No matter how much money you earn, it's tempting to spend every last dime -- and more. Remember MC Hammer? The rap star was once worth tens of millions of dollars, but he squandered it all and ended up bankrupt. Or how about Michael Jackson? Not only was he a superstar, but he also owned the publishing rights to many of the Beatles' hits. Yet even with all that wealth at his disposal, he recently narrowly avoided bankruptcy, reportedly by selling the Beatles catalog.
As their stories show, money can be fleeting, especially for those of us who aren't well-versed in how to manage it. For a select few, handling cash responsibly comes naturally. For the rest of us, however, it takes quite a bit more effort. Fortunately, there are simple steps that you can take to make the process of turning income into wealth as painless as possible.
Pay yourself first
The most powerful of these steps involves tricking yourself into thinking you're earning less than you really are. In fact, one of the world's most potent financial lessons can be summed up in a single sentence: "You don't miss what you never see." In a nutshell, it means that the easiest way to turn your hard-earned income into real wealth is to make sure it gets invested automatically -- before you have a chance to spend it.
Luckily, paying yourself first has never been easier. If your employer has a 401(k) plan, it may be as simple as filling out a one-page form. That form just might be your ticket to millionaire status. Not bad for 15 minutes of work! This table shows how it works, assuming a person currently earns $45,000 a year, expects a 4% annual raise, receives the stock market's historical 10% annual return, and can sock away 10% a year:
|
Year |
Daily cost of saving 10%* |
Potential worth, end of year |
|---|---|---|
|
1 |
$9.25 |
$4,500.00 |
|
5 |
$10.82 |
$29,539.28 |
|
10 |
$13.16 |
$83,512.36 |
|
15 |
$16.01 |
$178,222.85 |
|
20 |
$19.48 |
$340,228.26 |
|
25 |
$23.70 |
$612,665.22 |
|
30 |
$28.84 |
$1,065,450.36 |
*After tax savings, 25% tax bracket
Getting started
That's all fine in theory, but there's still the very real problem of how to begin. After all, saving 10% of your salary requires you to free up money that's likely already being spent. It's not as hard as it might seem -- if you earn $45,000 like the person in our example, you would need to save just $9.25 a day. There are several simple steps you can take to cut your expenses by that amount without completely cramping your lifestyle. These might include:
- Brown-bagging your lunch
- Carpooling or taking public transit to work
- Substituting homemade or cafeteria coffee for coffee-shop brew
- Cutting back on premium cable channels
- Picking up a bit of overtime
Even better, if your employer offers a match for your contributions, that $9.25-a-day starting cost could drop to as low as $4.63. Plus, once you've taken that first step, any future contributions come from money you've never really seen and will therefore likely never miss.
Make your money work harder
Contributing to your account is only half the battle. Once your money's in the account, you need to invest it in order for it to grow. Over time, very few professional money managers have been able to sustainably beat their benchmark indices. As a result, unless you get really comfortable analyzing companies, your best bet for long-term investing is to let the market do the work for you.
The simplest way to do that is Vanguard Total Stock Market (FUND:VTSMX). It's a one-stop shop, where a single investment buys you a number household names, such as General Electric (NYSE:GE), Johnson and Johnson (NYSE:JNJ), and Citigroup (NYSE:C). It's an extremely broad fund, so your money will be going to work not only in the giants of the American market, but also in many of the smaller companies out there.
As you get savvier about investing, you can focus on styles that better fit your temperament and risk tolerance. Are you concerned about the return of your capital more than the return on your capital? Perhaps you'd like to move some money into VanguardShort-Term Bond (FUND:VBISX). Would you prefer a little international exposure without the headaches of learning international accounting? Maybe the iSharesEAFE Index (AMEX:EFA) fund would be up your alley. Think small caps will outperform, since they have that much more room to grow than their larger brethren? Then you may want to invest in the iSharesRussell 2000 Index (AMEX:IWM) fund.
Once you get past the basics, there are literally thousands of investing alternatives out there, each tailored to different investors with different strategies. While it's easy to get overwhelmed by the options, you don't have to be. Simply remember to focus on what suits your needs and your risk tolerance. Those answers will drive the rest your choices and make your investing selections that much easier.
The Foolish bottom line
No matter what you choose to do, the most critical step is simply to begin. Get started on an automatic investing plan and let the power of compounding work its magic for you.
To help you get started, we're offering a free report , the first in our "Master Your Money" series. In it, Tom Gardner tells you how to make sure the companies you put your faith -- and investing dollars -- in are worthy of your trust. All you have to do is click here to claim it.
At the time of publication, Fool contributor Chuck Saletta owned shares in General Electric and Johnson & Johnson. Johnson & Johnson is a Motley Fool Income Investor recommendation. The Fool has a disclosure policy.
