How to Build Wealth, Part 1

Whether you make $25,000/year or $250,000/year, it is still possible to be either wealthy or broke. Broke? On $250,000/year? I agree that it sounds ridiculous, but it is too common of a story. You also may ask, “How can I be wealthy on my modest $25,000/year salary?” It is simply living within your means, being able to put a certain amount away each month/year, and then letting compound interest do the rest.

First of all, I would define being wealthy as the ability to not have to work and maintain a desired lifestyle. This is different for everyone. There are almost an unlimited number of financial/retirement calculators on the web, and I encourage everyone to take advantage of these ASAP. I know there are many ways to build wealth, but I will try to explain how to do it in the simplest terms possible.

We can use the two figures I mentioned earlier ($25,000/year and $250,000/year). Let’s first look at the person making the measly $25,000 per year. For arguments sake, let us also assume that this person is 25 years old and will never receive a pay raise. She wants to retire sometime, but doesn’t know exactly when. We can also assume that this person wants to maintain her lifestyle when in retirement.

This person spends $500/month in rent, owns his/her car, spends $175/month on gas, $300/month on food, and $100/month on miscellaneous. This totals $1075/month in living expenses. While this would definitely be living very minimally, it is possible to live this way. This would give this person approximately $1000 per month to work with. This person also has around 40 years until she will retire.

Let’s say that she took $500/month and put it into an online savings account making around 5% and the other $500/month and put it into a brokerage account making an average of 6-10%. After one year of doing this, she would have a little over $6000 in each account, and be 26 years old. Already, this is more than most others her age. At 30, this person would have around $35,000 in the 5% savings account and at an average of 8% in the brokerage account, it would be worth about $37,000 which is a nice start to retirement.

Now, let’s assume that this person buys a small house or condo and her mortgage payment is only $500/month because of great credit, significant down payment ($30,000), and inexpensive home value(under $200,000). Let’s say at this point the person wanted to save only $200 a month into her savings account and bump up the amount being put into the brokerage account to $800/month.

At age 40, this person would have around $32,000 in her savings account, and in her brokerage account she would have around $230,000. This time, let’s say she wants to keep $7,000 in her savings to cover six months worth of expenses just in case something happens. At this time, I would also recommend looking at her mortgage, and shop around to see if she can refinance to get a better rate. This person uses $15,000 to buy a new/used car and moves the other funds into her brokerage account (which would now total around $241,000).

Let’s assume now that she figures out that she wants to retire at age 60. How much money is she going to have upon retirement? Will she be able to maintain her lifestyle while paying for extra things like medical expenses? Well, when she reaches the age of retirement (60 in this case), she will have approximately $19,000 in her savings and in her brokerage account she would have more than $1.5 million!

This is an incredible achievement and would allow this person to actually live far better than she has in the past. In Part II, I will give the opposite example and present ways to avoid getting trapped. Please contact me if you have specific questions.