How to Become Wealthy and Retire Early
You might not believe it, but securing your early retirement can be very simple. At least, that’s the theory.
There are three easy concepts to understand for financial success:
How much money you invest, the rate at which your money grows, and how much time it has to grow.
Please know that it’s important to not only just understand these principles, but you must also be able to put them into action. You must be able to translate the concepts into results.
There are two obstacles to building wealth:
-Translating the three principles above into the rules that you can follow to reach your goal
-Living according to the rules
Most people know the principles of wealth building, but people rarely live up to them.
It is critical to understand that if you know the rules but don’t live according to them, you might as well not know them at all. Unfortunately, these rules are difficult to live your life by, which is a problem.
Because of this, the quality of our 12 tips for building wealth shouldn’t be judged by how original, exciting, or genius they are. The point is that smart wealth building is a straightforward process, so it shouldn’t be sensationalized.
Either you are working towards building your wealth, or you’re not. It’s truly that simple. You may recognize most or all of these steps, but think hard about how dedicated you are to the follow through.
As you peruse this article, you should question whether or not your daily habits helping you follow each of these steps. The honest truth might make you uncomfortable, but it’s when we leave our comfort zone that we are free to grow!
- Make a Plan
Many people make the fatal mistake of not having a written plan, so they easily go off course. Having a general idea of what to do isn’t enough. It is imperative that you actually write the exact plan down and create a system to stick with it.
As part of your plan, you should outline where you are not and where you want to be. The next part is as easy as filling in the steps in between. It isn’t random. You must take action to make it happen. Your written plan is your roadmap to success.
You make many small decisions every day. Financial success or failure is a result of these decisions. Making a plan will help you when decisions begin to feel cumbersome.
When you create a plan, you invest in your financial future. The steps of your plan will increase your efficiency, which will also reduce the wasted effort, producing exceptional results. Also, it doesn’t cost anything but time.
Even scientific research supports the conclusion that creating a plan is a remarkable and effective tool. An example comes from a study by the Harvard Business School that ranged over 30 years. It indicated that 3% of subjects who wrote their goals down were 10 times more likely to reach their goals than those that did not write them down.
That is a significant difference.
Your plan should include savings and spending goals, along with the steps that you will take to achieve those goals. You can utilize paper assets, real estate income, and/or business in your plan as well.
There is not only one correct answer to building wealth. Instead, your plan should be customized to your interests, resources, and abilities. Your plan should never be identical to another person’s, since your situation is different.
There are three financial stages throughout life, and you should formulate your goals and plan to fit with them.
- You will accumulate assets and income aggressively throughout your career
- During early retirement, your assets will continue to grow
- Later in retirement, you will start to spend down your accumulated assets after your income earned from working depletes.
When you transition from one stage to another, it’s important that you create a new plan. This is because circumstances change when your finances do.
Your plan should be set up in a way that you can use your career and early retirement to invest your residual income in assets that will allow your passive income to be greater than what you spend on living. If you are able to reach that point, you will be able to be wealthy indefinitely, as long as you do not deplete your assets, and continue to allow them to grow faster than inflation. You should always feel like you have enough without the fear that you’ll run out of means to take care of yourself later in life.
It may sound nice to get to this point, but this kind of result will only happen if you create a plan and stick with it. Have you begun?
- Lifestyle Inflation (BAD)
When most people get more income through a raise or capital gains, etc., they begin to spend more. This is a phenomenon called lifestyle inflation. It’s when you feel wealthier, so you want to live like you’re wealthier. An example is going to get a newer, nicer house after receiving a raise, or trading in your clunker for a new car at the dealership. People tend to like the appearance of being wealthy more than the freedom you get with actually being wealthy.
Hard to Believe?
How many people around you are drowning in debt, but wearing nice clothes, driving nice cars, and have the newest technology? These people are choosing their lifestyle over being financially free, and so they are violating the very first principle in making your plan fit the stages of your life.
Instead of accumulating assets, they spend money on frivolous things, often just for aesthetic value.
It’s a problem because you won’t become wealthy by spending money and outliving your income. You should control yourself when spending money and make sure that your lifestyle always lags in comparison to your income. You will then be able to create capital for investments.
Wealth building demands that your rate of savings or accumulation of assets be the most important part of your financial plan. Later in the plan, you will cross the point where you earn more from your assets than you spend on accumulating them, but that point comes much later.
