Get Rich Slowly!
Today is the second anniversary of Get Rich Slowly. In celebration, I'm reprinting this revised version of the article that started it all, a l-o-n-g post from my personal blog dated 26 April 2005. One year later — on 15 April 2006 — this site was born.
Today's entry is long and boring — it's all about the keys to wealth, prosperity, and happiness. Over the past few months, I've read over a dozen books on personal finance. Recurring themes have become evident. I want to share them with you.
These books often have embarrassingly bad titles, seemingly designed to appeal to the get-rich-quick crowd:
- The Richest Man in Babylon
- Your Money or Your Life
- Rich Dad, Poor Dad
- Think and Grow Rich
- Wealth Without Risk
- The Automatic Millionaire
- The Incredible Secret Money Machine
Some of these books really are as bad as their titles. But others offer outstanding, practical advice. The best books about money seem to have the same goal in mind: not wealth, not riches, but financial independence. According to Your Money or Your Life, which may be the very best of the financial books I've read, “financial independence is the experience of having enough — and then some”. More practically, financial independence occurs when your investment income (or “passive income”) exceeds your monthly expenses. Financial independence leads to psychological freedom.
To some of you, this will be common sense, stuff you've known all your life. To others, like me, this kind of thinking may be a sort of revelation. How is financial independence achieved? Again, the best books generally agree. What follows is my personal summary of the collected wisdom from their pages.
Step One: Prepare the Foundation
Building wealth is like building a house. The first step is to lay a foundation upon which the secure home of financial independence can be constructed. To prepare to build wealth, you must
- eliminate debt
- reduce spending
- increase earnings
There are many approaches to laying the foundation of your financial life; the key is to find the ones that actually work for you.
Most of the the books agree on one point: If you have trouble with credit cards, cut them up. Get rid of them. There is no compelling reason to keep them. You may or may not want to close each credit card account as you pay off the debt. Closing the accounts will ding your credit score (though not a lot), but some people believe it's a small price to pay to prevent possible future spending. I chose to cut up my cards and close my accounts — my credit rating is still outstanding. (For years, I lived without a personal credit card. I finally got a new one last summer, but only after I was sure that I would use it responsibly.)
Next, pay off your debts. All of them. For years, I tried the oft-touted method whereby you pay off your highest-interest debt first. Though this makes sense mathematically, it never worked for me. My highest interest debt was also my largest debt, and psychologically I just never seemed to make any progress.
However, I did have success with the “debt snowball”, as defined in The Total Money Makeover. I eliminated my debt by paying off the obligation with the smallest balance first. Then I took the amount that would have been applied to that debt each month and used it to pay off the second-smallest balance. When that was finished, I went to the next, etc. It only took me four months to pay off all my smaller debts this way, leaving me with two large balances (including a home equity loan). I was dumbfounded. I'd struggled with debt for a decade, and I solved the problem in four months? Good grief.
The next step in preparing the foundation is to reduce spending. First, track your expenditures for a month. Or two. Or three. (I use Quicken because it's quick and easy. Nowadays there are many web-based personal finance tools you can use.) After you've accumulated enough data, analyze your spending patterns. Are you spending a lot on shoes? Books? Alcohol? Dining out? Try to find expenses you can eliminate or reduce. For me, it made sense to reduce my comic book spending.
Many of the personal finance books encourage you to reduce your auto and homeowner insurance coverage to save money. This is also the point at which some books encourage you to adopt a budget. (I tend to think a budget is unnecessary if you remain aware of your current financial situation.) Note that all of the books I've read advise against purchasing a new car; all encourage you to purchase late-model used cars.
The final phase in laying the foundation is to increase your income. Not all of the books mention this, and many people consider it optional. However, some authors who are adamant that this is an important step on the road to financial independence, and I've found it a valuable tool in my own life. How do you increase your income?
- Become better educated so that your job skills are more marketable.
- Work harder (and smarter) at your current job so that you qualify for raises and promotions.
- Change careers.
- Find a way to make a hobby profitable.
- Or, as more than one book suggests, work two jobs.
By destroying my debt, slashing my spending, and increasing my income, I have changed my financial life. I no longer live paycheck-to-paycheck. I feel as if I really have laid a solid foundation for financial success.
Step Two: Build the Framework
The second step toward financial independence is to construct the framework upon which future wealth can be built: establish an emergency fund, maximize your retirement investments, and begin acquiring income-producing assets. This is what I've been doing for the past several months.
Build an emergency fund
Every book I've read stresses that the most important part of the framework, the first part that must be completed, is the establishment of an emergency fund. This emergency fund ought to contain enough money to support you for three to six months in case you find yourself without an income. I had difficulty grasping this concept at first. I wanted to skip this and move on to other, more exciting steps. But after seeing the results of “laying my foundation”, I was willing to suspend my disbelief and just do it. I built the emergency fund. I'm glad I did.
Maximize retirement accounts
Next, the books encourage you to maximize your retirement accounts. If you have a retirement account through work, contribute as much as you possibly can, as soon as you can. The magic of compounding derives its power through time. Establish a Roth IRA outside of work, and contribute the maximum amount every year. I've been funding my IRA for three years now — I wish I'd started sooner.
