I see posts like Jason’s Three Tips for building Wealth with Sorcery this morning, and my immediate reaction is “lots of folks don’t see wealth and money the same way I do.” Jason’s post is on-target, but I don’t think his advice is far-reaching enough. This post is my attempt to add some more depth to this discussion.
I should start with a disclaimer: my goal here is to talk in general terms about complicated concepts. I’m generalizing a bit – understand that going in. Readers who have never taken a finance class and know nothing about investments should be able to follow along, and if you want to be picky then you’re missing the whole point of this.
We all want to be wealthy, but what does that mean?
I believe that we all have a course in life that represents the best use of our time. To me, being wealthy means being able to devote all of our energy to that path, or at least as much of our time as we desire. That’s really it. To some being wealthy means “I can do what I want, when I want,” but advertising executives realized a century ago that human desires are unlimited, so I don’t believe this point can be reached. Most of us would like to be able to book a posh hotel in Paris for the 4th of July week because Manhattan sucks in the summer, fly there on a private jet, eat a week’s worth of expensive meals, and add some of the newest fashion to our wardrobe while we’re there. That’s certainly “wealthy” in a plebeian sense, but my definition is quite a bit more limited (and attainable).
If you’ve figured out your purpose in life, then being wealthy means having the resources to pursue that purpose without worrying about mundane things like where you will live and what you will have for dinner. Catholic priests don’t possess many earthly assets, but if they are following their true calling then they are truly wealthy despite their vow of poverty. If your purpose is to improve the lives of special needs children and you are working as a special ed teacher, then you’re already there as well. At least according to my definition.
Now let’s talk about money.
In the short term we need money to live. We work to generate more money to spend or save as appropriate. When most people talk about financial magic they are talking about getting more money in one way or another. But money is ephemeral, and generating money alone is not a key to becoming wealthy.
Take this example. Let’s assume you’re ready to retire now, and way back in 1964 you saw the new Ford Mustang and really wanted it. You were disciplined though, and decided to save the same amount of money instead.
- If you put the money in the safe, congratulations! You have $3,334 dollars to apply to your retirement.
- If you’d bought a weighted average of the S&P 500 instead (which was difficult/impossible, but stay with me) then that $3,334 would now be worth almost $167,000. (If you want to research this yourself make sure to take dividends into account. If you don’t you’ll lose about 40% of the performance.)
Let’s look at it a different way. That $3,334 in 1964/65 would buy the equivalent of $28,355 today (The Ford Mustang with serial number 1 was a convertible 6 cylinder, and the price here is the sticker price for a 2014 v6 convertible).
- The annual rate of return for cash over that time was negative 4.47 percent. Cash in the safe lost that much buying power every year, on average. (I’m using the Ford Mustang to measure inflation because I wanted to, but the point stands whether you want to use the CPI, the cost of a tailored suit, or whatever.)
- Your stock market purchase would have appreciated at 8.32% annually.
I’m using stocks as my example here, but the same concept can be applied to real estate, or any sort of investment. Investments appreciate while money slowly devalues over time. The caveat is that markets (and therefore your investment portfolio) are very volatile. Your stock portfolio would have lost 38.5% in 2008, but it would have more than recovered by now if you’d stayed invested. Cash is “safer” in that it underperforms the stock market by something like 12% per year on average, and if you can look past the panicky times then you can see why stocks are a solid option for long term wealth management. (Read Stocks for the Long Run for a much more eloquent and detailed presentation.)
OK, now on to the main point: wealth versus money versus investments
This is the end-point you should be working and planning for. This is a really dumbed-down summary, this is not financial advice, do your own research, and so on, ad infinitum.
The end goal is to spend less than your investments earn every year. That’s the secret, and it’s pretty obvious. If you’ve got $1,000,000 invested, and you can reliably make 5% on your money every year, then that investment is generating $50,000 per year (pre-tax) that you can live on without working. Jason talks about things like book sales as passive income, and investment income in retirement (even in early retirement) is just another form of passive income. The advantage of investing in the stock market is that while not everyone can write a successful book, the markets are open to anyone.
Remember though: some years you’ll be way down (2008 was a doozy at -38%), and other years you’ll be way up (last year the overall market return was ~ 29%), so you need to have a long-term approach to investment management.
Step 1: Get a solid financial base
Most investment authorities recommend having six months’ living expenses in cash, and this is good advice though I think a year is better. A solid financial base to my mind is:
- Living expenses covered way into the future. If you have 12 months of anticipated living expenses sitting available in cash, then you have a meaningful buffer when the unexpected happens.
- Insurance. Medical insurance, home insurance, auto insurance, etc. The most common cause for bankruptcy is uninsured medical expenses, for example, so make sure you’ve got enough cash set aside that if you lose your job you can continue to pay both your insurance premiums and your maximum annual out-of-pocket medical expenses in addition to your normal living expenses. A catastrophic health issue that makes you unable to work is much more probable than some of the stuff people successfully enchant for, so plan for the worst. Do this in all the financial areas of your life.
- Expensive debts paid off. It’s stupid to keep a balance on a credit card, so pay it off and never use the card for anything you can’t afford to pay cash for. It might not make financial sense to pay off home/student loans if they are at 3% (if you can make an average of 8% per year in your stock market portfolio then you’re better off to pay excess cash into investments.) The emotional security that comes from being debt-free is hard to quantify though, so feel free.
