My name is Damon Gonzalez. I am 38 years old, and if everything goes as planned, I will be financially independent in the next two to five years. I fortunately love my job and hope to work into old age.
Financial pundits make forecasts and try to tell you what stock they think you need to own for the next quarter, but have you ever wondered what they actually do with their own money? I am a little uncomfortable sharing such information, but I thought it would be refreshing to share how my wife and I have planned for our own retirement. (For related reading, see: How to Budget and Spend to Maximize Your Happiness.)
Invest in Yourself
All honest work is valuable, but it is hard to build wealth on a meager income. Every once in awhile you will read a story about a cleaning person who gave a substantial amount of money to charity or a man who died with $7 million worth of gold in his $100,000 house. These stories fascinate us because they are so rare and unexpected. There are ways to build a successful retirement on almost any income, but having a higher income obviously helps a lot.
If you want to build wealth, your best investment is being the best you that you can be. That means getting enough sleep, eating well, not abusing drugs and alcohol, and working hard. An education—one that encompasses more than just going to school—that allows you to become a professional or start your own business is probably the best money and time you will ever spend. Don’t shy away from investing in yourself.
My wife worked very hard to get a master's degree in tax and slaved long hours to work her way up at a Big Four accounting firm. Later in life, she transferred the skills she’d picked up from accounting and the relationships she made along the way into a career as a recruiter.
I started out as a financial advisor when I was 22 years old and had no idea how hard it would be to build a business from the ground up. For the first few years, while my friends were going out and having fun, I was cold calling and working five and a half days a week. My manager even made me work extra hours so I could take a weekend off to be in a friend’s wedding. In addition to the long hours I was logging at work, I used my free time to study for a Certified Financial Planner designation. To this day, I take classes at the community college and read dry academic books about investing and financial planning on the weekends to keep my skills sharp in this very competitive world.
I strongly believe that an investment of time and money into building your skills is the most important part of a financial plan. (For related reading, see: Investing Strategies to Avoid and Embrace.)
Take Care of the Downside
Bad things often happen to good people. You never know if you are going to get sick or hurt or what accident is waiting around the bend. Having a cash reserve is the second step in creating a sound financial plan. It seems like an unexpected emergency comes up every year. You may not be able to predict what will happen, but factoring the probability of something happening is important and can save you a lot of money, energy and sanity down the road. (For related reading, see: How to Build an Emergency Fund.)
In my case, this year our 12-year old HVAC system broke a month after we spent a substantial amount of money repairing our home from a hailstorm. As a general rule of thumb, my wife and I try to keep about $20,000 in our cash reserves and have a liquid brokerage account that we can tap into in the unlikely event that our emergency requires greater financial support than that. Since bank accounts are paying close to zero, I prefer to keep a smaller reserve in cash so we can have more money working for us in our liquid brokerage account.
We recognize that our most valuable asset is not our house or a 401(k) plan. Rather, it is our ability to get up each day and go to work. A good financial plan protects the downside and your most valuable asset—you. I hate paying thousands of dollars in premiums each year for something I don’t want or expect to happen, but an accident or sickness can ruin your financial life and it is nice to know that we will not be a burden to our families if one or both of us become disabled.
My wife has a $500,000 term policy, and I have about $1.5 million in permanent life insurance that will help the survivor in the event of a premature death. We also have the maximum amount of home and auto insurance our carriers allow as well as an umbrella policy. Lastly, long-term care insurance is not just for the elderly. We bought a policy when we first got married and are glad we did because a new policy today would cost more than double what we currently pay. (For related reading, see: Using Indexed Universal Life for Retirement Income.)
Sock It Away
Once you have invested in yourself, can save and have taken care of the downside, it is time to start building wealth. You might be surprised to learn that my wife and I don’t have a budget. We are natural savers; we pay ourselves first and make spending decisions with what is left over. Setting up automatic savings into 401(k)s, brokerage accounts, and IRAs works really well for the bulk of Americans.
We also have been leery of lifestyle creep. As our incomes have gone up, we have kept our lifestyle at the same, steady level. When you subtract the principal we pay on our mortgage, taxes, giving, and savings, our spending only comes out to about 35% of our gross income. Keeping our expenses low and choosing not to have children has helped us achieve our financial goals.
