What you earn doesn’t determine your wealth

The real confusion for so many is that income is viewed as wealth. The media and the government view them as one in the same. The advent of social media and technology has led to greater confusion. Our social media feeds are filled with consumerism, presenting the bling and shiny objects others have bought. According to a Federal Reserve study in 2015, almost half of all Americans could not pay an unexpected $400 expense without borrowing the money or selling something.

So let's break down income and wealth:

• Income is what you bring home today. It’s the pay you receive for the output of production you generate. It’s attached to you showing up and using your skills and your time in a creative pursuit of commerce.
• Wealth is what you have presently and what you will have also tomorrow and in the future without any effort being added. Wealth will produce more, but it’s not reliant on your additional labor. Wealth compounds even when you sleep.

The most unvarnished scoreboard of financial wealth is your net worth, which is what would you have left if you sold all your earthly assets. If you sold your home, cars, stocks, bonds, furniture, and so forth, how much actual cash would you have once all the debts are paid off? The remaining amount is your net worth. That is the number you are working to increase through saving, investing, and reducing debt.

The Federal Reserve, in 2017, calculated the median net worth in the United States to be $97,300. When the equity in one’s home is removed from the calculation, the median net worth drops to $25,116. When I read those numbers, I was shocked. Those amounts are frighteningly low. The average person has not enough net worth to even last a year without working. What this demonstrates is that earnings are the least of the challenges; it’s the expense side of the equation that causes the biggest issues.

Unfortunately, we spend what we make

Even if you are a high earner and you make more, or even much more, than the average income of roughly $59,000 a year in America, I have found that very high earning people are very challenged by the expense and savings side of the wealth equation. If you truly want to build wealth, it takes discipline in restricting consumption.

I truly believe that social media has played a pivotal role in accelerating our society away from wealth and reduced consumption. We have always been challenged with our consumption as people. Social media has made it easier for marketers to reach us with messages that tempt us with the latest goods we must have. It has created an open conduit of images, experiences, purchases, entertainment, and travel. We are inundated with pictures and tweets about what people are driving, doing, and buying through social media channels. All this leads to greater temptation to spend in our attempt to keep up with the Joneses. What’s also evident is the Joneses are going into debt and spending more than they make to keep up appearances.

Thomas Stanley wrote the landmark book The Millionaire Next Door in 1996. Since that book, he and his daughter, Sarah Stanley Fallaw, have continued their research of millionaires. In 2016, 91 percent of the millionaires they studied rated being disciplined as an important factor of success. And what do I mean by discipline?

• The discipline to create income and transform that income into wealth.
• The discipline to create a budget that balances your earnings and spending in such a way that savings numbers are achieved.
• The discipline to weigh and balance choices of wants and needs. It requires us to accept that we might not receive everything we desire or at least not yet. We must delay gratification of the now for the long-term freedom and security of the future.

Warren Buffett, widely regarded as one of the wealthiest and most successful investors in the world, made this remark about consumption: “The happiest people do not necessarily have the best things,” he asserts. “They simply appreciate the things they have.” Warren is a classic example of reasonable wants and needs. He continues to live in the same house in the central Dundee neighborhood of Omaha that he bought in 1958 for $31,500. He says that he has everything he needs in that house, which is not walled or fenced in. He preaches that we shouldn’t buy more than what we really need. He drives his own car everywhere he goes, having forgone a driver and security people. He could purchase anything on Earth he might desire, yet his spending has limits.

I think we have to figure out what we really need and focus on living below our means so that we can save at the level we need to fund both our present and our future. The athletes I mentioned earlier in this chapter lived at their income or above their income and had nothing left after the high level of earnings stopped. I'm not saying you shouldn't enjoy yourself, and I'm not advocating that we all live in tents and eat boxed macaroni and cheese. But there is a balance and a plan that we all need to control spending and start saving.

How much should you pay yourself?

If you want to achieve middle class now and beyond, you will save 5 to 10 percent of your gross income. That will allow you, over time, to access and stay in the middle class lifestyle and keep that lifestyle through retirement. That might seem unattainable. You might be thinking, “How could I save $100 out of every $1,000 I earn? My budget is so tight and stretched as it is now.” I have never expressed in the last few chapters that any of this would be easy. If you received that impression, I want to dispel that notion right now. It won’t be easy but it will be worth it.

Take a look at Table 16-1. It outlines how much you need to be saving, or paying yourself first.

We all need to make the choice. We choose how we are going to spend our money. We can choose to go to Starbucks less frequently and not pay for the lattes that costs $5.75. If we remove three lattes per week, that is $69 per month. If I brown-bag my lunch more frequently than going out for lunch, that can add up to $100 per month or more. If I quit smoking one pack of cigarettes a day, that’s $170 per month that I have saved. All tallied, we're looking at $339 in savings that I can pay myself first, and the yearly total is $4,068 per year, not including investment earnings. The median income in the United States is $59,000. That $4,068 is 6.9 percent of $59,000. I only need to find another 3.1 percent to guarantee middle-class income for life.

