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The Simple First Step to Build Wealth

Yes, you can start today!

One of the most common questions I get during speaking engagements is about how to get started. What can they do today? In other words, is there a simple first step to build wealth?

Often I ask my audience is to think about their current wealth – the difference between what they own and what they owe. Their faces give them away. It is clear that most of them have never thought about that number. They know the amount of their pay check, and some of them know the value of their debts or some of the things they own. But they haven’t put it together to know their actual wealth. Wealth is often called net worth, but many would take the position that our net worth is more than just the sum of our finances. So let’s call the number our Wealth Number.

There are lots of numbers to look at…

When people talk about getting rich, sometimes they talk about the stock market and spend time watching it go up and down. Often every few minutes on their smartphone, leading to unnecessary mood swings. Others set up a budget and try to track expenses, leading to spirited spousal arguments about who caused the biggest budgetary miss, or can one partner claim a credit for the savings from a 1/2 price beer and wing night? (answer: no) Some focus on paying down a debt, even as new debts spring up like bad weeds. As a result, they build frustration, not wealth.

While all of these numbers can be helpful, the most important is your overall wealth number. The difference of what you own minus what you owe. To calculate it, set up a simple table with everything you own at the top. Include things with real value, like a house, cottage, car and registered investments like an IRA, 401(k) or a 529 Education Savings Plan (or TFSA, RSP and RESP for my Canadian friends). Add up everything you own. Then make a section below that for everything you owe. Mortgages, student loans, car loans, and the line of credit you took out to pay for the dog’s new hip. Sum up the debts, everything you owe. Finally, subtract what you owe from what you own. This is your Wealth Number. You can do this on a cocktail napkin, in a spreadsheet or download the Net Worth Tracking Sheet here.

OK I have a wealth number, so what?

That number is a simple first step to building wealth. Why? What does the number mean? It is a measure of your financial wellness. Once it is big enough, your money can make enough money to take care of you. How fun is that? If the number is small, you may have a lot of debts that are cancelling out the value of the things you own. The monthly interest costs of those debts are pulling you backwards. If the things you own, like real estate and investments are growing, they are pulling you forward and helping you to build wealth. Sometimes people face a negative wealth number. Their debts overwhelm what they own. They need to work hard just to cover the interest on all their debts. Not fun, but solvable, read on.

What gets really interesting is tracking that wealth number each month to see what it is doing. If it is rising, you are moving in a great direction. If it is stagnating, or worse, declining you will be able to retire, well, never. Set up your cocktail napkin, envelope back or spreadsheet to track it every month and see what happens to it. Look as well at the sum of what you own. Is it rising? Awesome, how can you make it grow faster? Look at what you owe. Is it falling? Is there a way to pay things down faster? If you have an addictive personality, thinking about this will get your finances in shape just like your Fitbit or Apple Watch force you to get moving on your health.

Tracking your wealth number changes everything

Your wealth number is the simple first step to building wealth since it changes the way you think about money. The act of calculating it every month helps you build awareness of whether your wealth is actually growing. Updating it will take about 30 minutes a month using your paper or online statements. You got this.

Tracking your wealth number makes you start to think about the things you own:

  • Are my investments growing?
  • Am I getting value for the investing fees that I am paying?
  • Can I own more investments that will grow and build my wealth?
  • Have I bought a lot of things like cars, clothes and dinners out that lose value and lower my wealth?
  • Are there ways of lowering costs on the expenses that I pay for every month?
  • Can I use that freed up money to invest and build more wealth?

It also makes you think about what you owe:

  • Can I find more savings and use that cash to pay down debts more quickly?
  • What are the interest rates of all of my debts and which ones should I pay down first?
  • Have I been borrowing money to buy things that go down in value? (a double threat since the thing loses value every month, and lowers what you own, but the interest costs slow down your ability to lower what you owe)

Show me an example

Here is an example of tracking wealth. Interesting to lay it all out there. Be brave, you can do this at home. Looking at the green section, the house and 401(k) are moving up nicely, while the two vehicles are losing value each month (I depreciated them at 15% annually). Still the Total Owned is rising and slowly building wealth. Unfortunately, rising credit card debt in the orange section is working against the pay down of the mortgage and the car loan, as a result, the Total Owed is staying about the same and wealth is rising only slowly each month. Depressing.

Let’s try making a few changes and see what happens:

In this case, we have increased the 401(k) contributions by $200 a month, which will cause it to accelerate its growth over time. On the credit cards, we have curtailed spending and paid down each card balance by $500 per month. As a result, this family’s wealth is now growing by more than $4,000 a month and will accelerate as the investments grow and debts shrink. Nice!

Wait, where did the money come from?

It came from getting smarter about monthly costs and aggressively reducing monthly recurring expenses using ideas from Cashflow Cookbook where I lay out ideas to reduce monthly expenses by up to $13,000 monthly with minimal effort and sacrifice and from my blog posts. Lots of other blogs have great ideas including Barry Choi’s Money We Have and the classic, Mr Money Mustache. Some of the savings come from being smarter about spending, sometimes its about learning the joy of having fewer things, letting the Jones pull ahead and staying out of malls. Once you start tracking your Wealth Number, you will begin to find lots of ways to reduce expenditures and apply the savings to building the investments you own and reducing what you owe.

Summary

To build wealth, start by tracking your wealth. To accelerate it, focus on ways to free up monthly cash flow and immediately use those savings to pay down debts (especially high interest ones) and increase investments. Over time, what you own will accelerate and what you owe will drop. Work becomes something you do for fulfillment, bills go on autopilot, stress dissolves and life is fun. Welcome to financial wellness.

