Every gold piece you save is a slave to work for you. Every copper it earns is its child that also can earn for you. If you would become wealthy, then what you save must earn, and its children must earn, that all may help to give you the abundance you crave.
The importance of saving to build capital, for me, took a long time to learn. It didn’t come naturally, and my parents did not teach me this critical principle as I was growing up—just the opposite. My parents were like many middle-class families and lived paycheck to paycheck. When I started working my first job as a teenager, my list of wants outstripped my resources by a wide margin! I liked spending far more than saving.
I was a finance and economics major in college, and you would have thought I would have picked up this critical lesson then, but I did not. I figured my degree would give me a fantastic job, and with what I imagined my vast salary to one day be, would not ever have to stoop to the lowly trait of saving. In other words, I was the exact opposite of everything I write about on this blog!
My dim-witted views didn’t change until I started dating my wife. She grew up in an immigrant household with Greek parents that had a completely different attitude about money. My father-in-law believed in saving with every atom of his DNA. He was the most diligent man I ever met about saving and investing.
My father-in-law had every disadvantage you could imagine. He grew up poor and never finished school above the 6th grade. He learned a trade as a cobbler, but only worked at it for a short time in his native country. He dreamed of a better life. His uncle owned a hot dog restaurant in the U.S. and needed some help, so he brought my father-in-law to the U.S. to work for him. When he showed up in a strange country, he couldn’t speak English, and his trade was of no use here.
He worked in a restaurant serving food without a high school diploma in a country where he didn’t speak the language. I am not sure you can start too much further near the bottom than that. Despite all these disadvantages in his life, he paid off his own house in a nice part of town, paid cash for all his cars, had a few rental properties and various other investments, and retired in his early 50s. He lived into his upper 80s and had a comfortable life and long retirement.
On the flip side, I grew up with every advantage a solidly middle-class family could give. I had a good education, a decent home to live in, healthcare, and plenty of food. I was in my own country where I spoke the language and understood the customs but didn’t have two nickels to rub together. As I grew older, I discovered the trait of saving and investing is not unique to Greek culture. Many cultures believe in this concept, but Americans are notable because the majority are poor savers and even worse investors.
Therefore into the purse of each of you flows a stream of coins large or small according to his ability
American Savings Habit
According to the website Statista, the U.S. savings rate from 1960 to 2021 only exceeded 15% in a single year! In the early 2000s, it hovered around 5%! These stats are appalling but all too common. Americans do not appreciate or value saving and don’t understand its power if done correctly. Most have little to no net worth and are woefully underfunded for retirement. As a culture, we seem to live for the moment, giving the future no thought. My guess is if you are reading this, you have a different view of saving.
I believe part of the problem is that most Americans’ poor money management habits combined with the fact that this critical life skill is not taught in school creates a fundamental misunderstanding of the concept, reason, and importance of saving. If it occurs to people to save at all, most will confine their activities to opening a savings account at their local bank that pays a whopping .03% while unofficial inflation stats, as I write this, are at a 41 year high!
Even when inflation is at a moderate 2% and interest rates are not at 0%, the banks have not paid much more than 3% for the last 20 years. So, at best, you are not losing money by saving, but you aren’t gaining either. Under these circumstances, it doesn’t surprise me that people aren’t excited to save.
Historically speaking, when people saved around the world, the concept was conceptualized differently. They viewed it as building capital. Capital is what you use to invest, and investing is how you create wealth. Experienced investors will often refer to the amount of capital they have, not the amount of savings. The difference seems subtle, but the ideas behind it are powerful.
You need to change your mindset and view saving not as the end, but rather as the first step in accumulating capital for investing or starting a business. In other words, saving is simply a tiny but necessary transitional step to the goal of building capital, investing it, compounding the earnings, and building wealth.
I think this is a positive way to view the concept. The word saving implies deferring consumption until some future date, but building capital implies growing wealth. I like the latter image much better, and I think it makes saving easier.
No Capital – No Investments
The lesson growing up that I never understood was that saving was necessary to build capital, and capital was required to invest or start a business. Successful investments or businesses generate wealth which gives people freedom and security. If you don’t build capital and invest it, you will always be trading hours for dollars. If you spend everything you earn, you become the faux rich. If the income stops, your lifestyle goes into a nosedive. Far too many people don’t understand this fundamental concept, so they don’t save, build capital or learn to invest. The future wealth they could have earned is lost forever.
How Much Should You Save
As I stated earlier, the average U.S. savings rate for the last 60 years only exceeded 15% in a single year, and it was far lower in most years. The common excuse given would be that there is more month than paycheck, and there is simply no money left over at the end of the month. This is entirely backward thinking.