If you desire wealth and financial independence, you can achieve that through saving 15 to 20 percent of your gross income. That is more than most experts profess. The typical expert will tell you that you need to save only 10 to 15 percent to be well off. But I am talking about the wealth that someone, at retirement, has a few million net worth not including his home. That level of wealth puts you into the top 5 to 10 percent. That level of wealth, invested conservatively at 5-percent return, will provide you with an income of $100,000 to $200,000 per year. For most people, that level of income would allow you to not dip into the asset base. You would be able to live off the income or interest produced, never touching the principle.

How long do you make the payments?

If you want to achieve wealth quickly, then you must be putting 20 percent of your gross income into savings. Let me qualify the term “quickly.” Quickly does not mean 5 years, or even 10 years. I think that quickly, when it comes to wealth, is 20 years.

It’s possible to do it in less than 20 years if you find a rare and unique opportunity or investment, or if you save even more than 20 percent and perhaps hit 30 percent. Your definition of quickly might be different than mine. That’s totally fine. Do whatever is best for the strategy you are implementing.

I first created my income and savings plan at the age of 28 with the goal that it would be completed by 59 and a half. (That's the age when retirement accounts are free from the 10-percent penalty for early withdrawal.) There was a family component as well. My father worked as a dentist for 30 years. He was able to retire before his 60th birthday due to his own 30-year plan.

You have to determine the number of years for your plan. Some of you reading this don’t have 30 years or don’t want to take 30 years. That means that you will have to go to the top end of the savings scale. If you only have 15 years, then you better execute the “Wealth Quickly” strategy of 20-percent pay yourself first.

The habit is more important than the amount

Many of you are again thinking, “I can’t carve 10 to 15 percent, or even 5 percent, out of the money I am making.” I completely understand, but that is just an excuse to not do what you know you need to do. I am not saying to do the 10 percent anyway. I am saying that you have to start with something at some level. I didn’t start saving 20 percent of my income. In fact, it wasn’t even 5 percent. I started with 1 percent.

One percent was it. It’s all I could justify. I really didn’t feel I could even afford that, but I knew if I delayed starting to do something, I ran the risk of never starting. I recognized that if I didn’t start the habit, if I delayed even for one month or one commission check, then I was doomed. “Doomed” is a strong word, but I realized that about myself at the time. As the years have gone by, I recognized I was just like everyone else. You and I are no different. In fact, you might be saying the same things I said to myself: “That small amount won’t be worth it. It really won’t make a difference. I should put that toward my debts instead. That small amount won’t get me to wealth or retirement.” But it’s not the amount at first that creates the magic.

What percentage or amount works for you? There is no right answer, only your answer. What does your gut tell you?

What’s easy to do here is to let that small voice of doubt talk you out of doing what you know is right. Ignore that negative voice saying that the small amount you are thinking about saving doesn’t matter. The truth is, it’s the start that stops most people. Don’t let a small start influence the big finish you will achieve and desire to achieve.

Before you read another word, make the decision … right now! It will be the most important decision you ever make in your financial life.

Making your wealth commitment

There's a truism in life called the law of diminishing intent, which I mention in Chapter 3. We've all experienced it on some level. From the moment you intend to do something, your emotion and resolve are at a high level. But the longer the span of time from thought to action, the lower the odds you will actually ever do what you intended. My goal and desire is to help you beat back the law of diminishing intent. I am asking you to fill out the Wealth Commitment document right now:

• Wealth Commitment

  “I, _________________, hereby promise that I will begin paying myself the first ____ percent of my gross monthly income, or per each gross paycheck, no later than _______ (insert date).

• Signed, ____________________________________
• I expect my gross monthly income to be $___________.
• Of this, I will pay myself first the following percentage each month: $___________.
• By doing this, my monthly savings will total $___________.
• In one year, I will have paid myself first $___________.

The next step is to share this commitment with someone. The act of sharing your commitment solidifies it in your mind. It drives a stake in the ground that says, “This is important. I will do this!” Also, give that person permission to ask you how you are doing with your savings and wealth commitment.

Finally, I want you to open up a separate account to put your wealth commitment funds into. Don’t just save them in your other accounts. You need a separate account because you want to see your progress. You don’t want to comingle it with other savings or debt accounts. You want to establish the philosophy that you won’t touch it or dip into it when times get tough or money gets tight.

The amount you start with won’t be the final amount. My suggestion is that you review your wealth commitment. Decide for the year ahead what the amount or percentage should be. Then write up a new commitment contract with yourself. My guarantee for you is that in five years you will be saving vastly more than you can commit to now.