- Diversified investments. Jack Bogle has some investment books that recommend splitting your investments into X% in stocks and Y% in bonds, and every year you reallocate to maintain the correct percentage in each category (and the percentage changes with age – the thinking being that bonds are safer than stocks, and we need more safety the closer we get to retirement.) You can do a whole lot worse than to follow this advice, or to pay a small annual percentage to invest in a fund that does this for you. I don’t do this because bond returns are so incredibly low, but if I had I’d be ahead because the bond markets have been screwy for years now. Then again, I actively manage my money.
Step 2: minimize your living expenses.
The less you spend, the less you need. Easy to understand, right? Here’s another way to look at it. If you’re living on $50,000 per year, and you assume you can safely draw down your investment account by 4% per year, then you need $1,250,000 in investments to support your lifestyle. If you’re currently paying $180 per month for cable and you opt to give that up, then your annual expenses drop to $47,840 and your required next egg shrinks to $1,196,000. That’s still a lot of money, but it’s $54,000 less. Now, kill the $350 per month car payment by keeping your old car (assuming it needs an average $100 per month of additional expenses), you eat out one night less per week for a $45 per week savings, and you find another $200 per month that you can live without and suddenly you’re looking at $40,100 per year which requires $1,002,500 in your nest egg. We just took a number some of you view as unattainable and knocked it down by 20% by making small compromises in lifestyle.
Of course, now you need to figure out how to get $1 million in assets. Read on for the (mostly) non-magical way.
Step 3: figure out how to get there
Having $1 million in the bank may seem like an impossible dream for most Americans, but it’s really not. If you’re stuck in a wage-slave lifestyle and you’re currently 25, let’s see what it takes to retire at 45:
- You’re starting from zero in savings/investments.
- We’ll assume you can make that 8% per year that the stock market averages
- $1 million in the bank is your goal. If you’re happy with your $8.80 an hour lifestyle, then you can maintain that with $440,000 instead of one million, and this gets easier.
- If we break that down monthly, you need to put aside a bit more than $1,650 per month to get there.
If you’re serving coffee at Starbucks, then you’d have to put aside more than you actually earn at $8.80 an hour! Impossible! I agree it’s impossible if you continue to work at Starbucks as a barista. Get promoted to shift manager and you’ll bring home an additional $5,000 per year. Which still puts you in the sucky income range.
This brings up a key point: if you’re working a dead-end job, living paycheck-to-paycheck, then you’re inviting disaster. You’ll need to use emergency magic to avoid financial ruin if anything dire happens, and “getting ahead” will be nearly impossible unless you change course.
Here’s the real secret: raise your fucking earning potential. Go to a cheap school nearby and get an accounting degree while you keep working (I link “cheap school” and “accounting” because the national standards for accounting courses are consistent, and it doesn’t matter a whole lot where you went to school unless you want to work at a big firm.) Accounting may not sound like fun, but according to these folks:
The overall average salary for college graduates in 2011 was $41,701, but those graduating with a degree in accounting averaged $50,500 according to the 2012 National Association of Colleges and Employers survey. Those who go on to earn their CPA license can expect a median salary of $73,800, with top salaries around $124,000.
Let me put that another way: if you decide to be an accountant, and you pass the CPA exam, then seven years from now (four for the degree and three working) you will be making $56,000 more per year than you do as a barista. That single change will take early retirement from impossible to easy if you maintain your standard of living.
Want to make more money but you have a big negative reaction to the idea of being an accountant? Fine. Become a teacher and make $45,000 per year, give or take. MBAs do a little bit better, but you can choose to work at a company you like. Or get really good at a hobby and turn it into a sideline business, with some strategic sorcery to help. Want to really help? Invest in yourself by taking classes in accounting, marketing, and sales, then mix in the magic. Or take up poker as a hobby, learn the game, and enhance your returns (challenge yourself to make gambling magic work. Jason can’t do it, but maybe you can.)
Maybe you have a knack for home repairs, and you’re the sort of person who can buy some rental property (it’s still really cheap in some places) and make money on rent and the slow appreciation of your real estate. Or become a Realtor – their pay ranges from $23,801 – $190,067 per year, but with the right spiritual nudges you should be able to do better than the average there after a few years.
What if you don’t want to use investing to become wealthy?
Then don’t. The advantage of investing in the market using indexes is that it requires no skill and hardly any effort. If that’s not for you then buy real estate (a different sort of investment). Or start a property management company, hire employees, and work one day per week. If you’re a plumber then hang up your shingle, save, hire employees, and bill them out at $100 per hour while you pay them $30 – you can see how well you can do in a year by just staying on top of a functioning business. It’s not “retirement,” but you can focus most of your efforts on your purpose in life.
Don’t like business? Then write books, or poetry, or music. Start a local art/pagan/music festival and work to make it successful over time, paying yourself in the process. But do something to change your situation, and when you start to see some real income make sure you’re paying toward your future rather than doing the typical upgrade from your old Subaru lifestyle to a new BMW lifestyle with no real impact on your future.
My point, finally
“Becoming wealthy” is possible using a reasonable definition of wealth and an eye toward the future, and it doesn’t even take much magic. Hell, even business majors can figure it out. But there’s more to it than increasing your earnings alone. You need to find a way to make your money grow to a point where it can grow faster than you need to spend it – once you do that, you’re wealthy in a very real and liberating sense.