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Here's today's Ask GFC question from Stephen who's interesting in building his legacy:
Hey Jeff I would like to know the best foundation structure and tools for building a routine of keeping more of my own money in my own pocket and building a legacy for future generations. Thanks, Stephen C.
A recent survey by the Federal Reserve indicated that nearly half of Americans couldn't come up with $400 if they had to, so this question is a lot more important than it may seem. That means that we all need to spend some time reviewing the basics.
I like that Stephen asked not only about keeping more of his own money, but also building a legacy for future generations. From a motivational standpoint, embarking on a plan of financial improvement for the benefit of others can often provide a stronger incentive.
What's needed to accomplish those goals? We’ll keep it basic.
Step 1: Learn to Live Beneath Your Means
This is the first step, because everything else that follows will be impossible without it. People sometimes think that they will become financially successful as a result of luck – coming into a windfall, having a winning lottery ticket, receiving an inheritance, selling a house or a business, or picking the right group of stocks.
That does happen on occasion, but for the vast majority of people the only way to accumulate wealth is to create a plan, and execute it faithfully.
To save money and build a financial legacy, you first have to create room in your budget to allow for savings. That comes about by learning to live on less than you make. Simply put, if you earn $50,000 per year, you live on $40,000, and bank $10,000. After 10 years, you'll have saved $100,000 plus the investment income earned on that money. At that point, your savings will be several times higher than your income. That's what financial success looks like.
That's simple in concept, but very difficult in the execution. That may not be the case if you are a natural saver, and some people are. But for the rest of us, it takes discipline and consistency.
You have to start by lowering your living expenses. How far you will go with this will depend upon what your financial goals are. If you only plan to save a little bit of money each year, you can probably accomplish that by clipping coupons, cutting back on restaurant meals, and eliminating some services that you hardly use.
But if you want to save a serious amount of money, it will require genuine sacrifice. Some examples include:
- Trading down to a less expensive housing arrangement
- Buying no more car then you can afford to pay cash for
- Cutting back vacations from an annual event, to once every few years
- Ignoring the living and spending patterns of your peers
Not everyone wants to pay that kind of price, which is why relatively few people ever achieve financial independence.
Seriously evaluate how much you want it, and if you're willing to make the sacrifices necessary.
Step 2: Automate the Savings Process
Once you have made room your budget to save money, you need to create a mechanical process that will enable it to happen. The more automatic the process, the easier it will be. That means creating methods of saving money that take place out of view.
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You can do this through payroll savings deductions. It's common to do this with employer-sponsored 401(k) plans. If you have such a plan available, you should definitely participate in it. Not only is it a good way to accumulate money, but you also get a tax break for doing it. At a minimum, you should contribute enough that you will max out any employer matching contribution to the plan. On the high-end, you can contribute up to $18,000 per year to a 401(k) plan ($24,000 if you are 50 or older). If you can hit the maximum contribution, and get a company match, you will accumulate money quickly.
The nice thing about payroll deductions is that they make saving money completely automatic. If you can pretend that it isn't happening, you can accumulate a lot of money in a short amount of time with virtually no stress.
Another option is to bank windfalls. That can include income tax refunds, bonus checks, cash gifts, or the proceeds from the sale of personal assets. That will fast-forward your regular savings efforts. The key is to deposit the money into savings immediately, as in before you can spend it.
None of this will be easy, which is why it's so important to be able to live beneath your means. The basic idea is to take money out of your immediate control, and move it into savings where it accumulates and grows.
Step 3: Invest Your Money – But Don’t Get Crazy
Savings will bring liquidity to your life, but it’s even more important to invest for the future. That's how you make your money grow. But don't get carried away with this; very few people have the time, talent and inclination to invest their way to riches. It's best to keep your feet on the ground, and leave the job investing to the professionals.
That mostly means investing in mutual funds and exchange traded funds (ETFs). These are funds comprised of dozens of stocks that are managed by professional managers. You can invest in index funds, which match popular indexes, like the S&P 500, or in sector funds, that specialize in various industries, such as high-tech, healthcare, finance, and energy.
You should assume that your job is to save the money to invest, and let the funds do the actual investing for you. That will free you up to spend your time living your life and managing your career, while the dirty work of investing is done for you.
Step 4: Get Out – and Stay Out – of Debt
In our current culture, debt is seen as a benign ally; it isn't. What debt really is is a reduction in your net worth. If you have $100,000 in savings, and $70,000 in debt, your net worth is $30,000, not $100,000.
It will do little good to accumulate a large nest egg, only to have it offset by a large amount of debt. Your goal should be to stay out of debt if you don't have any already, or get out of it as soon as possible if you do.
Apart from the stress that debt causes, it also represents a reduction of your monthly cash flow. By paying it off, you increase your cash flow, which also increases the amount of cash that you have available to put into savings. In a very tangible way, paying off debt reduces your living expenses, which makes it a double win.
Step 5: Stay the Course
There's an emotional reason why more people aren't financially independent: getting there isn't that exciting. It means living on less than you earn, putting your money where you can't get it, and not buying as much stuff or doing as many things as other people.
It can help if you find ways to occupy your time and entertain yourself that are not so money-centric. But if you are serious about building a legacy for the future, you're going to have to make a long-term commitment. It will take not just months or even a few years, but many years. And if your goals are high, it will take decades.
You have to be aware of the time factor. You have to be prepared to stay with your plan, and apply it consistently. That means guarding against distractions, and they will come up along the way.
But understand this, the benefits of financial independence come mostly on the backend. It's true that while you are building your nest egg, life can be kind of boring. But once your wealth reaches a critical mass, you'll be able to begin enjoying the comforts of life, and to a greater degree than most people since you'll be more prosperous.
Set a plan, keep it basic, and execute it consistently. You get there quicker than you realize.