Tuesday, April 14, 2009

So, You Want To Be Wealthy?

Welcome to my new blog "So, You Want To Be Wealthy?". This blog is for people who want to learn how to build practical wealth. If building wealth was easy everyone would be financially secure and we all know that is far from the current situation. In this blog, I will not be writing about the type of wealth found on the Forbes 500 list, get rich quick real estate scams, or Wall Street's hottest stock picks. I will be writing about the type of wealth that the average person can achieve by living below their means, saving money from every pay check, and investing in low cost index funds. It does not matter if you earn a salary or are an entrepreneur. If you are interested in achieving financial freedom, planing for a financially secure retirement, or want to leave a legacy for your family, this blog will be of help to you.

The first step and maybe the hardest step to building wealth is learning to live below your means. What makes this difficult is that it is based on postponed gratification. We live in a world where marketers are bombarding us with ads that tell us we need the newest automobile, electronic gadget, or live in the right neighborhood to be happy now.

To learn how to live below your means, you need to learn to block out these false messages and focus on the long term goal of financial independence. It requires a thorough audit of your earnings and expenses to find out what expenses can be reduced and eliminated. Most people will be surprised how much money they truly waste on dinning out, cigarettes, trips to Starbucks, and many other frivolous expenses that add up to hundreds of dollars every month.

Once the habit of learning to live below your means is developed you will not want to go back to wasteful spending. For me, it was a realization that money is hard to come by and I have to work real hard to earn it, so why am I wasting it on things that are of no real value and do not make me truly happy.

Most people will find that after a few months of living below their means they will be pleasantly surprised with the extra money in their checking account. In many cases it will be hundreds of dollars every month.

So now what to do with that extra money? My first suggestion would be to pay of bad debt if it exists. I am not talking about student loans or the mortgage on ones house. However, if you have high interest credit cards, pay them off, cut them up, and don't use them anymore. Just keep one major credit card with a low interest rate for when a situation like having to book a flight arises and a credit card is needed.

Once the bad debt is eliminated, my second suggestion is to save that extra money that has become available. when the lawyer, actor, and economist Ben Stein was asked what was the secret to his wealth he suggested that "no bit of financial wizardry is more important than just putting another $500 a month in your savings account". First, save up enough to create an emergency fund to cover six months worth of living expenses in case a financial emergency occurs such as a job loss or major auto repair. After that account is established, it will be time to start working on your long term investments.

There is no greater tool for creating wealth for the average person than low cost index funds that track the major stock and bond indexes. For many people the thought of investing in the stock market gives them a feeling of anxiety due to the fear of losing money. Yes, in the short term there are ebbs and flows in the market. Over the long term, however, if building wealth is your goal the stock market is truly the best option.

A good moderate asset allocation of 40% in bonds and 60% in stocks is a good conservative allocation for most people. This allocation can be had with one simple investment The Vanguard Balanced Fund (VBINX). The benefit of a balance portfolio like the one in this fund is that it has 40% in bonds to protect your assets in times of recession when the stock markets are contracting and 60% in stocks to earn a real return that keeps ahead of inflation. In the past year the bond allocation in this fund allowed it to beat the performance of the S&P 500 by nearly 16%.

Another great feature of this fund is that it can be purchased without any sales load at Vanguard and has an expense ratio of 0.19% where the average moderate allocation fund has an expense ratio of 1.20%. So, if two funds with the same allocation earn a return of 10% per year you will receive a return of 9.81 with the Vanguard Balance Fund and only 8.80% with the average balanced fund. Over the coarse of 30 plus years the difference in one percent can eat up well over $100K of your portfolio.

The best type of account for this type of investment for most people would be a Roth or Traditional IRA. These investment vehicles allow your money to grow tax deferred. The basic difference is that the money that goes into a Roth is not tax-deductible like in the traditional ira, however, when the money is withdrawn is is tax free. Please check with your tax professional to see which one best suits your needs. More information such as who qualifies to invest in these accounts based on age and earnings can be found at this link http://en.wikipedia.org/wiki/Individual_retirement_account.

I have given you a lot of general information on laying a foundation for building financial freedom. In the my future posts I will dive into greater detail on topics I have touched on in this post. I will also write about many new topics as well as book and article reviews. Thank you for taking the time to read my first post and good luck on your quest to build wealth.

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