The early stages of your plan are accumulating the assets so your plan has something to grow on. Saving money is a good first step for most people.
If it helps you, you can think of your money as little soldiers and each dollar is on the battlefield, fighting for your future wealth. If you spend that dollar on something unnecessary instead of investing it, the dollar dies. However, if that dollar is invested, the little soldier recruits more soldiers, and your army becomes larger and more powerful. The larger your army grows, the greater the chance you will become financially independent.
Thomas Stanley and William Danko are the authors of a great book called “The Millionaire Next Door.” They teach that being frugal and exercising discipline in saving are the key elements of creating a successful financial plan. Millionaires that created their own wealth all have something in common – they practice frugality and discipline through creating budgets, controlling spending, and saving as much of their income as possible.
Considering the fact that Stanley and Danko are both self-made millionaires, it would be smart to do what they say.
Debt should be avoided. It is the enemy of wealth, and causes you to be a slave to whatever lender you owe money to. Instead of earning interest from your investments, you will be paying interest for someone else’s investment.
Certain debt is acceptable, but only if you have a productive asset because of it. Examples include mortgages and business debt. Consumption debt is not acceptable.
You make the choice every day between inflating your lifestyle now, or accumulating wealth for your future. You can either slaughter your dollar soldiers for instant gratification or you can invest them and enjoy the freedom you will experience in the future.
It’s easy to understand, but can be difficult to stick to. How are you doing with your plan?
- Financial Education
The rate of capital growth is the second principle in keeping your financial plan on track during the different stages of life. It’s based on your level of financial education. You have to learn before you earn.
Profiting from all marketing conditions is possible, if you have the education and knowledge to know how to work it. Granted, some conditions are less difficult than others. Remember, every investment you make towards your financial education will produce good returns your whole life.
It’s a good idea to regularly take courses, read, and do research to stay up to date with current trends, and also to help keep yourself motivated to stay on plan.
How much knowledge you have is directly proportional to how much you can earn. Make sure to invest in your financial knowledge because it cannot develop instantly, and neither can wealth. It takes discipline and time.
The sooner you learn the better. They will cost you less in the long run, and you’ll gain valuable experience in investing.
The longer you wait, the more it will cost you. You will miss out on years of opportunities, and make more mistakes along the way.
Remember, a little bit of education can cause you to be overzealous with investing decisions. A lot of education can be very profitable because you’ll know how to handle each situation. Get a lot of education.
- No Procrastinating
Remember how we discussed that the more time you allow your wealth to grow, the better? Starting late can be almost detrimental to your plan. If you wait even 6 years to start, assuming that your assets grow at a rate of 12% yearly, the amount you will have when you retire will be half of what you would have had if you hadn’t waited. If you wait 12 years, you will only have one-fourth as much as if you had not waited.
Your future living situation will be drastically improved by starting your path to financial freedom right now. It’s important.
Compounding is a powerful tool for wealth building, as money has a geometrical growth pattern, not an arithmetical one. It’s important to give it time to work though.
For many people, procrastination is a tool to help them cope with the uncomfortable feeling they get when dealing with financial decisions. They may feel ignorant or bored, and not have the education yet to understand the jargon.
Suck it up!
Financial geniuses aren’t born. They are made. Everyone starts from scratch, and then fumbles through until they figure out what they’re doing. Making small mistakes is better than not doing anything. Every day you fail to start will increase the difficulty you face when trying to build your wealth.
If you begin to save for retirement in your 20s, you can put away just 10-15% of your income to ensure financial security. If you don’t start until your 30s, that percentage jumps to 15-25%. Even worse, if you don’t start until your 40s, you are looking at 25-35% of our income being needed to protect your future. Waiting until your 50s or 60s will force you to reach for other, non-traditional strategies that involve different skills and more risk, because it will be too late to begin a normal savings pattern. These figures were calculated by the Schwab Center for Investment Research.
It’s obvious that starting earlier makes the whole process easier.
As sad as it sounds, most people will be lucky enough to have enough income to retire securely, but only a few will succeed.
Here’s a summary of what we’ve learned so far:
- Always have more income than spending. Save the rest.
- Make financial education an ongoing priority to allow you to make more informed decisions
- Start as soon as possible! Procrastinating can cost you big time.
- This is not the “get rich quick” path (which doesn’t typically work in real life). Slow and steady wins the race, right?
No matter which path you decide to use, your financial health always depends on your number of investments, their rates of growth, and how long you allow them to grow. The formula is always the same.