Studies show that you can maximize your happiness by spending on experiences and on others instead of on stuff. While we could afford much nicer things, I don’t think we would be any happier if we had them. We would much rather be financially independent than splurge on things that would only be acquired to try and impress others. (For related reading, see: Ways Money Can Buy a Little Happiness.)
Although we spend well below our means, we don’t feel like we are missing out on anything. I get an enormous amount of joy by spending much of my free time reading books ($100/yr), watching Netflix ($285/yr) and playing basketball at my gym ($155/yr). I also mow my own lawn and am happy to eat most of my meals at home. I recently sold my 16 year-old Camry with 240,000 miles on it and replaced it with a $25,000 vehicle that I am very pleased with. Wall Street wants you to focus on the Sirens of getting rich quick with a good stock tip. The reality for most people is simply this: how much they save is more important than the return they receive on those savings. After all, the S&P 500 is barely up after inflation since the year 2000. (For related reading, see: Paying Down Debt Early.)
How We Invest
The first thing my wife and I do each year is make the maximum allowed contributions to our 401(k) plans on a pre-tax basis. Because I am self-employed, my company can make an additional profit sharing contribution of 25% of my W2 wages into the 401(k). Unless the government dramatically changes the tax rules, we should be able to pull this money out at the very low 15% tax bracket when we are retired. One-hundred percent of my wife’s 401(k) is in a boring balanced fund that is 60% stocks and 40% bonds and cash. My 401(k) is invested half in one bond fund and half in 3 stock index funds. (For related reading, see: 401(k) Contribution Limits in 2016.)
After we save into the 401(k) plans, we save into a whole life insurance policy and an indexed universal life insurance policy that were designed for retirement savings. I like these policies for their tax benefits and because they don’t lose when stocks drop. We don’t need really high returns to reach our goals, so why take on a bunch of unnecessary risk?
We also contribute the maximum amount we can each year to a health savings account (HSA). This gives us another tax deduction for the current year and another cash reserve that can be used to pay for medical emergencies. We pay for healthcare expenses from this account tax free, and anything we don’t spend gets moved over into a balanced fund for long term growth. We have almost $20,000 saved in this account and it will be nice to be able to rely on it to pay our healthcare expenses when we are older. (For related reading, see: HSA vs. FSA: Navigating the Alphabet Soup.)
Another way we force ourselves to save is through our 15-year mortgage. We bought our current house when I was 35 years old, and there was comfort in knowing that if we never paid extra toward the principal, we would have a paid-for house by the time I reached age 50. The inventor of the 30-year amortization schedule was a mad genius. It almost doesn’t matter how low your interest rate is; you pay very little in principal in the first 10 years and many people move or refinance before they build up much equity in their home. There are benefits to getting a 30-year mortgage instead and investing the difference, but at the end of the day I don’t care. I don’t like debt, and it feels great to be knocking almost $20,000 per year off the principal of our mortgage.
After we have covered these first four buckets, we either pay extra towards our mortgage or save to our taxable brokerage account. The target mix for the brokerage account is simple like my 401(k): half in stocks and half in municipal bonds. Since we don’t keep a ton of cash reserves, it is good to have some conservative, tax-free bonds in our liquid account in case we need to sell something while stocks are in the middle of a bear market.
The Bottom Line
I am sure some people will be disappointed with how boring my financial plan is. It would be a lot more exciting to read about how I discovered some formula to get 25% annual returns. Unfortunately, the markets are almost impossible to beat over long periods of time, and the best thing most of us can do is buy low-cost index funds, reduce our taxes and buy and hold a portfolio that we can stick with for decades. There is no get-rich-quick scheme that will fix our financial problems overnight. There is only hard work driven by a solid plan.
The research in The Millionaire Next Door concluded that most millionaires didn’t win the lottery or get a big inheritance. The most reliable way to become a millionaire is to work hard, avoid lifestyle cree, and keep saving year after year. As Carl Richards has said, good financial planning should be short-term boring and long-term exciting. (For related reading, see: How Your Investing Misbehavior Can Cost You.)
Damon Gonzalez is a certified financial planner and president of Domestique Capital in Plano, Texas.