Cumulative Approach Rather than Spartan Approach
What does it take to be a millionaire? It really is not difficult to accomplish that financial goal. All it requires is a combination of skill, luck, and discipline. How each of these attributes are allocated varies depending on who you are and what your circumstance may be.
One important rule of thumb is to develop and follow a sustainable strategy. Momentum is the name of the game. The closer you get to accomplishing any goal, the easier it seems. It may sound like a cliché but focusing on the long term is the best approach.
Standard of Living
The key to living the good life is to avoid putting off the good life. This does not mean live beyond your means or “fake it until you make it”. This simply means decide an acceptable lifestyle that you can either maintain right now or one that you can work towards achieving within 18 months. This is important because it is the first step to budgeting. Below is a good starting point for goal development on your path to becoming a millionaire or maintaining an affluent lifestyle you may be enjoying right now.
- Savings: 10%-20% of your income.
- Emergency Fund: 6 months’ worth of nondiscretionary expenses (rent; car; utilities, etc.)
- Debt Ratios:
- Consumer Debt Ratio 20% (credit cards/financed purchases)
- Debt to Income Ratio 36%
- Total Housing Costs Ratio 28% (rent/mortgage; insurance; HOA, etc.)
The numbers above area good starting point for financial planning. Make no mistake about it, living the good life permanently without a plan is simply a dream rather than a goal!
Protect Tomorrow/Always Move Forward Financially
Once you have accomplished the goals listed in the table above, it will be time to review your budget to see if any adjustments are needed. Maybe you will find yourself in a position to give yourself a small reward. Remember the key here is sustainable financial habits. It is foolish to live like a pauper in your youth with hopes of being ultra-wealthy in retirement. You are earning every bit of what you receive, and you should enjoy your youth. Just do not enjoy it at the expense of your future.
You should always aim to earn between 60% - 80% of your current income during retirement. This number should change every year. Your annual income is more than likely a fluid figure, meaning this goal is constantly changing. Depending on the performance of your investments and other savings strategies, you will often find yourself either ahead or behind your goals. Therefore, annual reviews are so important.
Accountability Partner
An accountability partner is an often-overlooked aspect of financial planning. The accountability partner does not necessarily have to be an actual person. It is simply an added layer of protection from spending against your goals. An example of an accountability partner can be a block of ice that you freeze your emergency money or credit card in. it can also be certain types of accounts such as qualified retirement accounts like a 401(k). An accountability partner can also be a real estate investment or a partnership. A financial advisor is another form of an accountability partner.
Certain factors should be considered when deciding which accountability partner would be best for you. These factors include investment personality, risk tolerance, time horizon, and investable assets, among others.
Financial Efficiency
After you have laid the financial foundation of your path to living the good life permanently and decided which form of accountability partner you will employ in your wealth management journey, the next phase is incorporating financial efficiency into your strategy.
Proactive Approach to Finance (Tax Planning & Emergency Cash Reserves)
In finance it is always prudent to look ahead. A proactive approach to financial management is to make it a point to be ready for those inevitable “rainy days”. Things to be considered while proactively managing your finances are tax benefits and/or consequences. You should always consider where you are in your financial lifecycle. Do you expect to be in a higher income bracket in your retirement years or do you expect to be in a lower bracket? Your answer to this question can help determine whether a Roth or Traditional investment vehicle is best for you.
You never want to be at the mercy of the financial markets. Therefore, having sufficient emergency cash reserves is essential. It would be a shame to put in the work and exercise the discipline to get you on the path to living the good life permanently only to take a step back to something outside of your control. In financial planning, it is always best to plan for the best and prepare for the worst while reducing risk.
Home Ownership
Buying a home is often an investors first significant investment. It is advisable to identify a desired short-term and long-term effect of this purchase. Some of the questions to be asked are:
- Is this a starter home?
- How long do I plan on living in this house?
- Do I expect to still be paying a mortgage during retirement?
- When I move on, do I plan on selling this house or renting it out?
- How much should my down payment be?
There are many factors that go into home ownership. One thing is for certain. It is an investment no matter how you look at it and it should be treated as such. You can conservatively put yourself on the path to being a millionaire by properly managing home ownership.
Never base your decision on how much to pay for a new home on how much mortgage you qualify for. Always consider how it will affect your long-term goals. Some banks will approve you with a debt-to-income ratio as high as 43%, but you should base your purchase price on these ratios.
- Savings: 10%-20% of your income.
- Emergency Fund: 6 months’ worth of nondiscretionary expenses (rent; car; utilities, etc.)
- Debt Ratios:
- Consumer Debt Ratio 20% (credit cards/financed purchases)
- Debt to Income Ratio 36%
- Total Housing Costs Ratio 28% (rent/mortgage; insurance; HOA, etc.)