Monday, January 28, 2008

So You Want To Be a Millionaire

Many times I am approached by people who have recently graduated from college who want to know how they can become a millionaire. Many chatter about some far-fetched scheme to strike it rich by the time they are thirty and retire to some lush tropical paradise.

The stark reality for many of these recent graduates is glummer; there is no ‘easy money’. Very few of these individuals will become executive VPs by age 25 or agents for Hollywood movie stars. Most college graduates will labor in companies in professional positions starting in the $40K to $60K range, and can only look forward to 40 more years of being a cube rat in their selected career path.

The good news; you can still easily become a millionaire while laboring in a standard job in corporate America. It simply requires some financial common sense. Most of the millionaires in America are not famous superstars but the older person laboring away in the cube just down the hallway.

The majority of millionaires in America achieved this goal by simply sticking to a few basic financial rules after they graduated.

Scratch the fancy car when you graduate

One of the most critical mistakes that many graduates make is rushing out to purchase a fancy $30K plus car immediately after they graduate. This normally sticks the new graduate with a $600 per month or greater car payment. Sure the car may look hot outside the bar on a Friday night, however you probably have wreaked havoc on your financial future the day you signed the lien papers. Purchasing an expensive car with a sizable loan or lease payment greatly reduces the income available that can be saved; while sticking the owner in an asset that drops in value each month.

When you graduate from college you should focus on purchasing a good used car or low-cost new car. The key is to keep the size of your loan and monthly payment to a minimum. The loan is useful from the perspective of building a credit history, but you don’t want the payments to gobble up the majority of your monthly take home.

If you are able to keep using a car that faithfully took you through your college years while enduring all the tailgating, then you should strongly consider of sticking with this fine automobile. Not only for the enduring memories it carries, but because it makes financial sense. As long as you are not spending a huge amount on repairs each month to keep the old jalopy running, then sticking with the old car after college many times is an excellent decision for you financial future.

Fully fund your 401K

At minimum always fund your 401K plan to get the full company match. The company match is free money. It is better to fund it up to the 401K limit ($15,500 in 2007), but understandably this is not possible for many graduates. However they should always attempt to save at least 10% of their salary in their corporate 401K plan. Going beyond 10% is a great bonus.

It is important that you probably diversify your 401K investments within the funds offered by the corporate plan to align with your age and risk tolerance. An earlier article discusses proper 401K diversification in detail.

Portfolio Diversification – 401K

Save 10% more

Outside of your 401K; you should put away an additional 10% of your monthly salary. It is best to place this money in an IRA if appropriate for long term tax-free savings, or put it in a taxable fund destined for the down payment on your first house. Have an investment plan based on the long-term and short-term objectives. Do not put the money into risky investments, but focus on a diversified portfolio that aligns with your time frame. For example, if you are considering the purchase of a house shortly then if makes sense to leave the down payment in an interest-bearing cash account.

It is important that you also drive to create a rainy day emergency fund. Over time you should drive to put six months of pay in this “rainy day” account. It can be used in crisis situations such as medical bills, auto collision repairs, and to cover expenses in case of job loss. Remember that you live in the age of corporate re-structuring; it is very likely that you will experience being dumped on the street with less then one month’s severance pay before you are thirty years old. Since 1999, over 70% of professional Americans under the age of 30 have been “re-structured” according to one survey.

Buy a home

If you plan to stay in a particular geographic area and want to settle down there, then you should work towards purchasing a house, townhouse, or condo. You should only purchase a home if you qualify for the loan under traditional lending standards with a 30 year fixed rate loan. Do not over-stretch yourself with interest-only and other exotic home loans. We are currently watching the foreclosure drama in America of what happens to a million plus households who over-extended themselves with adjustable rate loans. If you can not afford a home with a traditional loan then you must continue saving or find a place that is more affordable.

Homeownership provides some good tax breaks and allows you to build equity over time, even with all the cycles the housing market experiences. Money spent on rent is basically lost and does not build your financial future – a home you own acts as a leveraged asset that allows you to build equity over time.

The following calculator demonstrates the long-term financial advantages of owning over renting.