The fabulous book The Richest Man in Babylon discusses saving as much as you can comfortably save, but let it not be less than 10%. Some of you might be thinking this already seems impossible. The book flips the script and tells you the 10% should be the FIRST thing that is paid each month, not the last. The concept is to pay yourself first, and sounder advice has probably never been written. When money comes to you, immediately subtract the first 10% or more and move that to savings, i.e., your capital accumulation account. Never let the percentage drop below 10% and if possible, raise it.
A part of all you earn is yours to keep. It should be not less than a tenth no matter how little you earn. It can be as much more as you can afford. Pay yourself first.
To Make More – You Need To Be More
If some of you are reading this and are entirely disheartened because you are underwater every month now and see no possible way to pull out 10% for capital accumulation and want to stop reading right now, please don’t.
I understand what you are going through. I was there once as well. Depending on your job, expenses, and other life obligations, saving can be a considerable challenge. I don’t want to gloss over that. Increasing your savings consistently and building capital requires a mental shift. You must want it more than you want to spend money. That is the first step. The biggest battle you will fight here is with yourself. Once you conquer that, you can start putting a plan in place to create a capital accumulation plan.
There are two sides to this equation. First, you need to reduce expenses. If you spend every penny and instantly adjust your lifestyle upwards each time you make more money, you will doom your efforts from the beginning. You can’t live a miserable and miserly lifestyle, but you can’t spend without regard. You need a balance between these two extremes. I believe adjusting your lifestyle expenses is the easier of the two ways of implementing a capital accumulation plan.
The second half of the equation is finding ways to increase your income. You might get a better job, boost your business, start a side hustle, learn a new skill, or build multiple streams of income. A speaker I heard once said if you want to EARN more, you need to BE more. In other words, doing what you do today and expecting more income is not realistic. You need to improve yourself and your situation.
I believe that lifelong learning is a competitive advantage. When you use that learning to find ways to generate more income, you are on your way to boosting one side of the equation and starting a capital accumulation plan.
However, as you can see, it is faster to be able to start cutting expenses. That is something you can start doing today. Building a new skill, starting a business, or generating multiple streams of income takes longer and requires a lot more work. I find it more enjoyable, but it takes more time to see results. Ultimately you need to do both. Cut expenses AND boost income. I wrote a detailed plan around this called the income & expense wealth building gap.
Wealth Building 101
When I was in college, I stumbled across a wonderful book in the school library titled How to Beat the Salary Trap by Richard K. Rifenbark. The book was published in 1978 and is still one of the most incredible and practical investment books I have ever read. It has been out of print for decades, but you might be able to score a used copy on Amazon, which is where I got mine. While elements in the book are now dated, the overall concept is still very applicable. I advise everyone to get a copy and read it. However, I will summarize some of the plan here with some minor improvements for those who can’t find it.
The author has 8 steps in his plan with capital allocated over four different buckets. Please note that I will only be covering 4 of those steps here. The author also doesn’t use the concept of a bucket in grouping his investments; I am adding that analogy because I believe it makes the idea easier to understand.
Care to guess what step one is? If you guessed saving, you nailed it. I want to quote the author word for word on this one:
“Your first effort in wealth-building is the accumulation of discretionary cash from your income. This means accepting the discipline of a methodical savings program. There is no other way.”
Did you catch those last five words? The bold is mine but illustrates what I stated earlier. Saving is the first foundational step to accumulate capital and building wealth, and there is no shortcut. When I was younger, I was too dumb to see this. Many people far older than my present age today still don’t understand it. Some never will. Ignorance of this financial principle doesn’t discriminate between young and old; it affects both equally.
Bucket One: Build a Cash Equivalent Reserve
I read a stat that said most Americans couldn’t put their hands on $400 for an unexpected expense without borrowing it or using a credit card. $400; let that sink in for a second. Access to liquid cash for emergencies and opportunities is the first step to wealth building. The author recommends this bucket is in money you can access right now.
With banks paying .03% interest, it is a tough step to want to maintain, but it is still necessary. However, as interest rates rise, you might be able to find some online banks that offer high-yield savings accounts. These bank competitors generally be higher interest than a brick-and-mortar bank. You can also check out money market accounts, which might pay a better rate. The author recommends having 6 months of monthly expenses in a savings account that you can access immediately. This is standard advice in personal finance. It isn’t bad advice, but watching a big pile of cash sitting in a bank account paying practically 0% interest while inflation eats away your purchasing power every day is hard.
