The Savvy Investor's Guide to Building Wealth Through Traditional Investments

H. Kent Baker, John R. Nofsinger, Andrew C. Spieler

• Publisher: Emerald Publishing Limited
• Year: 2020
• ISBN:
  9781839096105
• Topic: Business
• Subtopic: Investments & Securities
• Index: Business

Would you like to be a millionaire?
If you're like most people, your answer is "yes". But unlike popular opinion, this goal is not beyond your reach. Building wealth is more common sense than secret formula. You need to invest wisely.
This easy-to-read guide focuses on traditional investments - stocks, bonds, and cash or cash equivalents. Stocks and bonds are the heartbeat of Wall Street. Finance experts H. Kent Baker, John R. Nofsinger, and Andrew C. Spieler take you through how to invest in a single security, as well as mutual funds and exchange-traded funds (ETFs), which offer many potential benefits to individual investors.
This practical and straightforward book is written for novice investors. It takes an innovative question-and-answer format to help you learn about traditional investments and to become a better investor. If you want to become a millionaire, and don't have the luck of buying a winning lottery ticket, this guide is for you.

1

BUILDING WEALTH AND ACHIEVING FINANCIAL FREEDOM

“You can be young without money, but you can’t be old without it.”

—Tennessee Williams, American playwright

“Who Wants to Be a Millionaire?” was a popular American television game show based on the same-titled British program. Not surprisingly, few contestants walked away with the top prize. Winning $1,000,000 is difficult! Of course, nearly everyone would like to be a millionaire but how can this be accomplished besides winning a game show or lottery? Fortunately, several paths are available to becoming rich.

A recent study of wealthy individuals identified three common ways they built their fortunes. Saver-investors focus on having no debt, living well below their means, and saving and investing for many years. Virtuosos are those who are the “best of the best” in their career, industry, or profession. They work for large, publicly held companies that have stock options or own their own highly profitable businesses. Dreamers pursue a big dream and make it a reality, which lead to some massive gain or income. If you want to be rich, you need to select a path that’s right for you and stick with it for many years. With a few exceptions, each path requires considerable time to accumulate wealth.

This book follows the first path by focusing on saver-investors. Its primary goal is to discuss how investors, especially novice investors, can use their financial capital to build wealth with traditional investments. Savvy investors can predictably accumulate wealth with some basic strategies, financial knowledge, and patience. In other words, everyone has the potential of building wealth and some can become millionaires or even multi-millionaires and achieve financial freedom.

This chapter discusses the difference between income and wealth, ways to reduce and estimate retirement expenses, and the impact of inflation on future purchasing power. It offers realistic scenarios to start your journey to saving and investing more, spending less, and increasing your wealth.

1.1. WHAT IS A MILLIONAIRE?

For many people, the term “millionaire” conjures up images of extremely wealthy people enjoying the sun on their private yacht. The news media bombard us with pictures of the rich and famous including millionaire athletes, entertainers, and business executives. These images seem distant from the lives of most hardworking everyday people. Let’s examine the definition of a millionaire a bit closer. Traditionally, a millionaire is someone with net assets greater than $1,000,000 excluding the equity in a residence. Thus, if you can accumulate those seven figures you too can join the “two comma” club with $1,000,000.

At one time, becoming a millionaire was the epitome of success. Today, some of the luster of being a millionaire has diminished because it’s almost commonplace. During 2018 about 11.8 million households in the United States consisted of millionaires. This number represents about 3% of the US population. Of course, some people are mega rich because they’re members of the ultra-exclusive “three comma” club with at least $1,000,000,000. The United States has the most billionaires in the world followed by China.

Over time, the term “millionaire” has been shifting to signify individuals with an annual salary of $1 million or more. According to the Internal Revenue Service, you’d need to earn about $500,000 per year to be part of the top 1% of earners. The media talk about the “millionaire’s tax” on high-income earners and additional real estate taxes on expensive homes. Some politicians have proposed a “wealth tax” on the so-called “1%.” This definition of a millionaire is certainly a much higher standard with only about 1 in 400 US households reaching this elusive income mark. Clearly, the definition is shifting over time to identify the true elite earners. Although becoming a millionaire is a lofty goal, this chapter focuses on the traditional definition. Savvy investors know that developing a consistent investment plan using traditional asset classes can potentially help to accumulate the first million, then the second million, and so on. Of course, building wealth doesn’t happen overnight. It’s achievable but involves taking greater risks to gain higher expected returns.

1.2. CAN YOU RETIRE WITH A MILLION DOLLARS AND LIVE COMFORTABLY?

This is truly the “million dollar” question. The goal of investing is to accumulate assets to improve or maintain your lifestyle, particularly in retirement. As previously noted, no “one size fits all” approach is available to building wealth or becoming a millionaire. The right approach for you depends on several important factors such as your expected time horizon, spending patterns, tax status, and planned bequest to heirs. As a starting point, you should note some important but general observations in the Table 1.1.