Explore income-producing assets
The final step in building a framework for financial independence is to invest in income-producing assets. For some reason, I'd totally missed this recurring theme until my friend Sparky recommended I read Rich Dad, Poor Dad, a book that's almost solely about this particular portion of the framework.
Beyond your retirement accounts, you should pursue other investments, specifically in income-producing assets. For different people, this means different things. Maybe it means bonds, maybe it means dividend stocks, maybe it means investment properties. It may even mean starting a business. It does not mean things like cars, or collectibles (coins, comic books, baseball cards), or expensive furniture. These things may be assets of a sort, but they are not income-producing assets.
I've done very little research into income-producing assets, but it's on my list for the coming year.
Step Three: Finish Construction
After you've laid the foundation to financial independence, and after you've built the framework, you must then spend years (decades!) finishing construction. All that is required during this time is persistence and discipline. Resist temptation. Do not accrue debt. Spend sensibly. Faithfully contribute to your retirement plan. Wait. Have the patience to get rich slowly.
The challenge during this phase is to balance current quality of life with future freedom. It's okay to allow yourself indulgences, but only when you understand the implications on your long-term goals. If you want a nice car and can afford it, then buy it. But don't sacrifice financial independence to do so.
Step Four: Move Into the House
Some years later, you will wake to find that your financial house is in order. It's finished. It's ready for you to move in. How do you know when this is the case? Financial independence is achieved when your investment income equals or exceeds your monthly needs. If the total of your house payment and living expenses is $1000 per month, then you are financially independent when your investment income reaches $1000 per month. Achieving this takes time. It's a slow, gradual process, but every book emphasizes that it's not only possible, it's inevitable if these steps are followed.
That's it. That's the combined wisdom of more than a dozen financial self-help books. I haven't fleshed out the final two steps as much as the first two simply because I haven't reached them yet. There are many books on how to best approach each step (even each substep!). I'm sure to obsess over each one in turn.
As I've read dozens of personal finance books, it has occurred to me that these volumes are easy to summarize. Their content lends itself to bullet points. Here are summaries of five typical books:
The Total Money Makeover by Dave Ramsey was the first book I read. It features lots of practical advice, including the concept of the “debt snowball” I mentioned earlier. Here are Ramsey's steps to a “total money makeover”:
- Step #1: Save $1000 as an emergency fund.
- Step #2: Pay off debts, starting with the smallest first (ignore interest rates).
- Step #3: Increase the emergency fund so that it will cover three to six months of expenses.
- Step #4: Invest 15% of income in growth-stock mutual funds.
- Step #5: Pay off the mortgage.
- Step #6: Build wealth.
(I've left out a “Save money for college” step because it doesn't apply to me — I don't have kids.)
Your Money or Your Life by Joe Dominguez and Vicki Robin is, as I mentioned, the cream of the crop of these financial books. Its advice is sound. This is an especially great book for those interested in voluntary simplicity. It lends itself less to bullet points than some of the others, but I've made an attempt to enumerate the steps it advocates for financial independence:
- Step #1: Determine how much money you've earned in your life. Next, determine your net worth. Compare and contrast the two.
- Step #2: Establish the actual cost — in time and money — required to maintain your job. From this derive your actual hourly wage.
- Step #3: Keep track of every cent that enters or leaves your possession.
- Step #4: Determine which items are actually worth the money you spend on them.
- Step #5: Graph your total monthly income and your total monthly expenses.
- Step #6: Minimize spending through conscious decisions.
- Step #7: Maximize income by doing something you love.
- Step #8: Accumulate capital. Track its growth.
- Step #9: Invest this capital so that it provides long-term income.
The Richest Man in Babylon by George S. Clason is an aging chestnut. It's a classic in the field. Many later financial books are based on Clason's advice, which is framed in King James-style English rules:
- Rule #1: Start Thy Purse Fattening — save 10% of everything you earn
- Rule #2: Control Thy Expenditures — create a budget to live within your means
- Rule #3: Make Thy Gold Multiply — invest the savings from rule one
- Rule #4: Guard Thy Treasures From Loss — invest only where the principal is safe
- Rule #5: Make of Thy Dwelling a Profitable Investment — own your home
- Rule #6: Insure a Future Income — plan for retirement
- Rule #7: Increase Thy Ability to Earn — become better educated, more skilled; respect yourself
7 Money Mantras for a Richer Life by Michelle Singletary is a recent all-purpose financial book. I was ready to dismiss it for the absolute stupidity of mantra number one (stupidity in its phrasing, not in its advice), but after reading the book, I have to admit its advice is solid. It features:
- Mantra #1: “If it's on your ass, it's not an asset.” If you can wear it, it's not an investment. Also, if something is riding your ass (such as a high house payment), it's not an asset.
- Mantra #2: “Is this a need or a want?” This is a question Kris has been trying to get me to ask myself for years.
- Mantra #3: “Sweat the small stuff.” Do worry about the small expenses; they add up.