As hard as I have tried having a pile of money in a savings account, earning nothing and losing value every day with inflation was more than I could bear. I have made some modifications that suit me a little better and are still readily accessible.
- Physical Cash: The first category is actual physical cash in your home or other safe and easily accessible location. Get a home safe or some unique hiding spots. The amount you keep in physical cash will vary by person; it should be enough to deal with minor emergencies. This might include a car repair, a few days of expenses, or smaller purchases. $1,500 to $3,000 is probably enough for most people and a vast improvement over the $400 mentioned above.
- Bank Cash: The second category is cash in the bank. Set up a basic interest-bearing checking account, even though it is probably less than 1%, and keep approximately 2-3 months of expenses. This will cushion you against the larger “ouchies” of life, covering larger emergencies or a short-term income hiccup. I once had a hot water tank blow out and flood my finished basement. I had insurance, but it only covered certain expenses and lagged my immediate expenses. I needed to pay a plumber to replace the tank and pay other costs before the insurance settlement came in. Having readily accessible cash kept this from being a bigger disaster than it already was.
- Short-Term Cash Equivalent: This is money invested in liquid short-term and relatively safe investments. These are typically money market or short-term bond funds that earn a small return but are stable and liquid. Two funds I have used trade under the symbols GSY and FLRN. You can open a brokerage account with eTrade or Ameritrade, deposit money, and buy these funds. These funds involve some small risks, but they are generally stable and easy to turn into cash quickly. I am not a fan of Certificates of Depression (CD) for this category of money because it pays a low rate and it ties up the funds for extended periods of time. To me, that is the exact opposite of what I am looking for in a cash equivalent. Keep another 2-3 months of ordinary expenses in something like this.
If you follow this plan, you will have a spectrum of immediate cash to short-term cash equivalents. The three layers I outlined above will constitute your first bucket, an immediate cash reserve. You can choose to make your reserve larger than 6 months of expenses if it makes you feel better, but I probably wouldn’t advise it to be any smaller. Life has a way of throwing you curve balls when you least expect them, and your cash reserve allows you to weather the storm with fewer bruises.
This is the process by which wealth is accumulated: first in small sums, than in larger ones as a man learns and becomes more capable.
Bucket Two: Build a Liquidity Reserve
The second bucket will be composed of very stable equities and bonds. The investments in this bucket aim to generate a return but avoid massive day-to-day volatility and substantial losses during market corrections or bear markets. Your return will be lower but better than a money market. Your aim should be around a 4% return.
It is not a growth fund; it is still part of your liquidity fund. Think of this fund as your fund to handle large purchases, such as a down payment on new investment property, starting a business, or doing a more extensive repair such as a new roof or rehabbing an investment property. The expenses paid for with this bucket are planned expenses where you can use an orderly timing to liquidate it into cash.
The author recommends building this fund using blue-chip stocks and AAA-rated bonds. When he wrote this advice (1978), mutual funds were almost non-existent, and ETFs did not exist. You had to essentially build a stable blue-chip portfolio independently out of individual stocks and bonds. Today this isn’t the case. There are tons of choices of large-cap stable mutual funds or, better still, ETFs (Electronically Traded Funds) that will give you a basket of large-high-quality, stable companies, and very low expense ratios. It will diversify your holdings over many companies and lower your risk of having one company drop dramatically and put a severe dent in your capital.
I let my RIA (Registered Independent Advisor) handle this bucket. He stays up on the latest news and various funds better than I do. I just gave him my specific instructions. I explained the potential uses for this bucket of money and gave him two primary goals to maintain:
- Stable & Liquid: I wanted to be able to convert it to cash in a week or two. I didn’t want it moving substantially with the market, and I didn’t want investments that could drop 30% in a day. It will lose some value in substantial market swings, but very little. Overall, it is stable except in the craziest of markets, think the first few days when the market crashed after Covid lock downs began. However, it only moved a little while the rest of the market was clocking double-digit losses.
- Conservative Return: I was not looking for massive growth. I explained that I wanted investments that would beat modest inflation and give me a small return, so the money was growing but wasn’t in the riskier and hence more volatile securities. Sadly when I created this goal I didn’t know 8.5% inflation was around the corner and soon to be at a 41 year high! However, that aside this goal meant I needed to get the money without being in a position where my investments are underwater where I would take a substantial loss when I sold. The reason is because some of the best investments have a fire sale going on when the economy is in the toilet and being able to access cash to buy them is critical to magnifying your wealth when the sun comes back out.