Should I Rent or Buy A Home?

Don’t purchase all that junk brand new

So now that you have a nice house or apartment, there is no need to run out and purchase every single item imaginable at the local stores to fill every corner. Why buy that dining room set for $5000 brand new on store credit when the people with the garage sale next door are selling a better quality used set for a mere $300? You should be willing to purchase items used or online in order to get great discounts off of the retail prices in local stores, or wait until desired items go on sale.

In our consumer driven nation, the money that you will save over time by buying products at a discount adds up quickly towards your bottom line. Always take the smart path in regards to purchasing stuff. First ask yourself if your really need it. If yes, then use common sense in obtaining major items and don’t buy on impulse in the store. Usually you will land up with just as nice stuff in your home as the guy next door who purchased everything at a premium, but unlike the neighbor you won’t be burdened with $50K in credit card debt.

No credit card debt - EVER!

Don’t ever run up debt on credit cards that you can not pay off at the end of the month. Repeat over and over again until this becomes mantra. There is not reason to ever run up a credit card bill with frivolous purchases that you can not pay off at the end of the month. If you can not afford it then don’t buy it. This applies to luxury items, electronics, exotic vacations, and all other purchases. Once again, if you can not afford it then don’t buy it.

This general rule of debt not only applies to credit card debt but all other similar debt such as personal loans, unsecured loans, boat loans, car loans, and unaffordable store credit situations. From a general fiscal perspective, the only things that you should take out loans for are home mortgages and money for starting a business. These are items that hopefully appreciate over time.

The sole possible exception to this hard rule should be medical emergency bills. However you should always try to work out a payment plan with a hospital or medical office rather then putting these charges on your credit card.

Pay off student loans

After you graduate if is probably too late to provide advice about obtaining the most affordable student loans, and as many grants and scholarships as possible. It is preferable to walk out of college with little to no debt; however this is not realistic for many students.

What can a graduate do about that mound of college debt that they have to start making payments on? One is to consider consolidating multiple student loans within six months of graduating in order to minimize your monthly payment. There are multiple resources on the web that discuss this. One good resource is the U.S. Department of Education which provides some good information about paying student loans.

Many students walk out of college with sizable debt. Students should take steps if possible to reduce interest rates on the debt and minimize their monthly payment. I would also urge graduates to consider accelerating the repayment of their student loan debt, especially high interest rate loans, if this is possible within their monthly budget.

Avoid car loans

It is usually difficult to get your first car out of college without a loan. However after your first car you should never take out a loan for an automobile. Cars are depreciating assets, they lose value the minute your drive off the dealership parking lot. It usually makes more sense to purchase good used cars with cash then buying brand new cars with lofty premiums.

My family drives Mercedes. Why did I select these high end expensive cars – it does not sound very frugal? The immediate answer is because they are safe, as a recent accident which totaled one of the cars demonstrated. The good news - everyone walked out of the car without any serious injuries. Many of my neighbors think these cars in our driveway are new because they are kept in great shape. None were purchased new and I drove my last diesel till it had over 220K miles then sold it to our neighbor for his son to use. The key point here is that you can enjoy all the benefits of luxury cars without going into debt paying for them, if you simply apply some basic financial common sense.

Use common sense in your lifestyle – the 80% rule

Use only 80% of your take home pay and save the rest! Most people can cover their housing and food expenses while still enjoying a lifestyle that includes dining, clubbing, and vacations while saving 20% of their pay. Live within your means. Don’t make huge frivolous purchases; that new 62 inch plasma TV may look neat but it sure is going to cause a hit to the budget before the Super Bowl party.

Effectively “living below your means” will allow you to put aside money for investing that will fuel your long term financial success. The good news is that it is not necessary to live like a miser and worry about every penny in order to do this. When I first got out of school and was socking away twenty percent of my cash, I was not overly concerned what my tab at the bar was over the weekend, it came out of the ‘80%’ dedicated to monthly living expenses.

This concept of saving 20% of your take home pay aligns with the idea of saving 10% of gross pay beyond your corporate 401K contribution when taxes are taken into consideration. However, the key concept to take-away is that for long term financial success you should live at 80% or below of your monthly take-home pay, and avoid large frivolous purchases.

