The Core Issue of Financial Success (or lack thereof)

The most common phrases I hear when chatting with people about my firm and what I do for a living is some variation of the following...

"Sorry Jeff.  I don't have any wealth for you to manage!"

“Financial planning, huh. Do you help people with budgeting? I hate budgeting. I don’t even want to talk about budgeting.”

I get it.  The traditional power behind the term wealth suggests that it is reserved for only the elite and those with money coming out of their ears - the true 1%. And budgeting might as well be a four letter word to most people.

The terms go hand and hand. I define wealth as any money that you don’t spend or asset you own outright (including the equity in your home). You acquire wealth by becoming a good steward of your money, meaning you spend far less than you earn, and the money you don’t spend is saved and invested prudently. That’s it, super simple. The core issue of financial success really comes down to how much money you earn versus how much money you spend…in other words, how good you are at BUDGETING.

The great Nick Maggiulli from Of Dollars and Data had an epic tweetstorm last year and detailed some very uncomfortable truths about wealth, and I think it’s time to revisit those here.  I unrolled the thread and you can read it at your leisure in a conveniently condensed format in one page.

We in the wealth management and financial advice industry spend a lot of our time pounding the table for people to SAVE MORE MONEY, and often times we extrapolate the best way to do that is to spend less money.

You'll see articles all the time discussing silly things like The Latte Factor and how we can become rich by investing our $4 we spend on a latte in the stock market instead and letting it compound for 40 years.  

There are a ton of variations of these types of ideas and many a blog has sprouted up on the virtues of spending less money in favor of a frugal life style.  It's quaint, but it's not reality -- it causes enormous stress and strain to constantly cut your spending. The math works and I understand what they're getting at, but I think these things go overboard and often overlook the fact that some of us want to enjoy our lives a little bit while we're living it.

Nick points out that one of the most powerful things you can do for your own personal financial situation is to increase your income as opposed to decrease your spending.

"To start, raising your income is far more important than cutting your spending when growing your wealth. Spending definitely matters, but without sufficient income it is far too difficult to succeed. Just look at the lowest 20% of income earners. They spend MORE than what they earn for BASIC NECESSITIES. While there are low-income individuals that become millionaires through very low spending, they are the exception, not the rule." ~Nick Maggiulli

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In summary, housing and transportation are eating up more than 100% of the after-tax income for the folks that are the lowest wage earners in our country.  They don't have money left for food or healthcare. 

Compare that graph to one that shows the top 20% of wage earners and you get a nice visual about what it takes to have a little money left over in your budget to actually save some of it.

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So let's assume you're one of the lucky ones that have enough money left over every month to take advantage of your company's 401k plan (hopefully to the point where you can at least get the company match) or to simply stash in away in a savings account. Surely all you have to do at that point is sit back and watch your money grow until you retire, right?

Unfortunately, luck plays a huge role in our investing success, as well.

"Once you have a high income you can start to save and invest, but your investment results will be heavily influenced by luck. Consider this: from 1980-2005 the S&P 500 compounded at ~9.2% a year (post inflation + div). Even if you underperformed by 2% a year, YOU KILLED IT. That’s right. Even those that are objectively bad at investing (underperforming by 2% annually) would have seen their money grow 5.5x over those 25 years. But, start one decade earlier (1970) and the market only compounded at 5% annually for the next 25 years. This means that OUTPERFORMING the market by 2% a year from 1970-1995 made you LESS MONEY than UNDERPERFORMING the market by 2% a year from 1980-2005. The gods always have the last laugh." ~Nick Maggiulli

Let that sink in for a minute. When you start investing has a huge impact on the performance of your investments, and we aren't lucky enough to know in advance what the next 25 years will look like.

What Can You Control?

So, what's the point here, Jeff?

The point is that in life, as always, there are things that we can control and things that we can't.

We CAN control how much we spend.  We CAN control investing in ourselves and our education to try and get that promotion or a better job to increase our incomes.  We CAN decide to take control of our finances today and get some help. We CAN become more aware of what we spend our money on and how much we spend.

We CAN'T control the market.  No matter how much we think we might need or deserve a 10% return on our investments for the next 25 years, the market doesn't care, and we CAN'T control the tax code or the economy.

But we CAN decide to start saving now and we CAN control how much we want to save. Our savings rate is much more indicative of financial success then our investment returns.

The word "retirement" causes a lot of different reactions for people. Some recoil at the thought of the traditional idea of retirement. I prefer to discuss financial independence. There will come a day in the future where having enough money set aside for financial independence will mean a lot to you and your family.

So consider these numbers. Your savings today (or your wealth) will some day become your source of income. The 4% Rule is not necessarily the panacea for retirement income planning, but it's effective for some back-of-the-napkin math.

If you have $1,000,000 saved when you turn 65, using the 4% rule for what is considered a "safe" withdrawal rate means you can pull $40,000 a year off of those savings to live on.  Add in some Social Security, and you’re looking at $60,000 to $70,000 per year of income for your financial independence.

If you have $500,000 saved at 65, your number is reduced to $20,000 per year plus your social security.

Getting to those various levels of wealth in the future is going to take some good budgeting today.

My challenge to you - start using any of the available budgeting tools to track your spending this month, and do only that.

Here are some suggestions of great tools you can use to start tracking and observing your spending (some are free, some cost money, so be sure to check):

Mint.com

YNAB (You Need a Budget)

Tiller

EveryDollar

Microsoft Excel or Google Sheets - just download the file from your online banking portal

Once you get going, get into a routine of checking your spending and categorizing each transaction at least every other day, but every day is better. After a month, go back and look at where your money went.

What surprised you? What didn’t surprise you? And that’s it.

Don’t go overboard and try to cut everything out of your life… simply observe if you spend money on things you like and care about or if you waste your money on things that don’t matter. After you do this for 3 months, you will start to see patterns and your brain will begin to adjust accordingly.

After working with clients, friends, and family on this part of the financial planning process for several years, it never ceases to amaze me. Households almost universally underestimate how much money they spend every year and every month. Being aware of what you’re doing with your money is the first step in becoming financially independent and the core issue of your financial success.

Let me know how it goes.

Go be great this week, consider what financial independence looks like for you, and be kind to someone who needs it most.