Building wealth is a two-part job. You need to maximize your income while minimizing your spending. You’ll read a lot these days about how the little things add up. Stop going to Starbucks every day and you’ll save $1,000 per year. Cancel Spotify and you’ll have an extra $100 to feed your retirement account.
This is all well and good. But ain’t nobody gettin’ rich by laying off the mocha lattes. The real battle for personal wealth is fought at a much higher level, where thousands – or tens of thousands of dollars are at stake when you make a decision. Think pounds, not pennies. Here are two ways to save real money, and two ways to leverage those savings.
HOW TO SAVE IT:
Buy a modest house. Your mortgage is likely your largest monthly expense. And, yes, I call it an expense, not an investment. We have long been told it is a good investment to spend what’s necessary to buy a home in great neighborhood. But as we’ve learned in the past decade, residential real estate doesn’t always appreciate as much as we might expect. What’s more, when thinking about how much we netted on a house sale, we conveniently tend to forget to deduct all the maintenance, tax and upgrade expenses that went into that “asset.”
It’s much smarter to buy a more modest home in a modest neighborhood. How modest? That depends on your income. The real estate industry says you should devote up to 33% of your monthly gross income to the mortgage. I prefer that my clients spend between 20% and 25%. Figure out where you can live on that amount of money, and stick to it. The hundreds or thousands of dollars you save on your monthly mortgage payment by not living in Ritchie Rich’s neighborhood can be invested in your retirement account. So, too, can the money you save by not living where you’ll be tempted to keep up with the Jones’ by taking up such hobbies as polo or serial plastic surgery.
Sound depressing? Doesn’t have to be. Know who lives in a modest house in an average neighborhood? Billionaire Warren Buffett.
Stop buying cars. From a financial standpoint, cars are a necessary evil. It costs $8,876 per year on average to own and operate a car, according to AAA. There are two ways to minimize that hit. Buy quality used cars (I love CarMax) and keep your vehicles longer. You can save about $250,000 over your lifetime by owning your cars 10 years instead of five, according to Money magazine.
HOW TO INVEST IT:
Get a Health Savings Account. An HSA allows you to stash money to pay for out-of- pocket medical expenses. It’s sorta like a 401k in that the money you contribute is tax deductible, it grows tax-deferred, and funds withdrawn to pay medical costs are not taxed. And get this: your contribution to an HSA can be invested in stocks and bonds.
So, let’s say you contribute $5,000 to your HSA and use just $1,000 to cover doctor bills. The remaining $4,000 can continue growing in the account until… whenever. This can be a great way to continue saving tax-deferred once you have maxed out your 401k contribution.
Fund a Roth IRA. The Roth is an under-appreciated way to increase your cash flow in retirement. With a Roth IRA, you are taxed on contributions in the year they are made. Withdraws during retirement are then tax-free. And, because, there are no minimum withdraw requirements, you can leave your nest egg to grow until you need it – or bequeath it to an heir. The Roth is a good choice for younger workers who are currently paying a tax rate lower than what they will pay in retirement.
If you’re an aggressive saver, I recommend you first fund your 401k up to the employer match, then fill up a Roth IRA and finally, max out your 401k.
Don’t think you’ll ever have that kind of money to invest? Choosing wisely when buying things like houses and cars will get you a lot closer to that goal.