These twin goals have worked precisely as I need them to. In average inflation (not the stuff we are experiencing now), my returns beat inflation, and my advisor can turn it into cash in 3 days and wire the funds anywhere I need, which was even better than I had initially hoped.
It is important to understand this fund is for large and planned purposes or buying investments when everyone else is throwing them out the window at fire sale prices. I have primarily used mine for down payments on investment property or money to rehab properties. In my specific case, these were planned out events. Sometimes a great opportunity comes out of nowhere, and you need cash now. In that case, it can still be accessed quickly. I can use money from bucket one if necessary until I can get these funds freed up. That is the beauty of having multiple buckets of money across a spectrum of investments.
Bucket Three: Optional Investment Fund
Bucket three is when you start increasing the risk to generate higher returns; the exact level of risk you take is an entirely individual choice. I am going for at least market returns and, hopefully above average returns, occasionally hitting a high double or triple-digit home run.
I use ETFs combined with riskier individual stocks to juice my returns; I seek more significant returns here. The way I have this bucket set up, I can generate (or lose) 15-30% returns quickly. This is NOT the fund you plan to tap into for emergencies or even moderate-term expenditures or purchases.
With these investments, you could easily find yourself in a down or bear market for a year or longer. I am down, on paper, 30% from my high point as I write this, and it has been that way for eight months now. I expect it could be there for at least another year or more before I start seeing some life in some of these investments again.
Remember, I have riskier investments that are much more sensitive to market swings and volatile. On the flip side, this bucket has been up an average of 28% in the past with some investments doing even better, where I could cash out at a significant return. It works both ways, and you need to be prepared for either outcome.
If being down by 30% will keep you from sleeping at night, that is too much risk. Dial it back. This bucket should be generating higher returns than bucket 2, but not at the expense of your sanity and ability to sleep. Pick the risk level that works for you and build the investments around it.
Your investment horizon for this fund should be a minimum of 5-8 years, and I would argue possibly longer if we hit a nasty recession or bear market. If you are trying to generate outsized returns in any shorter time frame, you are gambling, not investing. I have made investments that shot up to high double digit returns in a year. It can happen, it just shouldn’t be expected. Also remember that any investments that you sell in less than a year will be hit with short term capital gains, which can get expensive.
A few years ago, I purchased a new investment property, and I had to put $10,000 down. The seller carried back a note for the balance. I also had repairs, improvements, closing costs, and attorney fees that added another $5,000 in expenses. These funds came out of bucket two, my stable investment fund. I took some of my best-performing investments from bucket three and sold them to rebuild this fund. I replaced my investments from bucket two and added some new assets to bucket three with the additional proceeds. I had several investments that had done very well and could do this, but I could have been in a down position and had to use savings from income to rebuild bucket two. Over a year or so I built bucket 3 back up again.
Keep in mind that even if investments are down and you are losing money or at a lower return than you had hoped for, the assets are usually not worth zero. If you need to raise cash for something, you could liquidate it even at a loss and raise cash. I try never to do this, but I could if I wanted to. If you have other options, you should use those instead.
For each ten coins I put in, to spend but nine.
Bucket Four: Invest in Residential Income Real Estate
The author recommends buying residential income real estate in the final wealth-building bucket. These investments can be SFR (Single Family Residences), small multi-family, or larger apartment buildings. He recommended staying away from commercial properties for a variety of reasons. This bucket, for me, is composed entirely of single-family homes that are long-term buy-and-hold investments. My investment horizon for this bucket of assets is conceivably forever. Once I acquire a property, I never want to sell it. My goal is to build a rental property portfolio with cash flow every month. Selling any of them becomes counterproductive to that goal. There are times to sell, but that is never the goal when I start.
I am a bonified, certified, genuine real estate investing junkie, so this plan fits my overall goals and has been tremendous for my wealth-building efforts. If you aren’t sure about owning real estate as an investment, I would advise you to spend some time learning about it and educating yourself on its possibilities. I admit it is not for everyone, but in my book, it is an incredible asset class, especially when you combine all the benefits of directly owning and managing properties. See my real estate investing primer.
The Plan in Motion
You have seen the plan and the various buckets of money and how they work. Once the program is in motion, it works much like a stepped waterfall. Your income begins filling bucket one, and once you have filled it, the money starts pouring into bucket two and then three, and finally four. The income from my freelance business is the stream that initially fills these buckets, BUT over time investment returns and cash flow from my other investments also fill the buckets for me. In other words, my investment returns grow my wealth in addition to the income I am feeding it. When you reach the stage where your income AND investment returns generate growth, you are on the verge of snowballing your wealth building.
