Build Wealth and Prosper
This post summarizes the universal, foundational principles for building wealth in the long term.
Bottom line: save and invest your money.
Why Become Wealthy? #
Some people want to be rich so they can buy a Lambo. Or maybe they want a bunch of hookers and cocaine.
“Money talks, wealth whispers”
Generally, reasons to become wealthy include:
Lifestyle Choices - higher quality of life
Generational Legacy - better life for your family
Financial Freedom - buy back your time = do whatever you want, whenever you want
“Escape the rat race”
How to Build Wealth? #
Wealth is “an abundance of valuable possessions or money.” An abundance of money is accumulated by living below your means = spend less than you earn and invest the savings.
$$ \uparrow \text{Income} - \downarrow \text{Expenses} =\ \uparrow \text{Savings} $$
Minimize expenses and maximize income to increase your savings rate, thereby increasing your ability to acquire more assets and become wealthy faster.
Assets put more money in your pocket, creating the “snowball effect” in building wealth. Liabilities drain money from your pocket, leaving you in a perpetual cycle of just scraping by to make “the next payment on your [insert credit card, car loan, etc.]."
Treat your finances the way a business manages its balance sheet. Prioritize investing in income-producing assets that make you passive money. Eventually, your assets will generate enough passive income to fund your lifestyle.
“If you don’t find a way to make money while you sleep, you will work until you die.”
– Warren Buffet
How Much is Enough? #
Once a man was lying on the steps of a plaza. A passerby awoke the man to say, “I have a job for you–you can make some money!” The man replied, “Today I already ate” and went back to sleep. "Oggi ho già mangiato" is an old Italian story my Nonno tells me about simple living.
Valuation is subjective; everyone has different definitions of needs vs wants based on their values, priorities, and situations. As a result, there is no single amount of money that will be satisfactory for all.
While it’s more about the journey than the destination, having a goal to shoot for is important to keep you on your path to success. One common way to come up with your “number” is to start by defining your ideal lifestyle, and then back-calculate how much it will cost to obtain and maintain.
For example, let’s say I need $40,000 per year to live a modest lifestyle; own a house, pay family expenses, annual vacation, whatever. Using the 4% safe withdrawal rate as an approximation, I need roughly 25x my annual expenses in income-producing assets to not deplete my principal amount.
$$ \char36 40{,}000 \times 25 = \char36 1{,}000{,}000 $$
How long would it take to accumulate this million bucks? Assuming an inflation-adjusted, market-average return of 6.5%, here are a few scenarios: Play around with the investment calculator linked here to model different scenarios based on your initial amount, monthly contribution, rate of return, and time horizon.
| Initial Amount | Monthly Contribute | Years to $1M |
|---|---|---|
| $20,000 | $2,000 | 20Y |
| $0 | $1,000 | 30Y |
| $0 | $500 | 40Y |
Where to Start? #
Where to start first can be hard. Let’s make it easy by identifying where your money will have the greatest utility for your current situation.
First, focus on developing healthy financial habits that contribute to reaching your goals. One widely adopted practice is to develop a budget to better manage your money. “If you can’t track it, you can’t manage it!“ The budget below is just an example and will vary across individuals (income level, cost of living, etc.) Many free budget templates are available online, linked here and here.
Example Budget: $5000 Monthly Income
For a detailed plan, Dave Ramsey offers the “7 Baby Steps” to building wealth. Dave is a big proponent of “get out and stay out of debt.” For many, this idea offers as much psychological relief as financial benefit.
Furthermore, this online flowchart offers greater detail about where to stash the cash first, such as prioritizing tax-advantaged retirement accounts for investments. It’s not the holy grail, but it gives you a general idea of what to do when, and what topics you might want to research further.
Each step builds off the other to create a foundation of financial…
- Stability (budget)
- Security (emergency fund)
- Growth (investments)
How to Invest? #
Investing in the present day is just a few clicks away - anyone with an internet connection can do it. Investing makes your money work for you, rather than you work for your money.
This section will focus on investing in shares of businesses (aka stocks) through low-cost, broad-market index funds because they contain the following ideal investment characteristics:
- High returns - average 6-7% annual return (after inflation)
- Low risk - diverse exposure and value goes up in long-term
- High liquidity - can sell and convert to cash in a few days
- Low maintenance - passive investing requires little to no time
- Low taxes - tax-free growth with low(ish) capital gains tax at distribution
- Easily accessible - can purchase yourself online for any amount of money (fractional shares)
You can expect to achieve a profit when investing in index funds for the long term. The chart below shows the inflation-adjusted S&P 500 index (top 500 U.S. companies weighted by market cap) over the past 100 years.
By owning the entire index, you own a small slice of each of the top companies. This provides diversification across many different companies and industries while requiring no attention at all since the index automatically adds/removes companies based on their market cap weights.
Furthermore, the visual below shows the rolling returns of the S&P 500 since 1871. Notice how by increasing the rolling period, the standard deviation decreases while the % of positive periods increases.
Created using the Shiller Data.
Inspiration from Lazy Portfolio Etf.
The data shows the longer you hold the index and invest over time, the more likely you are to make money; your average return converges towards the 6.5% inflation-adjusted compounded annual growth rate. For any 20-year period in history, there were virtually no negative returns.
It also puts into perspective the negligible impact a significant downturn, such as the Great Financial Crisis or Dot Com Bubble can have on one’s investment career. This is because most people are dollar cost averaging into the market as they receive income - always be buying!
Keep it simple and invest in an S&P 500 index fund. But don’t take my word for it - listen to these legendary investors who know a thing or two about making money in the stock market.
GOAT. The Oracle of Omaha
Warren Buffet, one of the greatest (and wealthiest) investors of all time, says to, “consistently buy low-cost S&P 500 index funds through thick and especially thin." For example, Vanguard’s VFIAX or Fidelity’s FXAIX.
Saint Jack. The Father of the Index Fund
Jack Bogle, creator of the index fund itself, says, “Buy everything and hold it forever." The Boglehead investment philosophy supplements US stocks with bonds and int’l funds for greater stability and diversification.
Ultimately, what index fund(s) you pick and how much you invest in each fund depends on your financial goals, risk tolerance, and time horizon.
Success in the market long-term is guaranteed unless you make these catastrophic errors: failing to participate, or selling out. Therefore, you ought to buy and hold your investments for many years.
Missing just the 10 best days can cut your overall gains by 64%! So don’t get smart and try to time the market… you can’t. Just take a look at this dude or this guy.
Revisiting our example from the beginning of this post for the time it takes to accumulate a million dollars, you can see that for the 40 Year scenario, about $750k of the $1M came from gains! Time is money, straight up.
The power of compound interest shows that the opportunity cost of investing as early as you can, even if the amounts are small at first, will have a big impact down the road.
“Time in the market > timing the market.”
Conclusion #
The amount of effort and resources it takes to do a little financial planning and set up automated investment accounts like retirement funds is disproportionate to the amount of financial gain and benefit as a result.
If you take nothing else from this post, understand the opportunities available to you and start today - even if it’s just a “baby step.”
$$ \text{Action} \rightarrow \text{Progress} \rightarrow \text{Results} $$
In summary,
- Find ways to make more money and spend less money.
- Use your savings to consistently buy income-producing assets, such as investing in low-cost, broad-market index funds.
- Buy and hold these assets over time.
- Wait and become wealthy.
And continuously pursue furthering your financial knowledge.
Thank you for reading!