This week, someone asked me if I would consider writing a post about not drinking a daily coffee in order to become wealthy. I responded that I though the “daily coffee” is a red herring. By following a few simple rules up front, anyone will become a millionaire with enough time.
Rule #1 – Invest
Take 30% of net pay and invest it in well-diversified exchange traded fund. Do this every single time you get paid. If you get a raise, maintain that 30% proportion.
If you can’t start with 30% right away, then start where you can and increase the percentage by 1% every chance you get. I didn’t start at 30% right away either. However, after 30 years of investing, I’ve managed to hit a 40% savings rate. It didn’t happen overnight but it did eventually happen.
The more you can save, the faster you will hit the goal of becoming a millionaire or being financially independent. It’s important to start today.
I promise you that if you don’t invest any money today, then you will have very little of it when you need it the most later.
Rule #2 – Build an Emergency Fund
Some people recommend having 3-6 months’ worth of expenses set aside in your emergency fund. I’m a little more conservative than that. Personally, I would recommend 12 months’ worth of expenses. My personal mantra when it comes to emergency funds is as follows.
It’s better to have it and not need it, than to need it and not have it.
You know your own comfort level far better than I do. Ask yourself if you would rather have more or less money in an emergency fund?
Saving up this much money will take time, probably years. If it makes you feel any better, I’m still working on building up my emergency fund, and I’ve been tackling this project for a long time.
Rule #3 – Pay off your debt
Much like building an emergency fund, it may take some years to pay off all your debt. And I do mean “all” of it: vehicle loans, personal loans, student loans, credit cards, mortgage, etc… If you owe money, pay it off.
A mortgage may take decades to pay off. This is why I think it’s best to invest while paying down a mortgage and building your emergency fund. Should you get an inheritance, a lottery win, an insurance payout, or a huge raise/bonus at work, then maybe you can consider paying off the whole mortgage. There are a many factors to consider before this decision is made so consider it carefully and don’t make any hasty moves.
It might make more sense to invest the inheritance/lottery win/insurance payout/ raise-or-bonus in the stock market for long-term growth, then use the dividends generated to pay off your mortgage. That way, when the mortgage is gone you will still have a cash machine churning out an income for you. Check out this video for more details of this plan in action.
If you spend the inheritance/lottery win/insurance payout/ raise-or-bonus right away, then it’s gone for good.
Rule #4 – Use sinking funds
When there’s something you want to buy, save up for it first before you buy it.
Sinking funds force you to prioritize where you want your money to be spent. I believe that when you work hard for your money, it should be spend on the priorities that will make you happiest. Wasting money on the things that don’t bring you joy seems to be a poor choice. You will never get back the time and energy spent at work. Instead, you get a paycheque. It should be directed to building the life you really want because it represents your precious, precious time and energy.
I realize that our capitalist society does not encourage this way of life. The Ad Man and his trusty sidekick, the Creditor, are relentlessly exhorting everyone to buy everything they want immediately. My rule is about delayed gratification, not a popular choice for most folks.
However, if you want to become a millionaire, then it’s better to not send interest payments to creditors. It’s better that you invest that money so that you can reach millionaires status as soon as possible, if that’s what you really want.
Rule #5 – Spend your money
That’s right. After you’ve eliminated debt and you’ve funded your emergency fund, then it’s time for you to spend your money however you choose without going into debt.
Your investments are happily compounding in the background. Dividends are compounding each year on a DRIP, aka: dividend re-investment plan. You’re continuing to contribute 30% of your net pay even after paying off your debt and fully funding your emergency account. You’re saving up for everything before you buy it.
Keep investing. Stay out of debt. Maintain a fully-funded emergency fund. Rely on your sinking funds to meet your life’s goals.
If you’re doing these things, then you’re following the first 4 rules. Your day-to-day purchases will have no impact on your path to becoming a millionaire.
So spend the rest of your money however you want. Coffee? Travel? Brunch? Spa days? Pets? Hobbies? Wine club? Sporting events? Clothes? Shoes? Vehicles?
It doesn’t matter how you spend your money once the first 4 rules are being followed. Again, spend the rest of your money however you want so long as you stay out of debt.