The Secret to Retiring Filthy Rich

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Many hucksters claim to offer a shortcut to wealth. They promise to increase your investment returns to some dazzling level: 100% a year, 50% next week. The problem is that neither they, nor anyone else, can achieve those results over a sustained period. Anyone who tries to build wealth by dreaming of spectacular returns year after year is likely to end up in the poorhouse.

I recommend a totally different approach. Amass your fortune the time-tested, old-fashioned way. By all means, strive for the best profits you can earn, without taking excessive risk. But recognize that the decision to grow wealthy rests with you and your personal lifestyle.

The Time-Tested Path to Wealth

If you want true financial independence, without a money worry in the world, you must learn the habits of a champion saver. My wife Enid and I got into the groove more than 35 years ago, when we were first married. We were living on one income (hers) while I was studying law at the University of Virginia. Enid took home about $130 a week as a legal secretary.

Yet, in spite of our low income as a student family, we squirreled away cash every week in the bank. I opened a brokerage account and started trading stocks. By the end of our second full year of marriage, we already had interest, dividends and capital gains running at nearly 15% of our wage income. The process fed on itself, so that in recent years these investment items have occasionally surpassed 30% of my work earnings.

Saving, then, is — for most people, other than the Bill Gateses of the world — the key to achieving a substantial net worth. Let’s assume you start with $25,000 of investments at age 40. You’re earning $80,000 a year, and you can count on a 3% pay raise each year. If you save 20% of your salary (not impossible, I’ve done it for years) and invest your money at a moderate 8% annual return, your $25,000 nest egg will grow to $324,554 in just 10 years — an increase of almost 1,200%!

Please note: I’m not saying that $25,000, left alone at 8%, will grow to $324,000 in 10 years. (The original $25,000 stake will only increase to $53,973.) You must keep adding to the kitty, through savings, if you want to enjoy the miracle of compounding. As Ben Franklin said, “Money makes money, and the money money makes, makes more money.” By adding to the account at regular intervals, you enlarge your investment base. As a result, the dollar amount of your wealth will grow much faster in later years than it would if you simply sat on your original $25,000 stake. This is true even though the percentage growth rate in your portfolio (which we’re assuming to be 8%) never changes.

What’s the practical impact of the advice I’m giving you here? Let’s bring the point home with an example. If you simply left your original $25,000 account undisturbed, the annual growth in year #11 would only amount to $4,317 — hardly enough to buy an older used car at today’s prices. By contrast, if you followed my advice, you could stop contributing to the account at the end of year #10 and buy yourself a nice new American car with the next year’s earnings for $25,964.

Incidentally, stepping up your savings is also the secret to retiring earlier (if that’s your goal). Let’s say you’re 40 years of age, again earning $80,000 a year, and you figure you’ll need $20,000 a year of investment income (over and above the pension you may get from your employer) to retire comfortably. We’ll assume three things:

  1. You start with no investments
  2. You collect a 3% pay raise each year
  3. Your portfolio earns 8% annually

If you save only 5% of your earnings, you’ll reach $20,000 of annual income by the time you turn 61. But now let’s say you decide to speed up the process. You’re determined to get out the door sooner, so you boost your savings rate to 11%. You’ll achieve the $20,000 in annual income by age 54 — seven years faster. In fact, if you really want to be a champion, you can push your savings rate to 20% and retire at 50.

As you can see, your retirement date is really up to you. How strongly do you feel about having more leisure time to do the things you’ve always wanted to do? If the goal is an important one for you, let me assure you: It’s within your reach. All you have to do is save.

5 Tips for Navigating the “New Normal”

I don’t have to tell you the economic and financial world has changed. Radically. I don’t even have to remind you that the changes are probably going to be with us for a long time. Truth be told, though, many of us are still in the early stages of adapting to a climate of slower growth, tighter budgets and fragile investment markets.

I’m adjusting, myself. As part of the process, I thought I would share with you a few principles I’ve drawn up to help pilot my ship safely through the financial rocks and shoals of what people everywhere are calling the “New Normal.”

NEXT: 5 Tips >>

Principle #1: Expenses

Ruthlessly pare unnecessary expenses. I’ve always been a thrifty person, but in today’s world, it’s clearer than ever that (as old Seneca said) “economy is itself a source of great revenue.” If your income isn’t going up, the one certain way to improve your lifestyle is by eliminating waste.

This doesn’t mean, incidentally, that you need to give up things you enjoy, like vacations. Just make sure you pay less than you did last year. Take advantage of discounts that hotels, airlines and cruise operators offer. Telecom and cable TV expenses are another fat, easy target. For our residence, Comcast made us a deal we couldn’t refuse, bundling telephone, TV and high-speed Internet into a package that costs us 20% less, per month, than we used to incur for telephone and Internet alone. I don’t mind watching CNBC’s Jim Cramer, but only if he’s priced at his true value — free!