Institute forced saving mechanisms

The use of forced savings that transfers money automatically is one of the secret weapons of the wealthy. Whether you are an employee of a company or owner of your own company, setting up deductions out of your regular earnings to pay yourself first is the pathway to wealth.

Left to our own discipline and commitment, the outcome for many of us will fall short. Most people who achieve wealth have instituted forced savings mechanisms. The secret is to automatically transfer the funds, so you don’t see or miss the money. It needs to automatically be transferred at a set time each month. The other option is to have the money taken out of your paycheck. That’s why I truly believe in company-sponsored retirement plans like a 401k. These programs help you automatically live on less because it is never missed from your paycheck.

I realize that some people are paid less regularly or have swings in income, which makes an automatic savings plan more challenging but not impossible.

Forced savings as a business owner or entrepreneur

Whether a part or all of your income comes from a business you own, it’s easy to not control your earning, income, and savings. You may have a side hustle like Uber, multi-level marketing income, or a side landscape business. I said in an earlier chapter, I have created my own personal economy for more than 30 years, and in that time, I have made numerous mistakes but have also come up with a system of wealth control for business owners.

The first rule is this: Put yourself on a salary. I have been on a set salary for almost 25 years. I take the same salary every month. Joan, my wife, takes a set salary as well for working in our business. The savings contribution to our retirement comes from our paychecks. We are normal, payrolled employees. Our taxes are collected and paid as well. I don’t get my hands on that money. I send it away, so I live within my means. And it becomes easy to max out your retirement contributions through forced savings. We have learned to live on the salaries. Then we put the surplus dividends away in savings or buy new investment real estate with the surplus in company profits.

So how do you determine the right amount for your salary? I think there are a few ways to look at that figure. You can come up with a number based on expenses and savings, and even Social Security can play a role in this wealth strategy plan. I am going to start with the most complex one, which is Social Security.

Most people do not understand even basic strategy with Social Security. The truth is, the strategy for Social Security does not start when you are reaching retirement age. The strategy and planning start 20 to 30 years before then, especially if you have an entrepreneurial business. Using Social Security as an evaluator of what salary or income you draw is important, but few people even factor Social Security into their thinking.

There is a Social Security Benefit Formula in monthly earnings. You get credit of 90 percent of the first $856 months earnings. What that means is that you would receive in benefits if you worked for 35 years and made $856 a month. You would receive 90 percent of that number at your full retirement age, which is $770.40 per month until death. You only need about 10 years of working to qualify for Social Security retirement benefits. For every year you work less than 35 years, the Social Security formula will apply a zero income into the average.

You receive 32 percent of credit toward income from $857 to $5,157 in monthly earnings. That means you receive 32 percent of every dollar earned and Social Security tax paid on the next $4,301 of monthly income. If you drew a monthly salary at the top end monthly of $5,157, you will receive an additional $1,376 in Social Security monthly income at full retirement age. Again, provided you earn that amount for all 35 years, your total retirement benefit would be $2,124 per month.

Beyond the $5,057 per month in earnings, you receive a 15 percent Social Security credit based on earning above the $5,057 per month threshold. So the credit decreases as your income increases. The maximum Social Security income for the year is $128,400. That would be $10,700 per month in income. You can earn more than that, but that is the maximum income that will be subject to Social Security tax.

You can also set your base salary level based on savings. Your salary would be filtered through the savings goals and automatic savings mechanisms you put in place. If you commit to saving 20 percent of your income and need $2,000 in savings going to your retirement nest egg (based on the Kiplinger calculator covered in Chapter 14). Then you need to set your salary at $10,000 per month.

You certainly need to factor in your expenses. What do you need in income to pay your obligations, food, shelter, and fun (along with savings) to reach your financial wealth goals? What does it cost you a month for your personal overhead? You want to use that number plus the savings level that is in your wealth commitment. This enables you to live more easily within your means. When your business does better and dividends and extra income are paid out to you, you can save a large portion of the surplus or spend it in a meaningful way.

Simple steps if you are an employee

Whatever your company is offering for retirement savings accounts, take full advantage of them now. Most companies, large and small, offer some type of 401k or retirement vehicle for their staff. The typical pension benefits of the 50s, 60s, and 70s are long gone in most companies. That doesn’t mean you can ignore what your company does offer. If your company provides a matching feature in the 401k based on what you contribute, you must fund your 401k to that specific level or beyond. For example, at my company, Real Estate Champions, we offer employees up to a 4-percent match of their salary into a 401k if they at least put in 4 percent themselves.

We have some employees who choose not to participate in the plan, even when they are eligible. I have others who put only 2 percent in. When your employer is providing some type of a 401k match, you are turning down a 100-percent return on your money if you fail to take advantage. This 100-percent return is above whatever investment gain you generate. Where else are you going to generate a guaranteed 100-percent return on your investment with zero risk?

