Wealth Building for Idiots

Inspired by JRL

The best way to get rich is to have someone leave you a big wad of cash, stashed away in some nice warm tax haven someplace far far away from the IRS. The second best way is to have someone leave it to you here in the US.

For the rest of us the only realistic way is to obtain it on our own. This is done by saving and investing. That’s it, the whole secret of dieing rich, save and invest. The only way you’re going to do this, is to accomplish the first part, first. That is to save, and the only way you’re going to save is to spend less than you make. That’s why you hear so much about getting out of debt.

Debt is negative savings. With debt you’re paying someone for the benefit of using their savings to buy stuff you want. If step one to building wealth is to save then step 1a is to get out of debt so you can save. I would advise getting out of all debt, by paying it off, as fast as you can. It doesn’t matter if that debt is tax deductible, take a look at how much of a deduction you get verses what credit costs you, verses what you could have received by giving the money to a cause you care about. You might be surprised how that looks once you do the math.

Savings means cash. Write that down, or repeat it to yourself till it sinks in. You need cash and you need more cash than you think. Do you have an emergency fund? How much is it? Could you live off it for a year or more? Could you get by without needing to raid your investments if you had to?

How much cash am I talking about? That depends on how much you need to live. Do you live comfortably on $1,500 a month? If you do then $18,000 is a good start with enough extra to cover contingencies, add an extra $5,000 to $10,000 to that figure for a rainy day fund. If you can’t live on $1,500 then adjust that number higher, for most middle class Americans I suspect the number is closer to $3,000 a month. So that’s $36,000 plus $10,000 or $46,000 or more.

Quit stammering the word “but”. I have a reason for this. Simply put: Life Happens. There is no worse time to get hammered by life than when you’re not prepared financially. If you’re setting on what amounts to about a years gross pay, you’re going to be able to stick it out through some tough times, without having to sell off assets at a potential loss.

There are different ways to handle your cash reserves. One thought is to stick it into a money market fund. Another is to stick it into a bank account. My personal thought on this is never stick it in a bank account unless the account is of the online variety that is paying a very competitive interest rate, preferably above inflation.

My advice is a two fold approach. First you have the $3,000 a month you need to live off for a year. Take that money $3,000 at a time and buy a 1 year CD from a good online bank that is offering a decent rate on the first day of every month. January 1^st you have a CD that becomes payable. The same thing happens in Feb, March, April, etc for an entire year. If you need to live off your savings each month you have an income stream to use.

The second step is take your $10,000 or rainy day fund and stick it into an account you can get at relatively quickly, that is paying a high interest rate. Most likely this will be someone like ING or Emigrant Direct or one of the many on line banks. The benefit to this is if you need a chunk of cash you can get at it to pay for an emergency that is too big to handle out of your normal budget.

This looks like its going to be a two part post so that’s all for this weeks installment. Next time I’ll take on investing. I will say if you work for a company that has a 401K plan that they contribute to, you need to maximize their match so you can get all the free money from them that you can. If they do dollar for dollar match to 3% then you need to do the same 3%.