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Simple Truths for Creating Wealth

J. Patrick Collins Jr., CFP®, EA

Clients often come to us looking for the magic formula for wealth creation.  We typically respond with the same answer, “It’s not our job to make you rich.  Our number one responsibility is to protect what you currently have and help you grow your wealth to achieve your goals.”  We believe there are three simple truths when it comes to wealth creation that we have outlined below:

1.  Save at least 12 percent of your income per year:  spending less than you earn is the cornerstone of wealth creation.  Unfortunately, the savings rate in the United States is currently hovering around zero.  The “buy now and pay later” mentality makes it difficult to fulfill this simple truth.  For example, a 30 year old who earns $50,000 per year (with an annual 4% COLA) and saves 12% of his/her income for 35 years will be able to replace approximately 65% of their pre-retirement income at 65 (1).

2.  Relish Risk:  as you save 12 percent of your income per year, it is important to invest in vehicles that adequately compensate you for the risk you take.  The statistics below (2) measure rolling 30 year periods from 1926 to 2004:

Number

Of Periods

Percentage of Periods

Of Outperformance

Results

589

100%

Stocks outperformed bonds (3)

589

86%

Small companies outperformed large companies (4)

583

93%

Value stocks outperformed growth stocks (5)

As indicated above, the risk that you take often has a direct correlation with the returns you achieve.  Designing an optimal portfolio to manage both risk and return is extremely important in the wealth building phase of your life.

3.  Pay off Debt:  this truth is frequently overlooked since it is not often preached by financial institutions.  A high debt load can create a hindrance on savings for the future.  If 40 percent of your income is paying off debt, and 30 percent goes to taxes, it is very unlikely that a family will be able to save 12 percent and have enough left over for regular spending.  Families should strive to keep their debt to income ratio (total debt payments divided by gross income) below 25 percent.  By doing so, you will not only have additional income to save, but you will limit the interest you are paying to lenders.

While this is not meant to be the magic formula I spoke about in the first paragraph, these simple truths will help you and your family continue to build and create wealth for the long term.

(1) Assumes a 9% return and Social Security Benefits collected at age 65

(2) Data from Dimensional Fund Advisors research

(3) S&P 500 vs. 1 month T-bills

(4) S&P 500 vs. CSRP 9-10 Index

(5) S&P 500 vs. US Large Value Index

The information in this article is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, and does not purport to be complete and is not intended as the primary basis for financial planning or investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.