After several years of working closely with successful entrepreneurs, reading dozens of finance books, speaking with thousands of families and working on my own wealth, I have created 10 wealth commandments for financial success.
Follow them and you'll increase your wealth. They share three common threads: discipline, common sense and a long-range perspective. That can be hard for some people to keep in mind, but they are ultimately rewarding and can lead to a happier life.
1. Pay yourself first
If I could only instill one financial idea into my children it would be to pay yourself first. That is, set aside money every month. No one else will, although it's difficult to keep that in mind after you fulfill regular financial obligations. If you have a mortgage with Wells Fargo, you work at least partly for Wells Fargo until that month's payment is made. You have to develop the discipline to pay yourself a minimum of 10% of everything you earn. Call it your wealth account and don't spend it.
2. What you save matters most for most of your life
So many times I see clients get hung up on rate of return. Yet they don't realize that what they contribute can build their wealth faster than what their money can earn. For example if you earn $50,000 and save 10%, that is $5000. The next year your $5000 may earn 5% and add $250, but you can add another $5000. That is 20 times what your money did for you. I'm not saying don't put your money to work. You absolutely should, but what you save will be higher than what your money can earn for many years. As you improve your skills, move up the company ladder and expand your income, you will be able to save a greater amount of money. Eventually, the goal is to have your principal passively earning more than you can contribute. As you near retirement, it should be earning more than you could earn working full-time. What you contribute makes a huge difference over time. Never stop saving.
3. Understanding opportunity cost and the rule of 72
It's important that people understand the rule of 72 and how opportunity cost plays into how money grows. The rule of 72 is a very simple mathematical equation that teaches us how often money will double over a period of time. The equation is 72 divided by the interest rate you earn. For example, if you earn 4% on your money you would divide 72 by 4 and see your money will double every 18 years. This equation is important for projecting how your money could grow but also for understanding opportunity cost. Many people have money sitting at the bank earning less than 1%. At 1% it will take 72 years for your money to double. If there is an opportunity where your money could grow at 6%, the opportunity cost is 5%. Would you rather your money doubles every 72 years or every 6 years? The math helps you see what you could be missing.
4. Be disciplined
Most of us are not as disciplined as we would like to be or as much as we know we should be when it comes to our time, our money and our diets. However, it's imperative to set money aside every time we earn and to look regularly for opportunities. It's also important that someone not spend into debt. These disciplines exercised over time add up.
5. Produce more than you consume
It's important to view yourself and behave as a producer and not as a consumer. Producing is one way to ensure that there is always enough and more. Consuming takes away from what we've produced. That's why it's more important to account for what you keep rather than what you make. You can produce and make a ton of money but if you keep nothing for yourself, then you're back to square one. I've met people who make $50,000 a year and keep more at the end of the year than people who make $150,000. Just because you make the money, doesn't mean you have to spend it!
6. Apply leverage
The application of leverage is one of the defining characteristics of wealthy people. Applying leverage means using less effort to get bigger results. It can be done with real estate, an employer matching your contributions into a 401(k) or a profit-sharing program. It can come in the form of building a team that produces income from other people's efforts. The greatest source of leverage in America is business ownership. Owning a business allows you to leverage your time, other people's time, technology, machinery, ideas, a sales force, money, etc. Leverage can also come in the form of OPM, other people's money. OPM from a bank or private loan for real estate that can be increased in value or bring in higher rent revenue than fixed expenses. OPM can be using investors' money to bring an idea to the market that creates income.
7. Understand before you place any money.
Whether you are saving money, lending money or investing money, you need to understand how the process works. If it is a company you need to understand its business model, how they earn money and the plan to grow your money. If you are in the lending program, you need to understand how your money is protected. It's important to understand the contract that ensures you will be collateralized and paid. Too often people stick money into a stock, mutual funds, a piece of real estate or business without knowing who is heading up the opportunity and how all the working parts bring value to your money. If you can't understand it, walk away from it.
8. Avoid losing money
If you are like the majority of Americans, you have lost money. Some people have lost significant amounts of money. Where would your nest egg be today if you had never lost money? With some investments, it is impossible not to experience ups and downs on an asset. But for the most part, someone can avoid losses simply by better understanding a company's business model, an investment, and where the risk lies in the opportunity.
9. Be mindful of fees.
People deserve to be paid when they exchange value for money. But this is one area where you can have some control over your money. Two in three Americans surveyed with 401(k)s believed they paid no fees on their 401(k). In reality, the average 401(k) has an annual fee of 3.12%. Anytime you deal with money, there are fees. Whether it's a mortgage broker, a real estate agent, a stockbroker, investment fund manager or insurance agent. What you need to understand is how the person is paid and how that comes off the top. In some cases, fees are paid directly from companies because the company knows they will make up for the commission by holding your money over time. Other times, investments and loans are front-loaded and the fees come right off the front end of your money. Understanding and controlling your fees will give you a huge advantage over those who do not. Again, I believe in paying for value but if one firm can do it for 1% and the other firms are charging 3%, it may be time to switch.
10. Treat wealth like a business
Treating wealth like a business allows people to use money as a tool and cut the emotion from money. When you treat your money as a business you think in terms of whether the business can afford a purchase and if the purchase makes sense for the future. You are also thinking about whether something will produce revenue or if it will require lots of money to sustain. A business also reviews its finances on a regular basis. Don't spend more than you make. You can use surpluses for emergencies, other investments or future capital expenses. But don't be flippant or casual with money or it will leave you for someone better prepared to handle it.
Following these wealth commandments over your lifetime will give you a road map for handling money and lead to a wealthier, happier life.
This article is commentary by an independent contributor. At the time of publication, the author held TK positions in the stocks mentioned.