The Top Habits of Wealth Builders
/Happy New Year! January 1 is the day many of us go about jotting down New Year’s resolutions designed to help us improve ourselves and our lives. Popular themes include getting in shape, eating healthier, and improving relationships. All great options! Here’s another I recommend: developing good money habits that improve your financial situation.
After serving more than 90 families and writing financial plans for hundreds of clients, I’ve had a front row seat to all kinds of interesting money behaviors. If I had to boil it down to the two things my multi-million dollar clients do that set them apart from others, it would be the following:
· Spend way less than they earn, even when they don’t have to
· Invest as much as they can in stocks
Most everything else that people worry about, like which stocks to pick, when to get in and out of the market, whether or not to clip coupons, or what the tax laws are going to be in five years, prove to be rather insignificant in the grand scheme of wealth building.
As you think about your own money behaviors, here are five important habits to consider if you want to grow your wealth in 2021.
Spend Less Than You Earn
Let’s start with maximizing your savings by minimizing spending. Data tells us that the average U.S. citizen generally directs about two-thirds of after-tax income to four main areas: housing, cars, food, and health insurance/costs.1
If you can get these four things right while collecting a modest income, you will put yourself on a path to major wealth. After all, it’s never too late — or too early — to develop smart money habits.
As a case in point, I recently worked with some of my ten-year-old daughter’s friends on a game called the “Life Budgeting Project.” The winner of the game was the person who saved the most. In a matter of minutes, most of the girls went from living alone in a three-bedroom house and working in low-earning careers to commuting by public transport and choosing to become managers. In fact, the winner originally selected artist as her profession and then opted for CEO. Second place went from buying brand-name cars, clothes and cell phones to renting an apartment with two housemates and taking her food to work.
Of course, playing a game on paper is a lot different than real life. But if you learn to establish good habits with housing, auto, food and health, it can transform your ability to save.
Housing
While thinking about how to minimize housing costs, I was reminded of Thomas J. Stanley’s book, The Millionaire Next Door. Throughout its pages, Stanley covers many habits of the wealthy. The main idea of the book is that people who “look the wealthiest” rarely are.
When you consider housing, Stanley emphasizes the following: choose neighborhoods with tall trees and stay there for at least 20 years.
For those intent on buying a home, Stanley offers these guidelines: “The market value of the home you purchase should be less than three times your household's total annual realized income…and most millionaires rarely have a mortgage more than two times their income.” 2
I admire Stanley for his observations, and I would go even further to emphasize that there is no weakness in having roommates, buying a “starter home,” or retiring into a smaller residence. For sure, there may be years as a parent where choosing a neighborhood with great schools or a home with a large yard take priority. Outside of the child-rearing years, however, consider right-sizing to that which is a better fit for your priorities.
By the way, the cost of living in places like California and New York would probably not fit Stanley’s model. Yet there are still ways for you to manage your housing costs if you reside in these states. For example, you can compromise on house size or proximity to desirable communities to get started in the higher end housing markets. In addition, you might consider building and/or renting a backyard studio or portion of land.
While housing costs are certainly higher in prime states, you may find that other costs are lower, like heating, cooling, maintenance, a one-season wardrobe and property taxes.
Cars
With cars, Stanley emphasizes buying over leasing, driving the same car for at least 10 years, and choosing cars for reliability. He also says that the typical millionaire buys cars made by Toyota® or Honda®, rarely leases, and typically opts for used. Interestingly, he cites that 67% of BMW owners are not millionaires.
Food
As far as food budgeting goes, you can take simple steps to keep a lid on expenses. Across households, I’m shocked when people with minimal savings buy most of their groceries from expensive grocers like Whole Foods®. On the other hand, those with abundant savings are content with stores like Ralphs® and Sprouts®. Could food budget control really be that simple? Absolutely!
Another strategy is to minimize eating out. While working with one individual on reducing his sizeable debt, I noticed that he was eating out multiple times per day. This daily habit was routinely driving up his expenses.
When it comes to food, eating in and shopping at traditional, no-frills grocery stores are key to reducing your spending and boosting your savings.
Health
High insurance premiums and unexpected health care costs can take a big bite out of any budget. By far the most effective lifetime strategy for keeping health costs low is to strive for good health. It’s important to get daily exercise, including strength training, and to eat plenty of veggies and fruits, especially as we age.
