Achieving lasting wealth is easier than most people think. It doesn’t require a big income, and it doesn’t require tremendous financial sophistication. All you need to do is a number of simple things right. Someone who follows this simple, Point #by Point #plan can set themselves on the path to lasting wealth.
Point #1: If you are spending more than you are earning, you must either start earning more or spending less. This is the starting point for good money management. Ignoring it can lead only to debt and disaster.
Point #2: Begin saving 10 percent of your net income every year. Ten percent savings is enough for most people to achieve all of their financial goals. Develop a budget that keeps your spending 10 percent below your earnings and make sure you stick to it.
Point #3: If you have credit card or consumer debt, use your savings to pay off debt before investing in anything else. Eliminating high interest debt is essential if you hope to accumulate wealth over time. Don’t start saving for your long-term goals until you’ve dug yourself out of debt.
Point #4: Once you have paid off your credit card and consumer debt, begin saving to achieve your short-term goals. Begin your savings plan by focusing on the items you’ll need to buy in the next 10 years. This enables you to avoid falling back into debt.
Point #5: Focus your annual 10 percent savings on accumulating money to buy your next car for cash. Once you buy your first car for cash, you’ll never need to take out an auto loan again. This simple Point #can add hundreds of thousands of dollars to your pocket during your lifetime.
Point #6: Buy a home only when you are prepared to live in it for ten years. A home can be a great investment IF you stay in it long enough. Rent, don’t buy, if you think you might have to move in less than ten years. Otherwise, the transaction costs of selling and buying wipe out too much of your equity.
Point #7: Think effectively about risk when you invest your savings. Your risk is not the chance that your investment goes up or down. It is the chance you won’t be able to buy whatever you intend to buy with your savings.
Point #8: Invest your short-term funds in fixed income securities. When saving for something you intend to buy in ten years or less, sacrifice the growth potential of equity investments for the stability of fixed income.
David’s Note: Notice though that what most people classify as fixed income investments (bond funds for example) can also change in value. Tread carefully, and remember that safe doesn’t always mean what you think it means.
Point #9: Select fixed-income securities to minimise credit risk and interest rate risk. Don’t try to be exotic; an extra 1 percent of interest won’t allow you to buy the home you want any sooner. Make sure your principal is secure and invested in securities that won’t lose their value if interest rates rise.
Point #10: Invest in equity index funds for your long-term investments. You need equity investments to make your savings grows faster than inflation if you have a long time horizon. Retirement and college savings should initially be invested in equities, but gradually re-allocated to fixed income as the time you’ll need the money approaches.
Point #11: Begin the process of saving for your children’s college education by estimating the amount you will be required to contribute. Good tools for estimating your family contribution are available on the college board web site. Focus on the parent’s expected contribution – that is the amount you need to have saved.
Point #12: Calculate a college savings target amount, and recalculate it every few years, or sooner if your income changes significantly. Based on your expected family contribution and the number of children you have, you should be able to estimate how much you’ll need to have saved. Remember, your eligibility for aid is dependent upon your income, so recalculate periodically as your income changes.
Point #13: Invest your college savings in equities when your children are young and fixed-income as they approach college age. You need to gradually reallocate your college savings from equities to fixed income as your children age. You don’t want to be holding stocks when they are 17 because the stock market is just too volatile.
Point #14: Make sure your savings rate is adequate to reach your target. This requires a bit of math. You need to estimate the rate of return you’ll achieve on your savings, taking into account your changing asset allocation over time.
Point #15: Begin the process of saving for your retirement by estimating the amount of money you’ll spend each year. If you can pay off your mortgage before you retire, you should be able to live on about 65 percent of your pre-retirement income. Naturally, you need to consider the lifestyle you expect to lead during your retirement.
Point #16: Estimate how much money you’ll receive each year from Social Security and subtract that amount for the projected annual expenses you calculated in Point #15. The difference is the amount of money your retirement savings fund will need to contribute to cover your expenses. Multiply that number by 20 to set a target for your retirement fund.
Point #17: Develop a detailed retirement savings plan that will allow you to reach your target. Like the college savings plan, this requires a bit of math. Estimate how much you’ll save each year and how much your investments will grow. If you can pay off your mortgage before you retire, you can use that extra cash toward building up your retirement fund.
Point #18: Adjust your annual savings rate and your retirement spending rate until your retirement savings plan works. Back in Point #2, you set a savings rate of 10 percent. If you can’t make a retirement plan work on 10 percent annual savings, you may need to save more. Adjust your savings rate until you can achieve your retirement savings target.
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