They, let us call this couple Dick and Jane, married relatively late in life—one was in his late 30s while she was in her early 40s. They were united by more than love—neither had very much in the way of assets and while both were employed, neither earned, or would ever earn, fabulous salaries. Their assets totaled less than $2,000. Yet, within twenty years, they become independently wealthy and, unlike many of their generation, they could confidently face the rest of their lives knowing that they were comfortable and could live well.
There were financial turning points in their lives. These were challenges in which they made the right choices. These choices allowed them to achieve financial independence just as they wanted to start doing more things—such as travelling and working only when they felt like working and work only at a job that he or she enjoyed. And, more than likely, most people of their generation and this one have faced the same situation as this pair. Let us examine how they made the right moves and why.
*A Commitment to Save and Invest on a Regular Basis
Even though neither made fabulous money at the outset of their marriage, both the husband and wife made a hard agreement and stuck to it: They were going to save and invest a significant amount of their income—20 percent each—so that someday they could be financially independent. This sounds great when one says it. But the challenge is to actually do it pay period after pay period. That’s because saving and investing healthy amounts can only take place in a marriage if both parties agree on it and do it. And that means they will consume less; they will put off some wants today so years from now they can consume more. With this mindset one can take the first steps toward financial independence because one views saving and investing in a different way than many do: Saving and investing doesn’t mean never buying things one wants. It means saving and investing today represent a kind of delayed consumption; a buying of things in the future when one can easily afford them.
How did Dick and Jane do it?
*Looking for Saving and Investing Allies
They’re out there but you must know how to use them. For example, many companies have retirement saving matching plans. In the United States they are often known as 401(k) plans for the section of the tax code that defines them. These plans have at least two elements that almost everyone with few assets and just starting to build wealth should use: An employer match—many employers, although not all, will match your contribution to a certain extent. Say you put in six percent of your pay into the 401(k). Your employer might match it up to six percent. Not all employers do it. But Dick and Jane’s did. In effect, their contributions were doubled. These contributions even make sense if the employer doesn’t match or, if perhaps, the employer stops matching because it is going through hard times as often happened in the last recession. The point is to get going and save on a regular basis in each pay period.
*Uncle Sam’s Help, Part I
Dick and Jane contributed for another reason: Their contributions reduced their tax liability. Jane, at the beginning of their program to achieve financial independence, was making $25,000 a year in a transcription job. The $1,500 she contributed came off her tax bill, which meant she was only taxed on $23,500 of income. Dick, who was making $30,000 a year, got an $1,800 tax break so he was only taxed on $28,200 of his income.
*Uncle Sam’s Help, Part II
Dick and Jane were in a low middle income bracket some 20 years ago so they qualified for another break. Besides their 401(k)s at work they qualified for deductible IRAs, individual retirement accounts. Each started contributing several thousand dollars a year to their IRAs. And, once again, they were able to take their deductions off their taxable income. Every year they funded the IRA. Now, along with their retirement accounts, they were able to build another pool of assets that brought them closer each year to financial independence.
*Dollar Cost Averaging
As Dick and Jane earned more and took more money home, and so of this was the result of taking advantage of the savings of retirement account tax breaks, they also started to invest outside of their retirement accounts on a regular basis. They only began with $100 a month in an index fund. But, as the years went by, they added to their monthly contributions. Now, as they started to become enthusiastic about their program succeeding, Dick and Jane increased their income with part time jobs. They started putting $500 a month and later $1,000 a month into various low cost index funds. They set it up to automatically deduct the funds from their checking account. They got into the habit of putting money into investments the way they paid their bills each month. They did this in good markets and bad. In the latter case, they were buying more shares because the fund price was depressed. In the former, they were delighted to see their investments’ value rising. Their discipline in adopting a saving and investing program was paying off.
*Let the Compounding Continue
Both Dick and Jane made the commitment never to break into their retirement accounts, which contain penalty clauses if one breaks in before age 59.5. In fact, at age 59.5, Dick and Jane were now working part-time jobs they liked. And they continued to add to their IRAs. Their retirement accounts were now close to $1 million dollars. Not bad for people who were once poor, who thought $2,000 was a lot of money.
They had made all the right choices at the turning points. They were now independently wealthy.