing from this post, it’s to manage spending.
Caveat: Of course this advice is for the average individual, not everything can be generalized to those who live in high poverty or other extenuating circumstances.
Tip: Consider placing the bulk of your spending and expenses on a single credit card, preferably one with a rewards program (i.e. points, cash back). This is helpful for two reasons. First, free money! Second, you can easily measure what and where you spend your money. Many credit cards have tools that will categorize your spending as well as provide monthly and year end statements so you know exactly what you spend each month and annually. Of course you can also use personal finance software to aggregate information across multiple accounts, but either way, keep it simple. Plus, less credit cards, less temptation to use them.
Contribute to an employer 401(k) plan up to the match
If your employer offers a sponsored 401(k) plan with a match, contributing to that plan up to the match can be a great option. Not only does it force you to start saving for the long term, but it’s free money! Even a small contribution creates the habit of saving and will grow over time. So for example, you put in 4%, employer matches 4%, you then have 8% invested.
Traditional vs. Roth
Most people know this by now, but to recap, there are two 401(k) options: traditional which defers tax (pre-tax) and roth (post-tax). The common guidance is to predict whether you will be making more or less money when you retire than what you make at present. I find that to be an interesting thought experiment but kind of ridiculous for pragmatically planning. If you invest wisely in yourself, your career, and your investments, it’s totally possible to make more in retirement than not. Of course there’s no way to know for sure.
I prefer roth contributions for several reasons that really seal the deal for me: you know exactly what you’ll have since it’s already been taxed, earnings grow tax free, and there are no required distributions. This last point is important because required distributions mean this money no longer stays invested in your retirement account and also gets counted as income (how the taxes are realized). If you have other sources of income, even social security, this additional distribution could bump you into a higher tax bracket and you could end up paying more in taxes.
Tip: I had an employer that didn’t match, so I opted out and instead invested in an IRA (individual retirement account). Employer 401(k) programs can be less flexible than managing your own IRA (more investment options, less fees). The only advantage I see in favor of contributing in this scenario is you can contribute more overall. For example, 2021 annual contribution limits for an employer sponsored plan are $19,000, but contributions on IRAs (combined total traditional plus roth) are only $6,000, which is significant. It really depends on how much you can afford/want to contribute to your retirement or if you would rather invest that money elsewhere. Or perhaps you want to put the money towards a mini retirement.
Note: If you’re a single business owner or self-employed, there are other 401(k) options to consider.
Max out a Roth IRA
A good self managed Roth IRA grows tax free and offers more investment options with less fees than employer 401(k) plans which operate according to the rules of the employer’s plan. Contributing up to the annual limit maximizes what you can save and thus earn over time. As a bonus, you never have to worry about rollovers if you leave your employer since it’s a personal account. The only downsides really are the contribution limits as mentioned previously on amount and income. If you fall within the income cap, you can’t contribute anything or it’s prorated. This type of account is easy to set up with any major investment company. You can manage it yourself or work with an advisor.
Max out a 401(k)
If there’s still money left over to invest, it’s time for a pat on the back!! Maxing out a 401(k), specifically roth contributions, achieves the same benefit as mentioned above and is a tax efficient way to save for the future.
Tip: If you’re self-employed, research a Solo 401(k). If there’s no option for an employer sponsored plan or you’re on a mini retirement, you’re left with less options for retirement saving, one of which is through an IRA. However, this has a limit much less than a 401(k) as mentioned, so it’s important to consider the tradeoffs and options when deciding where to put your money.
Passive Income
The ultimate dream and way of building wealth is through passive income. It allows you to do all the things you want, manage your time how you see fit, and lets your money work for you instead of trading money for time. You could certainly skip all previous steps and move right into this, but it requires much more self-education and energy for the average person. This is certainly a topic all to itself, so I’ll just note some examples to consider. These aren’t necessarily just options for passive income, but also other ways you could invest in your financial future that could supplement or replace the options listed above.
- Real Estate investing and rental property
- Stock market investing
- Angel investing
- Private money lending
Investment Strategy Matters
I’m not a certified or expert investor, but I do seek the advice of those who are. It’s less about what you invest in and more about how you invest. Optimize for the long run and compound interest will take care of the rest. Here are several simple strategies recommended by some of the greats.
- Invest in index funds and hold for the long term (Warren Buffet, Berkshire Hathaway)
- Invest in low cost index funds (Jack Bogle, Vanguard)
- All Weather Portfolio (Ray Dalio, Bridgewater)
Parting Thoughts
I don’t contribute to everything mentioned above every year, it depends on my circumstances. My salary may be different, I may be saving up for something, or I may choose to take a mini retirement for example. I start from the bottom of the model and move up until I have reached the limit of what I have available or am willing to contribute.
If you manage your own investments, be sure to rebalance at least annually, if not semi-annually or even quarterly if you’re so inclined. I only need to spend about 1 hour per year managing my retirement accounts with the above principals and strategies. There’s no excuse not to educate yourself so that you can take action and ownership over your own money. After all, no one cares about your money more than you do!
Further Reading
- 4-Hour Workweek, Tim Ferriss
- I Will Teach You To Be Rich, Ramit Sethi
- Unshakeable (short), Tony Robbins
- Money Master The Game (long), Tony Robbins
- All Weather Portfolio, Ray Dalio
- Navalmanack, Naval Ravikant
- Investopedia