Don’t ever use HELOC or other home loans as an ATM machine

We have recently watched a good number of homeowners in America using their homes as ATM machines while housing prices have risen quickly over the past few years. They used the increasing equity in their homes to purchases cars, boats, planes, and other costly luxury items. Now that home prices are dropping and the lending spigot has been cut off, the birds are coming home to roost. Many of these homeowners are stuck with loans that are worth more then the values of their houses, and are under stress to make the payments.

Homeowners should only use cash from HELOCs and other home loans to improve your house. This was the original intent of these types of loans. The concept was to build additions or re-modeling to your home that would add value, thereby maintaining your overall equity in your home.

For first time home buyers, HELOC and similar loans make common sense when they are used for the correct purposes.

Choose a partner with your values

Thinking of getting married? Some quick advice --- Be sure that your significant other is aligned with your values regarding money. I would urge couples to fully talk about finances before they tie the knot and define a plan of how to handle everything.

A good portion of the divorces in America are due to arguments over money. The average middle-class divorce now costs $187,000 when all factors are taken into consideration. This type of financial hit is nearly impossible to recover from when you are saving towards a long term objective.

Do these Principles work?

On a personal note, I can attest that following the principles listed above will enable people reach their goal of having a large net worth. Many of the concepts are not only applicable to those who just recently graduated from school but for people of any age. I am 43 and our family has a high net worth. Most of the money is in 401K plans, housing equity, and college money reserved for the kids. All saved while being a single-income family for the past 17 years. My wife had the really difficult job of focusing full time on our children and I would like to thank her for that very publicly; she has done a tremendous job! I got to escape to a cube each day doing software development.

I don’t feel ‘rich’ in the traditional monetary sense. I have three kids to put through college soon and am currently involved in founding a start-up with no revenue yet. Our family drives used cars, only has mortgage debt, and uses common sense in our spending. It is not as if we are misers, our family still enjoys nice cruises as vacations and goes on road trips around our region. Most people would not look at our family and think ‘they are rich’; I don’t have a leased $80,000 sports car in my driveway, nor can I brag about all the things I purchased with $120,000 worth of credit card debt. I expect most of the millionaires in America are like us; not ostentatious, but somewhat frugal and hard-working while living in middle-class neighborhoods.

I am probably more worried about money now then earlier in my life. I don’t really feel “wealthy” or financially comfortable despite being considered high net worth. My financial situation seems like a ‘bigger problem’ now then when I was only 22. This is because I currently have the responsibility of providing for an entire family and in those early post-college days I was more concerned about which night club to go to on Saturday.

While the concept of becoming a millionaire slowly over time may not sound immediately exciting; it is the sure path to achieving this goal. The further good news is that is does not require tremendous personal sacrifice or the scaling back of your entire life to reach this objective – just follow the guidelines listed above and in time you will join the many households with over a million dollars in net worth.

What is “Rich”

It is important not to have stress over monetary issues spill over into relationships and your perspectives on life. In many ways, being ‘rich’ is not about how much money you have in the bank, but being involved with your community, family, and friends.

One of the things I have always promoted is "Giving back to the Community". In many ways this is one of the cornerstones of our family philosophy. Our family is active in local schools, non-profit boards, and other volunteer activities. Whether you are helping in a school, coaching a youth team, building a home with Habitat, running to raise money for the Food Bank, or any other activity; I would urge everyone to get out and get involved. It does not matter what age you are. Many of the best volunteers in our local youth sports, education initiatives, and athletic events for charity are recent college graduates!

Some of my most personally rewarding experiences occurred when I was involved in volunteer efforts. These are the days I look back at and say "Wow, that was great. I made a difference."

Invest in your community - many times it will bring more meaningful returns then your portfolio. Common sense in spending starting right out of college can make you a millionaire, being ‘rich’ however involves much more then money.


More U.S. millionaires are middle-class


reneena davidson said...

Totally agree with all your tips, Bottom line is to avoid debt or any loans as possible and start small. Better start from down under coz when you're on top already, there's no other way to go anymore besides downhill.