Simple steps as a business owner or entrepreneur

There are really countless options and strategies as a business owner to guarantee your retirement success. There are numerous retirement account options that you control the decisions on as an owner.

As a business owner, the foundation is a good flow chart of your wealth plan with accounts and amounts clearly identified. Your wealth plan flow chart moves you from hope, theory, or desire, to execution. I have included a few flow charts in this book that I have used personally and taught to countless small-business owners who are now wealthy. You can see them in Figures 16-1 and 16-2. The differences between the models has to do with where you are going to pay taxes and fund retirement savings. Are you going do it at the corporate level or at the personal level? In some instances, your model might encompass doing that at both levels, and that's when wealth can really be exploded.

As a business owner, it’s easy to feel you are doing well because you see the gross revenue of the company. The employees only see their net check. A company owner can easily overspend when gross revenues are climbing. In reviewing these charts, you might feel there are too many accounts to manage. Wealth Plan #2 (Figure 16-2) has at least four accounts at the personal level:

• Tax savings
• Personal savings
• College savings
• Retirement savings

I have all those accounts and also a few more for investment savings and all the rental properties. I can attest that managing all those accounts requires work, time, and accounting. I also have discovered, for me, that the more accurate and compartmentalized I operate, the more money I can save through control and budgeting. As a business owner, comingling accounts is a bad strategy that can hide problems with the company or financial challenges personally. It can also conceal a lack of discipline.

The “secret sauce” for small-business owners

As a small-business owner, I have had every type of retirement account known to man. I have had 401ks, Sep IRAs, Keough, Money Purchase Pension Plans, Defined Benefit Plans, and Roth IRAs. There is not one that is the best over all the others. You and your accountant need to figure out — based on your age, income goals, and size of company — what options are best for you. All of the ones I mentioned have pluses and minuses, so a true professional is needed.

But the real “secret sauce” is beyond just the accounts you use. It isn’t the type of account; it isn’t a type of investment class (stocks, bonds, commodities, or real estate). The secret sauce for a business owner, especially a small-business owner, is setting up your retirement accounts to be self-directed. As a business owner for almost 30 years, I spent the first 20 following the standard path. I saved my money each paycheck religiously into my retirement accounts. I selected credible financial planners that invested my money in stocks and other investments. I got slaughtered in 1999 in the dot-com correction. I lost over half of the value of my retirement accounts for Joan and myself. Then in 2008, in the most recent downturn, after my accounts had built up again, I lost another 40 percent. After that loss, I was not philosophical; I was mad. I started to look around for the solution to fix this issue. I had saved consistently and done that well. I had not listened to myself and had trusted the judgment of others more than my own. Big mistake.

I found the solution or “secret sauce” in self-directed retirement accounts. A self-directed retirement account allows me more latitude to decide what I invest in. Because I own the company, I can set up all the retirement accounts in my company for the self-directed options. This change in my company’s retirement plan has enabled me to invest my retirement assets in a wider range of investment options. It’s different than when you have a standard, boilerplate plan that feeds funds to Wells Fargo, Morgan Stanley, Edward Jones, or any of the large financial advisor institutions. They generally don’t allow you to self-direct your assets into real estate, businesses, hard money lending, and so on.

I am a firm believer that as a business owner, and especially a small-business owner, you must set up your retirement accounts that allow you to self-direct the assets, but I caution you to invest in what you know. Because I have specialized knowledge in the asset class of real estate, that is where I have directed my retirement funds. I proved through losing almost 50 percent of my retirement fund twice in stocks that stock investing was not my cup of tea at least in terms of my knowledge.

My current retirement funds have enabled me to acquire numerous single-family rentals, duplexes, and four-plexes, as well as an apartment building. All the rents and revenue go back into my retirement accounts, and all taxes are deferred until I need them in retirement. I feel very comfortable with my investments. If the real estate market adjusted catastrophically, I honestly can accept that because it’s on my shoulders. What I have invested in is strong cash flow properties, so the cash flow is unlikely to go away, even if the values correct.

There are also lenders that will loan you funds to acquire real estate if you don’t have enough funds in your retirement accounts to acquire the property. This leverage enables you to control a larger asset while earning income and appreciation without having all the funds presently in your retirement account. Only by establishing a self-directed retirement account do you have access to all these options. It took me 20 years and two financial meltdowns for me to finally get frustrated enough with my situation to learn about self-directed retirement accounts. I moved my company 401k to be self-directed. I combined all my SEP IRAs, Keoughs, and money-purchase pension plans into one IRA to self-direct it all into real estate. If you are a small-business owner, professional doctor, or CPA with your own business, this one move can add millions of dollars of net worth to your retirement and give you stability in your income in retirement. It has been a game changer for me.