This is an article in an occasional series on personal finance. Each article will address a different aspect of personal finances and provide some tips for you. However, always consult your own financial adviser or tax professional for your specific situation.
Happy New Year!
New year. Fresh start. Optimism. New opportunities. And resolutions.
Many people partake in the annual tradition of making resolutions. Lose weight. Eat healthier. Stop smoking. Get finances in order is a popular one. Usually this resolution involves earning more money, saving more money, or getting out of debt. But I’m going to suggest something that is far harder to do, but can have a much greater benefit.
Change your money mindset and understand how money works.
Often, people tell me that they need to get their short-term finances in order, such as being able to buy what they need without wondering where the money is going to come from. But what I don’t often hear is how to do that while building long-term wealth.
To build long term wealth, understand the following principles.
Money is always doing something.
Most people work for their money instead of having money work for them. Which is completely the opposite of the wealthy. Wealthy people have their money earn in the form of rent (such as rental property), income from an owned business, or dividends from investments.
An example of how big of a difference this makes, imagine that you want to make $100k per year while working 40 hours per week. You would have to earn $48.07 per hour. To make the same $100k working 24 hours per day, 365 days per year, you would only need to make $11.41/hr. Nobody has the ability to work every single hour of every single day, but money can.
Money can also work against us. I am certain that money is earning interest for the bank holding your mortgage, and earning interest for the credit card company on your balance.
Here’s an example where money could be working for you but isn’t – how much interest does your tax refund earn while the money is being held by the IRS during the year? ZERO.
Please understand that I’m not advocating doing something risky with money, like buying the hot investment of the day – bitcoin. Rather, think about how can you get your money working for you at all times. Even in a high interest savings account, is better than doing nothing.
2. Debt is not always a bad thing.
To build wealth, sometimes that means to “invest” in a way that doesn’t lose money. What if I offered you this investment:
Invest with cash. The next day, you’ll lose around 30 percent of value. And pay a fee each year while the value continues to go down each year.
Would you invest? Of course not! And I’d lose my licenses and maybe go to jail!
Yet people do take that deal all of the time when buying a new car. And the value is guaranteed to go down each year. Is it any wonder that people struggle with their finances when every time they buy a car, they literally throw away money.
I like a new car smell as much as the next person, but it costs a lot for that smell. I would rather pay a low interest rate per year instead of guaranteed loss in value.
The same is true for any major purchase, not just cars. According to Bankrate, a minor kitchen remodel recovers 80 percent of the cost. WHICH MEANS YOU LOSE 20 percent OF YOUR INVESTMENT.
As the old finance adage goes:
Own assets that appreciate. Borrow for things that depreciate.
Using other people’s money smartly (i.e. borrowing) can build wealth because you’re essentially transferring that loss of value to someone else while only having to pay a small amount in interest return.
3. Win by not losing.
How do I earn more on my investments? What earns the most? These are common questions are all about winning. No one can control how much the stock market goes up. What we can control are the losses, such as interest paid, taxes and fees.
Costs matter much more in building long-term wealth. One example is taxes. Are you trading a small deduction today for a big tax bill later whenever you contribute to your 401k? Now with the passage of the tax reform act, tax free methods of savings just got a lot more attractive.
(By the way, although 401ks are the most common method, they are far from the only method of saving for retirement.)
What about fees? Whether it’s ATM fees or investment fees, those do add up. You also pay fees in your 401k plan or IRA accounts.
And are you avoiding investment losses to begin with?
These principles fly in the face of the common advice out there on the Internet. Yes, you can quit your Dunks (Dunk’n Donuts) habit, or bring your lunch each day to work. And you could get a part time job in your spare time.
You want to truly to improve your finances? Change how you think about money. Make money work for you. And you’ll focus on long-term wealth.