If I pull money out of buckets 1, 2, or 3, I let my savings start refilling what I took out. Suppose I remove cash from bucket one for an emergency or opportunity. In that case, I can either cash out an investment that is doing well to replace that money or let my continued savings refill it.
The Need for Self-Discipline
This plan requires some self-discipline. First, you need to begin diverting your income into the buckets discussed above. You should be consistently building those buckets every single month. If you only do it “when you can afford it,” you probably will never “find” the money. You certainly wouldn’t be alone. According to the stats cited earlier, you would be sharing company with most Americans, but I hope you want and strive to be better than that.
Second, you need to educate yourself on finding solid investments to grow your stream of savings into capital and then increase that capital into real wealth. That process takes some education, time, and practice.
Lastly, you need to guard against yourself. As your capital grows, it becomes an incredible temptation to pull money out for a nice vacation, new car, better house, etc. If you give in to that temptation, you will jerk your wealth tree out by the roots and will need to start all over.
I am not saying it is easy to maintain this self-discipline, but it is necessary; I must fight this temptation regularly. It is hard to see your friends and family taking vacations, buying big houses, new cars, etc., while you are not and choose to save and invest instead.
I find it helps to visualize the goal you are trying to reach. Picture what that new life will look like as you have streams of income coming from various sources whether you are working or not. Picture your net worth growing larger every year, soon, without you even contributing a lot of additional income. Pick a specific number. Don’t just say I want to be rich. That is too vague. I have my specific number written down in a one-page vision statement. I review this vision statement every day. This helps keep me focused and disciplined.
On the other hand, your friends and family might find they must work constantly, and even minor hiccups in income or a job can be financially devastating. Emergencies can be crippling as well. We never seem to concentrate on this part of the story, but it helps if you do.
I once talked to an investor who said:
“I live like most people won’t for a little while, so later, I can live like most can’t“
The sacrifice, in the beginning, will pay off, and someday people will be looking at you and wondering how you do it. Again, I highly recommend reading The Richest Man in Babylon. I read this book every year and have for at least 20 years. You can read the whole thing in an hour or two.
What each of us calls our “necessary expenses” will always grow to equal our incomes unless we protest to the contrary
Mr. Rifenbark started implementing his plan shortly after World War II. During the years of his wealth building, he didn’t have things like IRAs and 401(k) plans; THIS was his retirement plan. He used the tax advantages of real estate and various parts of the tax code to shelter some of his income and investment returns from confiscatory taxes. It worked for him, and it will still work today, but today we have some tools he didn’t have.
We have a variety of tax-advantaged investment plans he didn’t have. We can set up an IRA or 401(k) plan, which you can easily do if you have your own business you can create a self-directed 401(k) with a Roth bucket and also create a self-directed Roth IRA!
Self-directed retirement plans open up an entire world of alternative investing inside of your retirement plan where the investments are tax advantaged. Wealth building in the absence of taxes while it is growing will add some serious punch to your investment returns! If those self-directed accounts are Roth accounts you will NEVER pay taxes on those investments. That is like adding plutonium to your wealth building efforts!
So, you might be wondering where these retirement plans fit into the system outlined above. The answer is you can do both. You can work on the plan above and make this your retirement plan. Mr. Rifenbark did just that and was a very wealthy man. There is nothing wrong with that approach, but as a Money Outlaw I am always looking for angles, so I combine both tax advantaged retirement accounts AND this system.
If you decide to pursue entrepreneurship, you can create your own 401(k) plan and put any investments you want in there. You can also self-direct your retirement plans to use alternative investments. Whether you are an entrepreneur or not, anyone can have an IRA; I recommend a Roth IRA, which you can also self-direct.
The main point is that you invest using the plan above outside of a retirement plan AND contribute to a retirement plan simultaneously. There are some incredible tax advantages to using retirement plans in your investing. Still, some people want wealth before retirement, so building investments outside of a retirement plan is also intelligent. Doing both will give you more choices, flexibility, and tax advantages.
Saving some extra cash in an account at the bank, paying you almost no return, might give you a little extra money in an emergency, but the real power comes when you build a capital accumulation plan. Invest your capital into a variety of investments. Combine this with self-directed retirement accounts. Doing this will add plutonium to your wealth-building efforts. It all starts with a simple income diversion savings plan that you are consistent and diligent about following. Happy wealth building!
The information contained within this website is provided for informational and educational purposes only and is not intended to substitute for obtaining legal, accounting, tax, or financial advice from a professional tax planner or financial planner. Full disclosure
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