Nine simple words explain the foundation of a financial plan that will help you retire rich:
- Spend less than you earn.
- Invest the rest.
If you structure your financial life around those nine words throughout your career, it almost doesn't matter what investing returns you achieve. If you don't, basic investing math will tell you that $0 compounded at any rate for any period of time results in a nest egg of $0 at retirement.
Spend less than you earn
Regardless of whether you ever buy a stock, bond, or mutual fund, spending less than you earn is the critical foundation of any financial plan. It matters because:
- If you spend more than you earn, then in the short run, you add interest payments and debt servicing costs on top of your basic living expenses -- driving up your costs of living. In the long run, the credit spigot will get cut off, forcing you into bankruptcy.
- If you spend exactly what you earn, then the first time you have an surprise expense -- like a car repair, illness, or last-minute travel for a family emergency -- your plan will break down. That will propel you into the same financial death spiral as those that start out spending more than they earn -- and that's not a place you want to be.
- If you spend less than you earn, then you can keep most debt servicing costs out of your budget, have flexibility to handle the minor surprises life hands you, and free up cash to invest. All else equal, you can live the same lifestyle with less cash outflow while setting yourself up to build that nest egg that will help you retire rich.
There are two parts to spending less than you earn -- your spending, and your earnings. You likely have some power over both parts. On the earnings side, consider your ability to work more hours, take a second job, and/or position yourself for advancement at your current job. On the spending side, reexamine every penny you spend -- both planned spending and accidental. Cut out spending you think is frivolous, cut back on other costs you don't absolutely need, and negotiate costs on everything else.
Invest the rest
Take the money you free up by spending less than you earn and invest it. Your objective with your investments needs to be a focus on putting your money somewhere where you have a reasonable chance of getting back more than you put in. So whether you're considering traditional investments like stocks and bonds or upgrades like better insulation for your home or a degree that will help you advance your career, do so with an eye toward the return you can expect to get.
Especially as you're just getting started, the amount you'll be able to sock away may seem laughably small, particularly when compared to a lifetime portfolio target of $1 million or more. But don't despair -- it gets easier over time, for two key reasons: compounding and the virtuous cycle of spending less than you earn.
From a compounding perspective, the money you sock away keeps working for you as long as it remains invested. Using the "Rule of 72" as a guide, money that earns 7.2% per year will double in value roughly every 10 years. That means that the $1,000 you sock away in your IRA at age 20 could very well be worth $32,000 when you go to spend it at age 70. Add each new investment to that pile, and the total of all of them working together over your working life can add up to a life changing amount of cash.
From a virtuous cycle perspective, once you start spending less than you earn, it becomes significantly easier to free up new cash to invest. Because you're living on less than you earn, even 'inflation level' raises at work mean more money to you in real terms that you can put toward investing. Add things like the annual inflation adjustments to the tax brackets to that impact, and the little bit you put away each paycheck can quickly get bigger.
The first eight words form the foundation, but it's this last one that gives it its strength to propel you to a comfortable retirement. Every time you spend less than you earn, you have a little bit more to invest toward your future. Every time you invest toward your future, you add that much more to the money compounding on your behalf to get you there.
On its own, the amount you can invest from your next paycheck won't be enough to take you from here to comfortably and happily retired. But keep it up, slowly, steadily, and consistently over time, and your money will grow. It takes time measured in decades to amass a substantial nest egg, but with these nine words, you can get there.
Perhaps best of all, along your journey of consistently spending less than you earn, investing the rest, and repeating, you'll likely find that your needs change. As you start enjoying the flexibility that such a simplified lifestyle gives you, you might just discover that a comfortable retirement costs less than you think. And in the end, that's the true secret to a rich retirement -- having enough come in to meet your needs, enjoy the things that matter to you most in life, and be able to live your life along the way.
Get started now
Your financial future is waiting for you. Get started now along the path that these nine words offer you, and once you get going, you'll be incredibly glad you did.
Earlier this month, Fool contributor Chuck Saletta faced a $1,350.82 curve ball life threw at him when his car died on the side of the highway. Thanks to these nine words, he was able to cover those surprise costs without panicking.
Chuck has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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