The Millionaire Next Door - wealth formula

[Darkcyd]

Lud is exactly right in detailing what options are available to you as alternatives to fixed return investments. One thing that most people don't realize when they are saving their money is that a fixed rate may be guaranteed, but what it does is it guarantees you to fail, in reaching your financial goals. If you are getting 1% interest on your savings account and inflation is 3%, you're losing 2% of the value of your money every year. If you put it in a CD, you're hopefully keeping pace with inflation. But the key to smart money management is making your money work for you. And this is the premise behind some of the books that people have mentioned in our financial discussions in the past.

As was mentioned, there are several alternatives.
1. Stocks should really only be used if you know what you're doing and its money you can afford to lose. The stock trading boom of several years ago was fed from a Bull market that made everyone think they were a financial genius. They weren't. And the last 2 years have put most people in their place.

2. A more suitable option for the majority of the population is a mutual fund. It combines the growth of stocks with the safety of bonds and protects your investment through diversification. It is also considered a liquid asset because you can link it to your checking account, meaning access when you need through wire transfer. Depending on how old you are and your particular situation, you will decide how aggressive of a fund to go with. Typically the longer you have till you will need to access this money, the more aggressive you can afford to be. Consult with a financial planner. =)

In general, this is how I try to help my clients set up their accounts.

1. If you have a 401(k) or comparable employer plan, you should always contribute the amount equal to what they match. It's free money.

2. Then max out your Roth IRA (in a mutual fund) because tax-free income when you retire is better than just tax-deferred.

Depending on how much you have left after the above contributions, you can either...

3. Contribute to a regular mutual fund so that you have growth but also access to the money without tax penalty. This account should be used to save money for a new home, new car, etc... more immediate purchases.

or

4. Put the rest into your 401(k) to completely max it out.

Additionally you should look into life insurance as a way of protecting your family as well as saving money for tax free income during retirement.

Also, if you have money in an employer plan from a previous job or are getting towards retirement, I would definitely recommend looking into getting a variable annuity. They give you the opportunity to invest your money for growth while providing some very good protections both for your loved ones, and also for yourself as well.

There are a lot of different options out there. A good financial planner is worth their weight in gold. =) Go find one in your area.

 

[Nsxotic]

Thanks for the advice guys. I'm a little stuck as there is no company match on my 401k money. I do max it out every year however. I keep putting off the IRA thing as you can only put in 2k/year and that just seems too minimal to worry about although I know it's not. My 401k is way down from my total contribution. Only about 62% is still there. That stupid PIMCO fund....... I am buying a few pieces of real estate soon so I guess that will help. I just can't get myself to grasp the idea of putting money away for when I'm 60 'cos I might get hit by a bus next month. I'm all for saving cash, but only if I can spend it when I want.

 

[steveny]

Originally posted by Nsxotic:
Thanks for the advice guys. I'm a little stuck as there is no company match on my 401k money. I do max it out every year however. I keep putting off the IRA thing as you can only put in 2k/year and that just seems too minimal to worry about although I know it's not. My 401k is way down from my total contribution. Only about 62% is still there. That stupid PIMCO fund....... I am buying a few pieces of real estate soon so I guess that will help. I just can't get myself to grasp the idea of putting money away for when I'm 60 'cos I might get hit by a bus next month. I'm all for saving cash, but only if I can spend it when I want.

Excellent point about the bus. Last Saturday morning a Cornell physics grad student was hit and killed on his bicycle in front of my house. He was 24 years old. I am sure he invested a great deal of his very little time on this earth planning and working for his future. Unfortunately he had it snatched away from him in a second of bad judgment on someone else's part. Would his time have been better spent traveling the world, living with Eskimos, hanging out in the park?? Who knows. I am not saying to blow your money and not save for the future. What I am saying is there is a lot more to life than financial freedom. If given a choice tomarrow to live another 50 years and be poor or to live 10 more and be rich, which would you choose? I used to work all the time (14-16 hours a day) and had a stringent saving plan so I could be a multi-millionaire and retire at 50. At the rate I was working I would have never gotten the chance to spend any of it. Around September I changed my tune. I do not think it was the terrorist attacks as I had been thinking about cutting back for sometime before that happened, although the attacks may have accelerated my plans. I think it is important to recognize what life is about for each individual. It is not that important to me to have a Rolex watch. Not that I would not want one if it were given to me. Its just that I do not want to give up X amount of my time ( my life) working to buy it. I can tell time just as easy with a 100 dollar fossil while I sit in my hammock and read a book. With all this extra time gifted to me I have been able to do things that money simply can not buy or replace at any cost. Such as spend time with my family. I am stress free and have been able to QUIT SMOKING. YES!!! That alone may have added a few years to my life right there. I also have time to do the art work that I have put on hold for so many years now. The millionaire book is good. I have read it. The formula will work. But no amount of money will replace the things that you miss out on, running for the finish line looking through a telescope.

 

[nsxtasy]

One correction is needed, I think:

Originally posted by Darkcyd:
2. A more suitable option for the majority of the population is a mutual fund. It combines the growth of stocks with the safety of bonds and protects your investment through diversification.

A mutual fund does provide diversification (so that you don't have to choose specific stocks to invest in). However, there are different kinds of mutual funds; they do not necessarily consist of a mixture of stocks and bonds. Some mutual funds are all stocks. Some are all bonds. Some are a combination of the two. Some are money market investments.

