Balance Is the Key to Maximizing Net Worth Growth

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. balancing-stool 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.

18 thoughts on “Balance Is the Key to Maximizing Net Worth Growth

  1. In all of this I see #1 as the key. I lived that $40k salary for several years before heading back to school. Yes, we could save, but it was only after I came out of school that we really started to bank meaningful dollars. The inflection in net worth trajectory was incredible (as was the most recent downward inflection when I got laid off :-). But, things are looking up again, and life as an independent consultant has many perks.

    One other small note is that Schwab ETF’s are a great way to invest too, and often have lower fees than Vanguard with no transaction costs. My new SEP IRA is with them. I think Vanguard has been synonymous with low fees for so long that it’s easy to overlook other viable options.

    • Sorry to hear about the layoff. Sounds like you’re realizing there is a silver lining to your situation. I agree that income is the primary driver of NW growth at the outset. Expenses are merely obstacles on the way to converting income to investments, which is the ultimate goal.

  2. I agree that income seems to be the most important lever – at first sight.
    Reducing your expenses leeds to a) more savings and b) less net worth needed. So this has double impact.
    Also, good investment results help you achieve FIRE earlier and maybe do it with less net worth. So this, too, has double impact.

    • Thanks for the comment. It can be a tough mental hurdle to cross. Every dollar saved is precious — why risk losing it? That being said, the long term benefits are definitely worth it!

  3. Really, your advice is if you make 40k it would be better if you made 150k lol.
    Stop please. And when has 40-30= 15?

    • Thanks for the comment, Mike. Good catch with the math. Us lawyers tend not to be great with it! That being said, I think you are missing the point a little bit. If you make $40K, try to make it $45K, then $50K. Try to make it higher. In my personal experience, my income has gone up over 6x in the ~15 years I’ve been working. For me education was the key, but for others being an entrepreneur or taking risk may be the key, etc. I don’t know what your situation is, but perhaps the mentality that you can’t go from $40K to $150K is part of what is holding you back.

  4. Pingback: Balance Your Financial Life With The Three Prongs Of Wealth | Lifehacker Australia

  5. Not trying to sound like a know-it-all, but this is some real basic stuff.
    It’s really easy to say make more money, but in this day-and-age, it’s not so easy to do.
    There’s a good reason why income inequality in the US keeps getting worse.
    The employment numbers don’t tell the whole story. Income growth has been stagnant for way too long.
    Spending less is also subject to each person’s circumstances. But what’s the point in earning a good living if you can’t enjoy some of it now, while you can? You really never know what will be knocking at your door tomorrow.
    As for investing…unless you have someone who is going to leave you their fortune when they pass…long-term, dollar-cost average index investing, is probably your best bet at acquiring wealth.

    • I agree it is pretty basic stuff. But sometimes people lose sight of the forest for the trees. I know it’s happened to me and what helped was seeing things in perspective. I understand there is income inequality in this country. I think that is just the way things are pre-programmed to keep the capitalist engine running. But people can and do break through all the time. You just need opportunity and the right mindset. One of the reasons things are pre-programmed is because people are resigned to their circumstances. That leads to a self-fulfilling prophecy.

      On expenses, you’re also right that everyone has different circumstances. Sometimes you just can’t do anything about high expenses — like you have a serious health issue. But many times, people simply dug too deep a hole for themselves, and can’t figure out how to get out. I am surrounded by people who make millions of dollars a year and think they can’t possibly take some time off or retire until they’re in their 60s. Those people simply don’t know that change is possible. It’s sad to see so many people shackled by the golden handcuffs. Part of this blog is intended to speak to such people without grabbing them by the collar and screaming at them.

      Also you’re right there is a balance to be struck on expenses. No point in living like a pauper to save money you never enjoy. But the flip side is many people kill themselves for money and think that buying a Cartier watch is going to make their lives better. It won’t. But perhaps it might be worth it to forgo the watch and some other material things in exchange for the freedom to follow your dreams. Others who aren’t so well off might feel better not being one paycheck from being on the street by forgoing other material goods.

      • Please understand that I pretty much agree with everything you’ve posted.
        It’s just so easy to write the kind of blog that you’re writing when you’ve already succeeded. My point is…you didn’t know the path you took would work out for you. Others may have copied your path and failed.
        Most people truly are programmed to believe that what they have achieved is as far as they can go. In many cases it’s true. In others, it’s not. Every story, every life, is so different with so many variables. And never leave out the ever powerful forces of “luck.”
        Your line…”You just need opportunity,” is just about the biggest obstacle to most peoples success. There are just so many talented people in the world that will never be discovered because they never get the opportunity.
        Congratulations on being in the minority that has been able to achieve a higher level for yourself.
        Forgive me, but I personally do not “feel sorry” for those encumbered with “golden handcuffs.” I was just talking today with a very high-level executive for Citigroup. He’s well into his 70’s and still trudges to work every single day. He could have retired very comfortably 20 years ago. People are just programmed differently. Everyone has a different set of circumstances that makes them “happy.” Who are we to judge if they are right or wrong?
        I make considerably less than your multi-millionaire counterparts. Considerably less. My net worth is less than they make in a year. I’m in my mid 50’s and ready to retire in another year or two. I have very modest needs and like to travel, but always do so with value in mind.
        Maybe those “golden handcuff” folks you speak about care more about their position and the power they wield then the money they earn. If it was about the money, would they really still be doing what they’re doing?
        As for the Cartier watch, people have their goals. Everyone’s goals are different. For some, attaining the Cartier watch might be the pinnacle of their life-long goal. Should it be? Of course not. But who are we to tell them that.
        What makes you happy makes “you” happy. What makes me happy makes “me” happy. Yet…our happiness’s might not equate with each other’s.
        Those people don’t need to be shook, they need to be left alone to their own devices. If they weren’t on “their course,” I’m sure they would’ve figured it out a long time ago.
        Live and let live.
        Be happy with who you are and what you’ve accomplished. Don’t let it bother you that someone else don’t see eye-to-eye on what happiness and accomplishment is.

    • First, I would max out 401k contributions. That takes 18k or so off your adjusted gross income.

      Then I would determine whether to make a backdoor Roth IRA contribution. This hinges on whether you have any untaxed contributions in an existing IRA. If not, then you can contribute the maximum to a nondeductible IRA account then convert it to a Roth account without having to pay any taxes. The conversion can be done by anyone regardless of income, unlike a direct Roth IRA contribution. But if you do have untaxed contributions in your IRA, then you have some things to think about. Worst case, you might have to pay a pro rata share of tax to make the conversion. If you have $5k in existing pretax contributions and want to backdoor another $5k into the Roth account then you’ll have to pay taxes on half the conversion amount. One way around this is to reverse rollover the pre-tax amounts into your 401k, but whether or not you can do so depends on the policies of your 401k administrator. Let me know if you have questions about this.

      Finally, if you are in good health, consider a high deductible health plan. You’ll have to pay for doctor visits in whole, until you hit your deductible. But this allows you to contribute to a health savings account, which is like a super Roth IRA as the contributions are also deductible.

      • I used a Roth IRA last summer and this year since the income levels were under the limit (this is my stub year) so I won’t have any regular IRA contributions next year. Would that mean I am free to do a backdoor Roth from the get-go?

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