Table 1.1. Factors Affecting Retirement

Factor	Change in Retirement
Retire later	More comfortable
Withdraw more	Less comfortable
Longer life expectancy	Less comfortable
Higher tax rate/location	Less comfortable
Larger bequest	Less comfortable

To get a sense of your comfort zone, consider the projected withdrawals in retirement based on the following assumptions (rounded):

Funds at retirement	$1,000,000
Retirement age	67
Life expectancy	20 years
Planned inheritance	none
Earnings rate	4%
Tax rate	15%
Annual withdrawals	$62,500 after taxes

The final result allows you to spend $62,500 each year in retirement for 20 years. At first glance, that sounds like a livable amount, but the analysis ignores inflation. Prices won’t remain the same during the 20 years of retirement. Assuming inflation of 3% per year, a more realistic estimate of your actual purchasing power would be closer to $48,000 per year.

1.3. WHAT TIPS CAN HELP YOU BECOME A MILLIONAIRE?

“If inflation continues to soar, you’re going to have to work like a dog just to live like one.”

George Gobel

Here are the “big four” tips on becoming a millionaire as a saver-investor: (1) save more, (2) spend less, (3) limit taxes, and (4) invest wisely.

• Save more. The first tip seems obvious: save more of your earnings. The more you save, the less risk you need to take to increase your wealth. Although most saver-investors have a modest income, they often save 20% or more of their salary. As discussed in later chapters, you should make sure to save at least enough to get your employer’s 401(k) match, if you’re part of a defined contribution plan. Think of your employer’s contribution to your retirement plan as “free money.” To get this “free money,” you need to contribute a minimum amount specified in your sponsor’s plan.
  According to an old adage, “A penny saved is a penny earned.” In other words, if you spend less, you can save more. And the savings is likely to grow if invested wisely so a penny saved can become two or more pennies in the future.
• Spend less. The second tip is to spend less. Savvy saver-investors live below their means. As simple as this advice sounds, it’s not easy to follow given the convenience of credit cards and “buy now, pay later” offers. According to Experian’s annual Consumer Credit Review, the average credit card balance per person in the United States was $6,194 in 2019. Spending less requires controlling expenses and being disciplined such as sticking to a budget. Otherwise, savings and retirement accounts can dwindle quickly.
• Limit taxes. The third tip is to reduce your tax bill. This step can be a complicated issue and is discussed in more detail in later chapters. For now, the idea that lowering current taxes and/or deferring taxes is good. Sometimes, you can eliminate some taxes entirely based on lifestyle choices such as by installing solar panels to get tax credits, moving to a state with no state income tax, or taking advantage of the gift tax exclusion. Under the US tax code, if the amount stays below the gift tax exclusion, you won’t have to worry about any tax. For example, the annual gift tax exclusion in the United States for 2020 is $15,000.
• Invest wisely. Investing wisely is what savvy investors do and that’s the main focus of this book. By properly using traditional investments you can build wealth over time. To invest wisely, you need to not only to have sufficient knowledge but also the discipline to carry out your plans.

“I’m proud to be paying taxes in the United States. The only thing is, I could be just as proud for half the money.”

Arthur Godfrey

“I believe that through knowledge and discipline, financial peace is possible for all of us.”

Gordon Ramsey

1.4. HOW CAN YOU SAVE MORE AND SPEND LESS?

People are tempted daily with instant gratification purchases. It takes discipline to spend less and live below your means. Try to go just one day without spending money while out of your house – walk/bike to work or pack your own lunch – and you’ll see spending less is not so easy! As many know, those fancy latte drinks can add up quickly.

A safe, prudent guideline to follow is the “pay yourself first” rule. Specifically, make sure that you immediately invest some part of your paycheck before it touches your hands. For example, contribute to your employer 401(k) plan with a direct payroll deduction or your own individual retirement account (IRA) with withdrawals from your checking account after your paycheck direct deposit.

Another easy “pay yourself first” idea is to establish a college savings plan known as a 529 plan with small, frequent contributions. Although the rules about current tax deductions for 529 plans vary by state, many states allow a state tax deduction. Your investment is immediately earning a return while reducing your tax bill. Regardless of where you live, all 529 plans allow the funds to grow tax-free, and the withdrawals are tax-free when used for qualified higher education expenses. The chance to have years of tax-free growth is highly attractive.

Another large expense individuals pay over a lifetime is interest on debt, especially credit card debt. When you buy a car, house, and other products, you may be using debt. The interest paid on that debt is related to your personal credit score. A higher credit score reduces the interest rate ...