The next 8 tips are a bonus. Only the previous 4 are necessary for success, but the next 8 will help you to succeed faster and avoid some common mistakes. These tips will assist you in sticking with the plan.
Putting your saving and investing on auto-pilot is by far the easiest way to increase your wealth. This involves organizing your finances so that a specific action will take place to automatically increase your assets with no extra effort. This helps to keep you on the right track by enforcing discipline.
Here are some examples:
Your Home: Buying instead of renting your home has its advantages. Part of each monthly payment goes toward the principle balance, paying down that debt, and building equity in your home. If your interest rate is fixed and your mortgage is fully amortizing, your home should gain value over time through inflation. Despite the increased inflation, you will repay the same amount of debt. It’s automatic. You can even schedule your final mortgage payment to line up with your anticipated retirement date. If you can do this, you won’t have to worry quite as much about income when you retire.
Rental Homes:Owning your home is an excellent idea, so owning a bunch of homes is even better, right? It especially helps if others are paying you rent, which in turn pays your mortgage. Be careful though. Ensure that each property has a safe buffer of cash flow so if the tenant doesn’t pay one month, you still have the money to pay the mortgage. Also, you should be sure that you’re up to the challenge of being a landlord. It’s not everyone’s cup of tea, but being a landlord can be a fantastic way to grow your wealth.
Retirement Accounts: I cannot stress this enough: Maximize your contributions. The money is deducted from your pay and is pre-tax. This also lowers your tax burden on your income because when you have contributions to certain retirement plans, the amount you contribute can come off the top of your yearly income.
These accounts are relatively pain free since you never see the money in-hand. Also, many employers offer a match program, which is essentially free money. It’s frankly the easiest way you’ll ever be able to save. Additionally, it costs less to save in this way because of the tax break. So, to put it in perspective, let’s say you earn $50,000 annually and your company matches 50% of your contributions, up to 6% of your yearly salary, which is common. A $250 monthly contribution ($3,000 yearly) would earn an additional $1,500 from the company. Free. Let’s also say that you are in the 30% tax bracket. $175 would come out of your take home pay, but you would receive benefits every month of around $375. You’d be crazy not to take up the offer.
Automatic Savings:This is another excellent option to help reduce the likeliness that you’ll spend all of your money as soon as you get paid. These programs are created to deduct money directly from your paycheck, so you never actually see it in hand. It’s a whole lot easier to never see the money than it is to see it and then give it away. The main point is that the money is saved without any effort on your part. Signing up for the automatic withdrawal is the only think you have to do, and then the process is on auto-pilot.
Investment Club: Joining a club can lend you a vast social circle, support, learning, and even forced savings. This will keep you inspired and help to automate your financial education and wealth building process.
The previous examples were only 6 of the man different ways you can automate your savings. There are a lot more.
“Life is what happens when you are busy making other plans” –John Lennon
We apply this quote to the financial situation by saying that automating your growing wealth can provide the support so that the rest of your life has a normal course. It’s imperative that you plan for retirement, even while planning the other non-finance parts of your life. You can arrange life so your wealth building becomes a habit, or you can procrastinate and let wealth slip away.
Automate. Don’t procrastinate.
- Take Responsibility
Unless you are independently wealthy before you begin this process (either through rich parents or lottery winnings, etc), you will have to own up to every decision you make, and take responsibility for your plan.
Taking responsibility means that you take action and manage your plan until your goal is reached. You are the only one responsible for making a habit out of wealth building. Don’t expect anyone else to do it for you.
You are the only person that can determine your spending priorities and whether your lifestyle is too inflated based on your income. Only you can decide whether you start now or if you put it off until tomorrow.
“Liberty means responsibility. That is why most men dread it.” – George Bernard Shaw
If you use consistency in your actions, you will get the desired result, making the question of financial security a “when,” not an “if.”
You also have to take responsibility for any growth you create when you make all of the decisions on your own or even if you hire an advisor. You cannot blame external circumstances such as your broker, bad luck, market conditions, etc. The results are your own; this will teach you make better decisions when you have another opportunity to do so.
If the idea of being fully accountable for your actions and results feels intimidating, that’s because it is. However, it can also be empowering. No matter what has happened in the past, YOU have the power and capability to turn the situation around, starting now.
