3 steps to achieve financial success

I believe that most Americans can achieve financial success. I am living proof that it's possible. Granted, I have a well paying job, but I don't make an obscene income. Besides, I know plenty of people in my income range that have little to show for their years of working. And I think that even if my income was more modest, I would still be well on my way to financial independence; I just wouldn't have accumulated as much.

Here are the three steps that I feel are necessary to achieve financial success:

1. Live below your means. I realized that to make money, I needed capital, and to generate it I had two options: reduce my expenses or increase my income. I increased my income by gaining valuable work skills and hopping jobs, but that may not always be possible depending on the stage of your career. I also kept my overhead low, and that is something that everyone can do.

For one thing, I never tried to keep up with the Joneses. I knew from reading "The Millionaire Next Door" that self-made millionaires lead pretty modest lives, and people who flaunt extravagant lifestyles are financing those lifestyles at enormous opportunity cost. I kept my focus on becoming debt free and saving for early retirement.

I differentiated my needs from my wants, and carefully evaluated each expense that fell into the "wants" category. If it didn't match my priorities, then I opted to forgo it or found cheaper alternatives. That meant no luxuries like designer clothing, Starbucks, BMWs, concerts, etc., but I really didn't care about those things anyway. That doesn't mean I always deprived myself, I just made sure that any money spent on non-necessities was used to buy things that brought real, lasting happiness. I bargain shopped to find the best deals, and I made sure that I could pay off the credit card bills when they arrived. I also understood the eroding effect of taxes on my money: the combined impact of income tax and sales tax meant that only about half of every dollar I earned was available for me to use, so I spent them very sparingly.

2. Save. I knew my ability to work was finite, and I wanted to have the option of not having to work as soon as possible, so I treated my earnings like lottery winnings. I socked away the max into my 401(k) plan immediately upon starting my first job, and continued to do so as I changed jobs (and never cashed out). I figured I wouldn't miss 15% of my salary, and even if I did I could always scale it back. I survived just fine though, and because I kept my expenses low, I was able to save a significant portion of my take home pay and use it to pay off my first house early. I also started a ROTH IRA as soon as I was eligible, and maxed it out every year.

3. Invest.I learned about the amazing power of compounding, and the risk of inflation. Because I started early and had a long time horizon, I was able to invest aggressively. So far it has worked out pretty well for me.

There you have it, the three key steps to building wealth. These aren't new ideas, and it takes time and patience to see the results, but as someone who has done it I can confirm that they will work for you--unlike most get rich quick schemes. I think the most difficult part is the first step, where you have to make the paradigm shift from instant gratification to delayed gratification. Think of robbing your future self when you spend your money in the present, and perhaps that will help you resist the temptation to buy stuff you don't really need.

So if you want to do something to get started on the road to wealth, here is a simple action you can take now: log into your employer's 401(k) plan, and bump up your contribution amount. Remember, if you find that you can't live without the reduction in take home pay, you can always change it back, but I'm betting that you'll learn to live without it, and you'll be thanking yourself later.

Those Black Friday deals

Well, another Black Friday has come and gone. I'm sure there were some good deals for people who needed them, and were willing to fight the crowds. However, if you didn't need the items, then they probably weren't a good deal. For one thing, things like consumer electronics tend to get better and cheaper over time, so what seems like a good deal today probably won't seem that way a few months from now. Secondly, if you watched the Oprah show on hoarders, you know that keeping stuff has associated costs: making space for it, keeping track of it, and opportunity cost.

Although I enjoy a good deal as anyone else (and I do bargain shop when I need something), I value my time too much to spend it waiting in line battling the elements (it was interesting to drive around and see all the people who were willing to do that, however). Instead, I spent my Thanksgiving evening with family, followed up with an enjoyable experience at the movies.

Enjoy the rest of the holiday weekend, and as you browse through the ads, think about whether you own your stuff, or your stuff owns you.

On the subject of frugality

I've been thinking a lot about the topic of frugality lately, and just read a good writeup on it at The Simple Dollar (via Get Rich Slowly). I also like the Wikipedia entry for frugality, which is as follows:

"Frugality (also known as thrift or thriftiness), often confused with cheapness or miserliness, is a traditional value, life style, or belief system, in which individuals practice both restraint in the acquiring of and resourceful use of economic goods and services in order to achieve lasting and more fulfilling goals. In a money-based economy, frugality emphasizes economical use of money in meeting long term personal, familial, and communal desires.

Might also mean economical or avoiding waste."

To me, being frugal is about prioritizing my (limited) resources to focus on things that are most important to me, and bring me true happiness. It isn't about deprivation, neglecting wants, or being stingy for the sake of accumulating money above all else. It is about maximizing the returns on my hard earned money so that I get the most value (taking into consideration quality and price) in accordance with my priorities.

While I consider myself to be frugal, other people may not view me in the same light because their priorities are different than mine. For example, my house is much bigger than I need, and not representative of the typical Millionaire Next Door at all. "Your Money or Your Life" describes the concept of having "enough", and a smaller, more modest home would certainly meet my needs.

Am I being wasteful by having a larger residence than I need? Perhaps, since my utility bills are bigger than a smaller place would generate, and my land usage is more than I require. I struggle with this dilemma sometimes, but in the end I realize that life would be pretty dull if we only satisfied our needs. I truly enjoy my home, and the fact that it's an appreciating asset is icing on the cake. I could downsize and live completely debt free, but I've done that before and buying stocks just isn't as satisfying to me as building home equity.

On the other hand, I'm very economical in other areas. For example, I don't buy designer clothing as I don't care about brand names. I don't drive a luxury car, or carry a ton of gadgets. I recycle as much as I can to reduce my impact to the environment. I don't smoke or drink alcohol/soda/coffee, and while that's primarily health driven, I also consider them a waste of money because I derive no pleasure from those substances. I brown bag my lunch to work every day (I do spend quite a bit amount of money on organic foods, so while I may not be saving money in the short term, it is cheaper than eating out in the long run if you consider the health benefits).

So frugality is a matter of perspective, and I try not to judge others based on what they choose to spend their money on as long as they're getting true enjoyment out of it. However, if they fail to live below their means, then I would not consider them to be frugal. Achieving wealth requires that you spend less than you earn, and invest the excess. Being frugal can help you accomplish that by eliminating wasteful spending on stuff which doesn't bring you happiness, leaving you with more to invest.

To summarize, my acid test for frugality is:

1. Does it bring you true, long term happiness?
2. Does it prevent you from meeting your financial goals?

If you answer 1) yes and 2) no to those questions, then you've passed the frugality test.