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.
These books 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, Creating Wealth, etc.
Some of the books out there — most of them? — really are as bad as their titles. Others, however, offer outstanding, practical advice. The best books seem to have the same goal in mind: not wealth, not riches, but financial independence.
According to Your Money or Your Life, which I consider 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 meets or exceeds your monthly expenses. Financial independence is linked to psychological freedom.
How is financial independence achieved? Again, the best books all basically agree. (To some of you, this will be common sense, stuff you've known all your life. To others, like me, this kind of thinking is a sort of revelation.)
Here, then, is my personal summary of the collected wisdom found in these books.
Step One: Prepare the Foundation
The first step is to lay a foundation upon which the secure home of financial independence can be built. To prepare to build wealth, one must first eliminate debt, reduce spending, and increase earnings.
There are many ways to approach debt elimination; the key is to use the one that actually works for you. All the books agree on this: cut up your credit cards. Get rid of them. There is no compelling reason to keep them. Next, pay off your debts. All of them. For years, I tried the oft-touted method whereby you first pay off your highest-interest debt. This never worked for me, because my highest interest debt was also my largest debt, and psychologically I just never seemed to make any progress. What worked for me was the "debt snowball", as defined in 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 my debts this way. I was dumbfounded. I'd struggled with this 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. (Many people — including myself — use Quicken; it's quick and easy.) 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. I cut my comic book spending by a huge amount. 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: it's in this step that I should 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 I happen to think it's optional. However, there are a couple of authors who are quite vocal that this is an important step on the road to financial independence. 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.
I can testify first-hand that by following these three steps, you can lay a solid foundation for future financial independence. I've only recently finished my foundation, and am amazed at the amount of money I'm suddenly able to save each month. Amazed. And that means I'm now ready for...
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'm preparing to do. (I've already done one part, but only by happy coincidence.)
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 have a very hard time grasping this concept, admitting its usefulness. All of the books stress it. Kris, who is always right, insists that it is important. Yet I want to skip this and go to other, more exciting steps. However, having seen the results after "laying my foundation", I'm willing to suspend my disbelief and just do it. I'll build the emergency fund.
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. Establish a personal IRA outside of work, and every year contribute the maximum amount. I already do this, at least in part. Custom Box has a retirement plan, but not one to which the employees can contribute. The company itself contributes approximately ten percent of each employees' annual salary to a stock plan. One of my goals for when the bathroom is finished is to get a Roth IRA set up.
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 this weekend; on Paul C.'s recommendation, I read Rich Dad, Poor Dad, a book that's almost solely about this particular portion of the framework. Beyond your retirement investments, the collected financial wisdom is that you ought to participate in further investments, specifically in income-producing assets. For different people, this means different things. Maybe it means bonds, maybe it means stocks, maybe it means investment properties. 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.
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's required during this time is patience and discipline. Resist temptation. Do not accrue debt. Acquire income-producing assets; avoid non-income producing assets. Faithfully contribute to your retirement plans and your IRAs. Wait.
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 those steps yet. There are scores of books on how to best approach each step (even each substep!). I'm sure to obsess over each one in turn.
There seems to be only 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 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.