- Mantra #4: “Cash is better than credit.” There is almost no reason to carry a credit card.
- Mantra #5: “Keep it simple.” With money, avoid anything that seems complicated. If you don't understand it, avoid it. You'll probably lose money.
- Mantra #6: “Priorities lead to prosperity.” Determine what's important to you, and pursue that with your time and money.
- Mantra #7: “Enough is enough.” Don't overconsume. Recognize when you have fulfilled your needs and your wants.
I haven't reviewed Singletary's mantras since originally posting this article three years ago. I like them. I like that she emphasizes goals, that she advises against consumerism, and that she encourages people to keep things simple. These are great tips.
Ordinary People, Extraordinary Wealth by Ric Edelman is rather a unique book. It features advice distilled from surveying 5000 people of moderate wealth. Each chapter relates a secret for obtaining financial security. At the end of the each chapter, there are excerpts from the surveys featuring anecdotes and advice from the respondents.
- Secret #1: Carry a mortgage even if you can afford to pay it off. — This flies in the face of every other financial book I've read, and I do not subscribe to the idea. I'm willing to bet that the people surveyed carry a mortgage out of habit, not because they think it's smart.
- Secret #2: Don't diversify the money you put into your employer retirement plan; instead, put all your contributions into stock mutual funds — I'm okay with this. It may not be appropriate for someone close to retirement, but for younger people, this seems like sound advice.
- Secret #3: Make many small investments rather than a few large investments. — The key is to make investing a habit, and to invest the money when you have it.
- Secret #4: Rarely move from one investment to another. — Market timing is not something to be treated lightly; it's not easy for a casual investor. Buy and hold.
- Secret #5: Don't measure success against the Dow or the S&P 500. — Understand what you own and why you own it; don't compare it to market indicators.
- Secret #6: Don't spend a lot of time paying bills and fretting about personal finances. Don't bother budgeting. — Many books encourage a budget, though I've not adopted one. And my success these past few months has come precisely because I have fretted about my personal finances. Maybe this advice is true for the long run, but I'm not sure it's applicable to somebody just starting to lay the foundation of financial independence.
- Secret #7: Involve your children in family finances. — This is another piece of advice that all of the books offer. I haven't mentioned it because it's not appropriate to me, and doesn't actually fit my metaphor.
- Secret #8: Don't pay attention to the media. — The media are about hype. They have to sell a product, even if it's just news. If you allow yourself to be caught up in the frenzy of the moment, you're apt to make a rash decision. Don't follow daily financial news — it's enough to check in every month or so.
The rest of this book contains three wonderful chapters entitled: “The Biggest Mistake I Ever Made”, “The Smartest Thing I Ever Did”, and “My Advice to You”. The number one thing these people recommend is to start investing as soon as possible, as much as possible. They also recommend finding a financial adviser. (Looking back after three years, I think my evaluation of some of Edelman's points has changed.)
I was going to include a point-by-point summary of Rich Dad, Poor Dad by Robert T. Kiyosaki, but when I went to write it up, I couldn't put Kiyosaki's advice into words. I re-read a chapter. Everything seemed generalized. I did a google search, and found that not everyone agrees with the author. I, too, found the book amorphous and vague, full of outlandish claims. I thought it was inspirational, and that it contained some kernels of wisdom, though, and consider it influential in my financial development. I've incorporated advice from Rich Dad, Poor Dad in my general summary at the beginning of this entry, but I cannot recommend the book.
Finally, there seems to be one major point on which these books disagree. Some argue that your home should be considered your most important investment, that you should carry a thirty-year mortgage and not attempt to accelerate payments. Others declare that a home should be considered a liability, the same as a car or a credit card. (The latter admit that a home will generally appreciate in value, but they note — rightly so — that a home is a cash drain, not a source of income.)
All of the books, with one exception, encourage readers to only purchase modest homes; they smash the commonly held belief that you ought to “buy as much house as you can afford”. Instead, these books say you should only buy as much house as you actually need.
Three years later
In the three years since I first published this article, I've re-read most of these books. I've also read dozens of other personal finance books, scores of magazines, and hundreds of articles on the web. Surprisingly, I've seen little to change my initial philosophy. I still believe in the four-step “building” process I outlined above.
My thinking has become somewhat more refined. I now know about index funds and high-yield savings accounts. I've discovered Amy Dacyczyn's remarkable Tighwad Gazette. I've exchanged ideas with countless readers. And I've begun to explore the notions of financial independence and early retirement in more depth.
In the original version of this entry, I reminisced about another time I was deeply interested in personal finance. When I got out of college, I went to work at the worst job I ever had, selling insurance door-to-door. During training, we were asked to make a poster illustrating our life goals. I cut out a picture of a log cabin in a lush, green woods. My goal was to retire to a peaceful lifestyle within ten years. Now, fifteen years later, I have the exact same goal. Only this time, there's a chance that I just might achieve it.
Final note: Last winter, I re-examined the “house” analogy in an entry entitled The architecture of personal finance: Choosing the right materials. I hope to elaborate on this metaphor in the months ahead.