Regarding steveny's comments, the thrust of the present discussion is how to achieve an appropriate level of financial security. I don't think anyone is saying that we shouldn't try to enjoy the here and now at the same time as we're trying to save for the future. The two are not mutually exclusive. However, each of us needs to find the right balance between current consumption and savings that meets all of our needs best.

If anyone knows how to enjoy the here and now, I would think it would be a bunch of NSX owners...

[This message has been edited by nsxtasy (edited 29 April 2002).]

 

[Darkcyd]

Originally posted by nsxtasy:
One correction is needed, I think:

A mutual fund does provide diversification (so that you don't have to choose specific stocks to invest in). However, there are different kinds of mutual funds; they do not necessarily consist of a mixture of stocks and bonds. Some mutual funds are all stocks. Some are all bonds. Some are a combination of the two. Some are money market investments.

Regarding steveny's comments, the thrust of the present discussion is how to achieve an appropriate level of financial security. I don't think anyone is saying that we shouldn't try to enjoy the here and now at the same time as we're trying to save for the future. The two are not mutually exclusive. However, each of us needs to find the right balance between current consumption and savings that meets all of our needs best.

If anyone knows how to enjoy the here and now, I would think it would be a bunch of NSX owners...

[This message has been edited by nsxtasy (edited 29 April 2002).]

My apologies for not stating the above information more clearly. Mutual funds are indeed sometimes 100% equity or 100% debt. I was just thinking along those lines when I mentioned choosing how aggressive you would want to be. Forgot to note that you could be conservative in a mutual fund as well by going completely the way of bonds or vice versa.

In regards to the decrease in value of the 401(k), what one should know is that a 401(k) or IRA or anything of these tax advantaged accounts is purely a label. What determines how the account performs is what you decide to put into the so-called container. Just having a 401(k) is not sufficient, you must make sure that your investment choices within it are well-chosen.

My advice is not to worry about the depreciation of the account too much. If you have your money invested in the right place, it will eventually turn around. That is why it is considered a long-term investment. If anything, you should continue to pump money into it. You will effectively be getting yourself more shares because the price per share is lower now. When the market does recover as it is starting to, you will find that your account will do the same.

** Open the Roth. That $3,000 now per year will really make a difference in the long-run. =)

 

[Ag NSX]

Darkcyd,

Correct me if I'm wrong, but based on Todd's example income, would he qualify at all to put money in a Roth? Just wondering, because I thought there was a limit around $90k?

Kenric

 

[nsxtasy]

If I'm not mistaken, anyone can put money into a Roth IRA, regardless of his income level, and whatever that money earns is tax-deferred. However, the contribution itself can be tax-deferred (deductible in calculating current taxes) only if his income is below a certain threshold.

Darkcyd, correct me if I'm wrong on this.

 

[Ag NSX]

I did a quick search and got this: http://www.quicken.com/cms/viewers/article/taxes/25850

"Roth IRA Income Limits - You can contribute to a Roth IRA if your adjusted gross income is below these limits:

Full $2,000 contribution - Single/Head of household Up to $95,000 or Married filing jointly Up to $150,000.

Reduced contribution - Single/Head of household $95,001-109,999 or Married filing jointly $150,001-$159,999."

So if you are single making over $110k or Married filing jointy making over $160k you cannot contribute to a Roth IRA.

I sort of remember this, because I got hit with this a few years ago (I believe the amount was lower) and had to withdraw part of my contributions. I believe its a decreasing linear scale from from $2000 down to $0 when making between $95k-$110k.

Kenric

[This message has been edited by Ag NSX (edited 29 April 2002).]

 

[Darkcyd]

There are two types of IRA's (individual retirement accounts).

1. Traditional IRA - They originated in the 1970's, with two major tax advantages in order to give people an incentive to save money. Contributions are 1) tax deductible and 2) the money in the account is allowed to accumulate tax-deferred.

Tax deductible qualifications are a little complicated.

If you are single and NOT part of an employer's retirement plan (ie 401k, 403b, etc.), you qualify for a full deduction on any contribution up to the current maximum of $3,000. If you ARE part of plan, your contributions are fully tax deductible for income levels up to $33,999 after which there is a sliding scale up to $43,999 when you no longer qualify for a tax deduction. Regardless of whether or not you qualify for a tax deduction, you can still contribute to a IRA for the tax deferred benefit.

For married people filing jointly, there is a range... which I am not about to try and completely type out here. It depends on whether one or both or none of the spouses is covered by an employer plan and then income levels. If both spouses are covered, contribution tax deduction qualification phases out between $53,999 to $63,999.

2. For Roth IRAs, the tax advantages are slightly different. Contributions to a Roth are not tax deductible and are made with after-tax monies. Funds do accumulate tax-deferred as with the traditional IRA. But the most important difference is that the whole account will be accessible in retirement, tax-free. This is major because over your working career, all the money in the account will make more money on base contributions, on the taxes you would've paid, and on all the money that you've earned in the account.

The AGI (adjusted gross income) phase-out for Roth IRAs is for single between $95,000 - $110,000 and married filing jointly $150,000 - $160,000.

** Depending on your age there are also catch-up provisions for those nearing retirement age, which allow you to contribute an additional amount to these accounts (as well as other types of retirement accounts) in excess of the maximum.