To plan a successful retirement, you must be able to provide the required resources in order to reach your goals. Not committing enough will set you up for failure. For example, if you don’t want to work part-time, you shouldn’t plan your retirement around rental property income. While not as time consuming as a typical 40 hour/week job, it still requires some work. Real estate is not entirely passive. It is an investment, but it’s also a business.
Likewise, If you’re in your 50s and are getting a late start, building your retirement plan based on paper asset investing, and have no assets, you will require a greater amount of leverage and strategic investment to catch yourself up. Remember, when you invest in paper assets, a large chunk of the return on those assets is cancelled out by inflation. So, if you’re just now starting and you’re in your 40s or younger, it is mathematically viable. You must just remember to set realistic goals.
No matter how you invest, you should always be realistic in your assumptions for various asset classes. It’s easy to set yourself up to fail by not committing enough capital to your financial plan, and expecting unrealistic returns. To set yourself up to win, you need to carefully design your retirement plan to be consistent with your particular circumstances, including timing, finances, and money available. Not only should you design your plan carefully, but you should also be willing to commit your time and other resources to the plan.
Does your wealth plan fit your specific situation?
- Hard to Access
If you have money that is easy to get to, it will be easy for you to justify using that money when you shouldn’t.
If you use your savings to buy a new car when your old one break down or if you use that savings to pay your bills after you get laid off, it can be extremely easy to use more of that money than is necessary. It also may prevent you from seeking other solutions to your situation, which could have kept you from spending so much.
Retirement plans that are sponsored by the government have a lot of difficult rules to understand and penalties attached to early withdrawal of your money. These help to deter you from taking the money out, providing a bit of discipline for someone who otherwise wouldn’t be able to help himself.
It’s a simple rule. Build a nest egg, but don’t ever raid it. Don’t ever borrow from it, and don’t touch it until you retire. Let it go so it continues to grow until you are ready to access it for its intended purpose. Though the concept is easy to understand, it can be very hard to live by.
“Self-discipline is that which, next to virtue, truly and essentially raises one man above another.” – Joseph Addison
Some of the smartest investors put their retirement funds in assets that are hard to access. Some of these are real estate, as you would have to sell the property to access the funds, or government-sponsored plans, as discussed above. These harder to access assets also have tax advantages, which is never a bad thing.
While using retirement plans, you money can compound while avoiding taxes or at least deferring them, depending on the circumstances, but real estate has depreciation deductions as well as 1031 exchanges that provide tax advantages.
Becoming financially independent is more involved than just making a lot of money. It is more about the amount of money you retain, so tax savings are a crucial part of your financial plan.
Are you taking advantage of these tools?
- Risk Management
Avoiding loss is as equally important as chasing large gains and making your wealth grow. Building a valuable portfolio won’t do you any good if bad decisions end up making you lose everything the day before you retire. Because of this, smart investors make sure that their plans manage risk, including loss and volatility, with a variety of resources. These resources begin with diversification, but also include careful selection of assets, valuation, and a discipline when it comes to selling. Using these tools, you can create an investment plan that is defensive and will protect you from catastrophe.
Defensive investing by minimizing risk is essential; however you should not avoid risk completely by only investing in “safe assets” such as Treasury Bills. If you only invest in these safe assets, the amount you put into it won’t decrease, but it won’t really increase either. To build wealth, you should have an aggressive strategy to ensure that the value of your assets grows faster than inflation.
It’s all about a balance. You don’t want to go too far in one direction or the other.
These principles can be equally applied to your personal finances. For example, you should have insurance for anything of value that would be a big loss in the event of an accident. This includes automobile insurance, home owner’s insurance, health insurance, etc. Alternatively, you could spend your lifetime working hard, saving your money, and investing it for the sole purpose of covering a large loss, but that’s not a good plan.
Risk management is absolutely essential to any financial portfolio you have. You should never be put in a position where you are losing more than you can afford to.
How are you managing risk?
- Common Sense
Even if you’re investing for personal reasons, it’s really a business world. Speculative manias and the frauds that might deplete your retirement plan can be avoided by remembering a simple rule: Whatever you pay for an investment should be economically consistent with the business’s capacity to earn. Valuation is important. It’s one of the best risk management tools.
So, for example, if the NASDAQ is selling for 200 times the amount of earnings than it sold for in the year 2000, you should not allow your risk capital into that market.