5 Reasons Not To Panic About The Market

The paper statements won’t be arriving for a while, but no one reads those anyway. It’s the online numbers that hurt. It takes some courage to login and look at the big number at the bottom of the page. The one that used to be big. That sickening feeling in your stomach like when you overslept for an exam back in college. Relax. You don’t need to panic about the market. Here’s why:

1. Corrections are normal

Look at the chart for most any stock over a 1 week period. Or even a month. How did it do? Who cares? Always a lottery over the short term. Now look at some long-term data for quality companies. Likely sold growth over 20 or 30 years. Over the long haul, stocks outperform bonds. The short term dips and dives are the price to be paid for the superior returns.

As an example, let’s look at Apple. Here is the company stock chart. A disaster. A price drop from $178 to $156. A heart wrenching plunge of 12.4% in just one month. Even the red shading on the chart looks scary. Good time to sell? Move into something else? There are lots of factors to be considered in making buy and sell decisions, but the short term stock direction, and the shade of the chart isn’t one of them.

Let’s look at the same stock over 10 years. Now the stock goes from $13 to $156. If you invested $10,000 back then, it would be worth $120,000 today. Nice! Even with the recent drop, that is an average annual growth rate of 28.21%. That doesn’t even include the dividends you would have earned. Not a lot of bonds pay that. Pretty good ride. And if you hung in for 10 years, you would have seen plenty of drops, like the 43% one from Sept 2012 to July 2013 where the stock dropped from $98.75 to $56.65. Ouch. But your patience would have been well rewarded.

This doesn’t mean that I am recommending any one stock. Or to buy Apple. Just that corrections are a part of investing. Pull up any stock charting tool and look at short term and long term data for individual stocks and for the market as a whole. The long term trend for quality stocks is up. The short term is, well, we know not what. Build a well diversified portfolio that is suited for your age and risk tolerance and let the power of compounding work for you. Don’t panic about the market.

2. Stocks are on sale

When clothing goes on sale, we rush in to get the best bargains. Boxing Day deals bring out the beast in people. And a 2 for 1 deal can work us into a frenzy. But when stocks go on sale, everyone panics. Why? It’s a chance to buy quality companies for less. Same employees working just as hard to earn you money.

Using the US Dow Jones Index as a view to the overall US market, we see that it has risen from 9,035 to 22,859 over 10 years. Thats an average annual growth rate of 9.73%. Even after the recent drop of 14.5%. By staying in the market and not exiting on the drops (tough to do) an investor would have earned a solid return. And that doesn’t include dividends. Keep investing through the ups and downs with a well diversified portfolio.

3. DRIPs help ease the pain

DRIP stands for dividend reinvestment program. Your financial institution can set this up on your account so that the dividends that you earn are used to buy more of the stocks you already own. The compounding effect is a powerful way to build wealth. In a quality company, the dividends often grow, providing more cash with which to buy more shares. But this becomes even more important as share prices fall since your dividends now buy even more shares since they are on sale. And fewer as prices rise. DRIPs build wealth and help stabilize a portfolio.

4. You don’t need the money right now

For those of us in our 20’s, 30’s, 40’s or 50’s we needn’t be concerned since we likely don’t need our investments right away. The numbers on the statement are just numbers on a statement. They don’t need you reacting to them. Time is the great healer. Keep saving and investing for the long haul. You don’t need to panic about the market.

5. Retiring? You still don’t need to panic about the market

But let’s take the case of a 65 year old who just retired with a plaque, a party, some bad speeches and a gold Apple Watch. Her $500k portfolio has declined 20%. It is now $400k. The projections might suggest that she no longer has enough to live on. Time to panic, or at least sell her Apple Watch? First off, her advisor shouldn’t have had her in a portfolio that could decline 20% at age 65. That is true even if she is her own advisor. But even still, she doesn’t need all of the money this week. The average bear market lasts 11 months. Time for her to withdraw what she needs for now and let the market run its course. When the market recovers there will be an opportunity to rebalance to an investment mix that is better suited to her age.

Summary

Here are a few thoughts to keep in mind as the market tumbles:

  • Don’t panic about the market and succumb to the instinct to sell everything. Take the long view. If you own quality companies, they are full of people getting up early and working hard to grow these businesses. If you own their shares, they are your businesses. Stay invested and let them work for you.
  • Over time, rebalance your portfolio to get a mix of quality stocks, bonds and cash that is appropriate for your age risk tolerance. A qualified financial advisor or robo advisor can help. Not tips from your Uber driver. Unless she has a Certified Financial Planner. Who loves driving.
  • In uncertain times with rising interest rates, the best defence is to aggressively pay down debt and reduce expenditures. Being rich is about spending less than you earn. And the longer you do that, the richer you get. Especially if you invest your savings in quality, well managed companies and give them time to grow. If you need some ideas to reduce your expenses, subscribe to my blog or have a look at Cashflow Cookbook where I offer 60+ “recipes” to reduce recurring expenses. If you are in the Toronto area, I am doing a series of free lectures on wealth building ideas. The complete schedule is here.
  • Set up your finances so that a fixed percentage of your income goes directly and automatically into savings. If your employer has a matching RSP or 401k, that is a great place to start. Can’t afford to make the contributions? You can’t afford not too. Reduce other expenditures. Find the money. Make the contributions.

What are your thoughts on the market correction? What are you changing in your approach?

Photo credit Yu Tang of Unsplash