As far as health insurance, the costs have increased significantly over the years. To avoid overspending, follow these tips:
· Obtain insurance through an employer, if possible, for lower health costs
· Consider the Affordable Care Act options for lower income households (Important to note that the current act does not consider a household’s assets in the subsidy calculation)
· Put aside funds in a Health Savings Account (HSA) to take advantage of tax deductions, which can offset healthcare costs
· Embrace T.G.I.M. – Thank God for Medicare – if you’re 65 or older and in good shape, a healthy individual can expect lower costs
Investing in stocks
After developing strong savings habits by following the four strategies above, the next step is to put your money to work in diversified stocks.
Jeremy Siegel, a finance professor at the Wharton School of Business, is a proponent of this strategy. In his book, Stocks for the Long Run, he shines a light on the fact that, during most time periods, stocks have beaten other publicly traded investments like bonds, commodities and real estate investment trusts.
He specifically provides key data on annual “real” (after inflation) returns going back further in history than anyone has published before. From 1871–2001, for example, U.S. stocks averaged 6.8% real return, compared to bonds at 2.8% real return. Gold averaged a paltry -0.1% real return. In his book published in 1994, Siegel projected that stock returns in the future would be somewhat lower for at least a couple of decades, but they would still surpass bonds.
It’s important to note one period of abnormal underperformance in Siegel’s book: From 1966–1981, gold beat stocks due to very high inflation. In addition, Treasury bills beat stocks over this same period. Under typical inflation circumstances, however, stocks remain high performers.
So why not just throw in the towel, and put all your money in stocks?
For one, there can be a lengthy period of time where stocks run negative. From 2000–2010, for instance, the S&P 500 returned a -1% average annual return.
To offset these negative periods, sensible investors balance their goals of allocating strongly to stocks with the importance of holding enough in bonds and cash to cover their cashflow needs over a five to 10-year bleak stock performance period. The exact percentage to hold in these more conservative funds is very specific to your cash flow needs in the near term and your risk tolerance.
Of course, your ability to withstand a bear market crash like this past spring is also extremely relevant. Not everyone has the courage to stay the course during the volatility that will most definitely occur. There’s a reason typical retirees hold 40–50% of their savings in bonds.
Siegel’s book also faced a great deal of criticism from reputable economists like Yale’s Robert Shiller. He warned that 20 to 30-year holding periods were not necessarily risk free, and that purchasing stocks at a high price-to-earnings ratio could yield poor returns. Of course, putting your money into stocks all at one time can be minimized by dollar cost averaging. This tends to apply to most individuals who are steadily saving.
While there is no guarantee that stocks will offer superior returns to other investments, especially in the short term, there are compelling reasons why stock return will likely persist. The building blocks of stock market return continue to be dividend yield (currently averaging 1.8% across the S&P 5003) and corporate earning’s growth. The latter results from many factors, including population growth, inflation, innovation and household wealth expansion. Not just in the U.S., but globally as well. Also, we can’t forget that the extremely low interest rates of our times offer few other options.
As you head into 2021, keep your money management habits in mind. Perhaps this is the year to amplify core wealth-building practices. There are so many possible behaviors to consider, and I encourage you to keep it simple by answering two questions:
· Are you maximizing your savings with smart housing, car, food and health choices?
· Are you putting each and every one of your spare dollars to work with emphasis on allocating to stocks?
If you can answer “yes” to both of these, then 2021 may be the year you stick to your New Year’s resolutions and start building your wealth significantly.
All trademarks are the property of their respective owners.
References
1. U.S. Bureau of Labor Statistics. (Sep. 9, 2020.) “Consumer Expenditures – 2019.” U.S. Bureau of Labor Statistics. Retrieved from https://www.bls.gov/news.release/cesan.nr0.htm.
2. Stanley, Thomas. (Dec. 8, 2009.) “$1 Million: Something or Nothing (Part 1).” Thomas J. Stanley blog. Retrieved from http://www.thomasjstanley.com/2009/12/1-million-something-or-nothing-part-i/.
3. J.P. Morgan Chase. (Sep. 30, 2020.) “Guide to the Markets” presentation (page 4). Retrieved from Guide to the Markets | J.P. Morgan Asset Management.