Principle #2: Debt

Minimize your own debt and invest in businesses that do the same. When my daughter Priscilla called from Nashville to ask whether she and husband, Matt, should take out a 15-year or 30-year mortgage on their first house, I pointed out that they could save $500 a year in interest by taking the shorter note. That’s the equivalent of a new major appliance (dishwasher, clothes dryer) every year, just from the interest saved.

Debt is the biggest scam and scandal in today’s American economy. The debt explosion facilitated by clowns in pinstripes nearly ruined capitalism. Nowadays, I’m buying only a handful of banks run by Scrooge look-alikes — and frankly, I prefer companies like McDonald’s, because they can operate on minimal amounts of debt.

Principle #3: Taxes

Use the tax law to your benefit. I understand, and sympathize, with the disillusionment that many workers feel toward their company 401(k) and similar savings plans. The 2007-2009 bear market losses shook investors’ faith to the core. Nonetheless, tax-sheltered retirement plans continue to be one of the best hideouts the average American has from the gang of robbers in Washington.

If you’re covered by an employer’s 401(k) plan at work, I encourage you to sign up for the biggest contribution you can afford. Don’t believe for a moment the defeatist propaganda in Time magazine (and elsewhere) that says 401(k)s have somehow “failed.” Investors who continue to plow cash into their retirement accounts through the stock market’s ups and downs will come out far ahead of those who count on the government to care for them in old age. In 2012, you can deduct up to $17,000 in 401(k) contributions, plus another $5,000 if you’re over 50 years of age. In addition, most employers will match part of your contributions, allowing your balance to grow even faster. I recommend maxing out your 401(k) contributions as a top priority.

Self-employed people can pour in even more. A SEP-IRA, for instance, lets you contribute (and deduct) up to $50,000 a year in 2012, with minimal paperwork requirements. For a taxpayer in the top bracket, that’s an instant tax rebate of $17,500 from Uncle Sam. Virtually all discount brokers and mutual fund families offer SEPs.

My advice: Keep funneling as much as you can into any deductible retirement plan you may be eligible for, even a traditional IRA with a $5,000 annual contribution limit (plus $1,000 for folks over 50).

You might be wondering if it makes sense to convert a traditional, deductible IRA into a Roth IRA, since the Roth promises income-tax-free payouts forever, and there is no income limit for conversions in 2012. It’s tempting to say, “Yes, absolutely.” But there’s a downside. When you convert, you must pay taxes up front on the account balance.

My concern is that someday, Congress will find a sneaky, roundabout method to tax Roth IRAs, too — perhaps by counting Roth IRA income in the formula for taxing Social Security benefits or setting Medicare premiums. You don’t think the pols would dare? I’m not so sure.

Over the next 10-20 years, the U.S. Treasury will face an excruciating, unprecedented burden from the aging of the baby boomers. Promises will be broken. I would rather have a tax deduction now than a pledge of tax exemption down the road.

Principle #4: Market Savvy

Invest with an understanding of the sea changes that have occurred. We aren’t going back to the economy or financial markets of the 1982-2000 boom era anytime soon. The huge overhang of debt in the United States (and other industrialized countries) will hinder economic growth for several years at least, while pinning financial markets at higher risk levels than normal.

To adapt, you and I will need to maintain plenty of liquid reserves, even when (as now) cash equivalents and fixed income investments don’t fetch terribly attractive yields. The insurance value of cash and stability of fixed income outweigh any disadvantage from the yield.

When choosing equities, it will be imperative for us to insist on “quality bargains” — companies that not only appear cheap in terms of earnings power but also possess strong, cash-rich balance sheets. Over the past few months, I’ve rejected scores of stocks that failed to meet these criteria.

We’ll also want to sell more often. Selling allows us to raise cash, of course, which helps insulate us from market storms. But there’s an equally important reason for us to be more active on the sell side.

We’ve entered an “era of lower ceilings.” During the Reagan and Clinton years, many investors came to believe that trees really do grow to the sky. In the past few years, we learned otherwise. I’ve already picked up the selling pace in my Profitable Investing advisory service, and subscribers can expect more sell signals as the current bull market matures.

Principle #5: Things That Count

Put your time, energy and money into things that really count, such as family, friends and community. If the two market debacles of the last decade taught us anything, it should have been “the uncertainty of riches.” Your house and your brokerage account seemed worth one thing in 2007; a couple years later, the market valued them at about 30% less. And while the S&P 500 was priced a little over 600 at the bottom, in 2012, it topped 1400 — more than double.

Financial assets can fluctuate drastically. While there’s nothing wrong with seeking to improve one’s material lot, it’s a good idea not to lose sight of the importance of investing in stable and rewarding human alliances.

I’ve taken the lesson to heart. I’m still working full-bore on Profitable Investing, but I’ve cut back on some other business commitments to make more time for family, friends and charitable causes that mean a great deal to me. The New Normal, I’m determined, will still find me a wealthy man — and not just in dollars and cents.


Article printed from InvestorPlace Media, https://investorplace.com/2012/04/the-secret-to-retiring-filthy-rich/.

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