Someone recently asked me what I thought was the most important contributor to growing net worth. For someone in the accumulation stage, the most important thing to do is balance the three prongs of growth: (1) maximizing income, (2) minimizing expenses, and (3) investing. Ignoring any one of these prongs will handicap your NW growth. Income Prong: I’ve been fortunate and did not have to worry about the income prong. But say you are stuck in a low paying job making $40K a year — even if you save 75% of your gross income, you are only saving $30K a year. That means living off $10K a year, including income and payroll taxes. On the other hand, if you made some changes and increased your income to $150K, you would only need to save 20% to save the same amount. There’s a world of difference between those lifestyles! Increasing income is sometimes an obvious lever to pull, but many in the ER community focus too much on savings. Here are some suggestions to increase income:
- Ask for a raise — it’s amazing how many people are too afraid to do this. Even if you ask and are told no, your boss will likely respect you more for having asked.
- Interview for a new job to see what the job market is like. Other companies may pay more. Engineers often job hop.
- Invest in higher education, especially if your employer will cover your tuition or you can qualify for assistance from the school. With a better degree, you will likely be able to get a raise at your current company or elsewhere.
- Get a side hustle. I’m not as big of a fan of this option unless the side hustle might lead to more. Otherwise, you are just spending more time working for money.
Expense Prong: This one should be pretty easy for those of you who read this blog. In fact, I’m sure many of you are much better at limiting expenses than I am. Here are my keys to minimizing expenses:
- First, track what you spend. Failing to do so is like putting your head in the sand. There are many services that can help, such as Mint, Quicken, YNAB, etc. Look at your spending over time and across categories. You’ll likely be able to spot areas where you spend more than you would like.
- Second, focus on cutting the big expenses like housing, food, and transportation costs. If you are single, live with roommates. It’s a good way to socialize and save money at the same time. If you eat out a lot, then start packing lunches or go to the grocery store more often. If you drive an expensive car, try trading down or limiting your driving. For us, these three categories easily cover 60% or more of our total spending.
- Third, cut out the pesky recurring expenses that can really add up over time. A $100 a month cable bill will require almost $40K in assets to cover in retirement assuming you withdraw 3% of your assets to cover your expenses.
- Finally, for the high earners, focus on minimizing your tax liability. Maximize tax deferred accounts to lower your AGI. Use a high-deductible health plan in conjunction with an HSA if you are in good health.
Investment Prong: For a long time, I was guilty of ignoring the third prong of investments. Part of me felt “smart” for having avoided the 2008 financial collapse. When stocks starting to zoom up in 2009, it didn’t feel right — it felt propped up by quantitative easing. So I sat on the sidelines waiting for that double dip that never came. It was not until 2012, when I was sitting on hundreds of thousands in cash, that I finally started to deploy my capital. Now my assets are working for me. They’ve generated $250K in gains over the last 3 years. Investments are truly the engine that will power our financial engine in the future. Over time I became more comfortable with the fact that the value of our assets are subject to the whims of the market. Here are some high level investment philosophies that I try to follow:
- I’m the person who cares the most about my investments. I’m also the only person who will manage my own investments for free. There’s no need to pay someone a percentage of your assets to “manage” them for you. If you need discrete advice, there are always professionals who are willing to provide advice for an hourly fee.
- Always diversify. Benjamin Graham advised that investors should never own less than 25% bonds in their portfolio. John Bogle recommended that investors should own their age minus 10 years in bonds. For example, a 45 year old investor might own 35% in bonds. Geographic diversity is also important. Even though there is a trend of globalization, certain countries may fall under bad times while others thrive.
- Minimize expenses. Vanguard index funds have some of the lowest expense ratios in the industry. Why pay a fund manager 1% in expenses — he doesn’t have a crystal ball either. Very few fund managers can consistently beat the indexes.
- Don’t get too emotional over volatility. You’re still accumulating so you should be rooting for a drop in prices. Buy low.
The important thing is not to ignore any of the three prongs. Let them work with each other to maximize net worth growth.