Nobody would ever pay that much for a generic technology business stock, and you should avoid it as well. It’s not good business because the price is unsupportable
No businessman in his right mind would ever pay 200 times the earnings capacity for a broad cross-section of technology businesses, and you shouldn’t either. It’s bad business because the valuation built into the price is unsupportable.
If you can, think back to Southern California in 2005, when real estate was selling for ridiculously high amounts, and rental income would be unable to cover the mortgage. Even assuming that there were no vacancies or delinquencies, no insurance or taxes, no maintenance costs, and very low interest rates, rental income still wouldn’t have been able to cover the mortgage. So, purchasing a property in this area to be solely a rental home would make absolutely no sense.
Similarly, if above market yields are offered by an investment, then you should step back and think about why the yields are so high. Often, the reason is that it is very risky, and they are being forced to increase their rates so high in order to attract capital. Above market yields should always be interpreted as a warning, and extensive due diligence should be performed before committing to this kind of investment.
Finally, common sense says to only pay for services that don’t take more money from you than they provide. These services must add value to your portfolio, or they should be discarded. An example of this is paying a broker’s fees. They are only justifiable if his knowledge and services help you to attain higher profits than you have to pay him for his services. Basically, you should just make sure that you get what you pay for.
Many clients have avoided hundreds of thousands of dollars’ worth of mistakes by using common sense in their business strategy.
- Estate Planning
One day, you will die. This is 100% certain. And when you die, the last thing that your loved ones should have to worry about is being burdened by your financial legacy. It’s irresponsible to not have a clear-cut plan in place. It’s not fun to think about, but it is necessary.
Estate planning helps to determine what happens with your financial assets, and helps to define a legacy. Your affairs should be in order, and decide which of your loved ones are going to inherit which assets. Depending on your circumstances, your estate plan might include documents such as a Will, a Living Trust, a Power of Attorney, Life Insurance documents, and much more.
There are some people that rationalize not planning their estate because they feel like they won’t care what happens after they die, but think about the people you love, and think about whether or not you’d want someone you love to die and leave a financial mess for you to sort out while you’re mourning.
Additionally, you have to plan for what to do it you become incapacitated, but are still alive. At what point are you to be moved into an assisted living home, or put on life support? Will you allow CPR to be administered to you, or do you want to have a plan for when it’s time to “pull the plug?”
There is so much more to estate planning than just deciding who gets what, and it’s a step in your financial plan that you really should put a lot of thought into. Additionally, you should hire a competent lawyer to help you customize a plan to fit your specific situation.
Do you have an up-to-date estate plan?
- Enjoy Your Life
Retirement isn’t only about money. You have lots of things to look forward to, such as relationships, keeping healthy, finding activities that you enjoy, etc. Money only helps to make life easier, but it’s not the only thing worth focusing on.
“I have never been a millionaire. But I have enjoyed a crackling fire, a glorious sunset, a walk with a friend and a hug from a child. There are plenty of life’s tiny delights for all of us.” – Jack Anthony
Many retirees are happy because they are fulfilled in their daily lives and have the good health and money to do what they want. You should make sure that you have a lot left to do in life so that when you stop working, you have something to fill your days. Also, take care of your health. After working hard your entire life, you are entitled to the energy and wellness needed to do whatever makes you happy.
Health can be protected by getting the proper nutrition and exercising regularly. Preventive healthcare is crucial to minimize the risk of the catastrophic breakdown of your health. Make sure you get enough sleep and avoid stress and anxiety as much as possible. We never realize how important our health is until it goes bad.
Also, now is the time to invest in relationships that will enhance your life. You should start building or strengthening connections with friends and family so your life will continue to be full and happy. Life without them would be sad.
You shouldn’t retire just to avoid your current job. It’s much better to retire for a life that you are excited about rather than retiring from a life that you don’t like.
Money isn’t the end. It’s only the means. There is so much more to live for that will enhance your life, and money is just there to make it happen.
Once all of the financial tips are put into effect in your retirement plan, it’s time to focus on your life plan. Both life and financial plans are essential to a fulfilling retirement.
It is simple to understand financial planning, but it’s difficult to put into action. Because of this, few succeed at building enough wealth to retire early. It all comes down to being prudent and performing routine management of your portfolios. It’s not complex like rocket science.
The last thing to consider is whether or not you are putting into practice what you’ve learned. You may have heard most or all of these tips, but have you started doing them?
If you read through this list and you are utilizing less of the tips than you would like, it might be a good idea to hire a good financial planner to hold your hand as you incorporate everything into your plan.