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IN SEPTEMBER 2014, The Wall Street Journal published a column entitled “The Simple Secret to Building Wealth.” An early paragraph began thus: “Wealth is born of great savings habits.”
As I read along, I found myself not only agreeing, but also wondering if the author had secretly consulted with my wife prior to penning the column. The similarities between his suggestions and our savings habits were striking.
I wrote an email to the author—who, as you might have already guessed, is now HumbleDollar’s editor—and he graciously wrote back. I described the steps we took going from a negative net worth, when we married at age 31, to a net worth that, excluding home equity, is now in seven figures. This was a 26-year process, although I doubt we had that goal in mind until it seemed imminent. Instead, we just pushed hard to build wealth and reduce debt.
Over the years, in thinking about the process of building wealth, I can offer readers the following six steps. Although the steps are simple, it takes uncommon dedication and discipline to see things through.
1. Save 15% of gross earnings. Dedicate yourself to living on the remaining 85%. You need a mechanism that moves the 15% directly to savings without the possibility of spending it. This may be the most difficult step. Where should the 15% go?
2. Skip the big cash reserve. Contrary to almost everything you read, I suggest skipping the step of building up an emergency fund—in cash, that is. This money is too easily spent. I’m willing to bet that only a small minority of people build up an emergency fund and then truly use it for emergencies only.
My suggestion: Start a Roth IRA in place of the emergency fund. In a few short years, you’ll gain sufficient satisfaction from watching your Roth grow that you’ll no longer be tempted to spend your savings.
There are limits on Roth IRA contributions, of course. Assuming the maximum allowable Roth contribution amount is less than 15% of your gross, the rest should go into your 401(k) or a taxable investment account. I’m a firm believer that the Roth IRA is superior to a 401(k) because you’re free to choose exactly where the money gets invested, plus the account’s tax bill is prepaid. You have far less control over where your 401(k) money is invested and who is actually in charge of investing it, although you do benefit from your employer match.
3. Buy used cars. What you drive is perhaps the most important aspect of building wealth. In Jonathan Clements’s column, mentioned above, he wrote that great savers “take pride in driving their car until the odometer breaks.” My wife and I purchase cars that last a long time. These are top-of-the-line cars, but typically have 80,000 to 100,000 miles on them when we buy them. My wife’s everyday car is a 2010 Lexus SUV with 252,000 miles, bought used with about 80,000 miles at the time.
In other words, let the new car buyer take the huge hit on the initial depreciation and the massive amount of sales tax. After all, these cars are built to go hundreds of thousands of miles. I drive a 2008 Chevy pickup truck with 231,000 miles on it. We have, as a backup vehicle, a 1999 Toyota Avalon with 358,000 miles on it. All three vehicles are in perfect running condition and we will drive them until death do us part.
Consider how much money is lost in the transaction for a new car. The sales tax alone is enough to dissuade me from ever buying a new car, let alone the interest costs on a car loan. Once you build some wealth, you can buy the types of vehicles I’m suggesting with cash. We bought our 1999 Toyota Avalon in 2005 for $11,000 and it had 98,000 miles on the odometer. We’ve been driving it now for 17 years.
4. Prepay your mortgage. We all know that, if your return in the financial markets exceeds your mortgage interest rate, paying off your home loan early is not fiscally prudent. Still, I would suggest some acceleration in the paydown. A 30-year mortgage can be reduced to 25 or 20 years with a certain amount of extra principal paid each month. The psychological advantage of living mortgage-free is huge. Once paid down, you can then seriously ramp up your monthly contributions to your portfolio.
5. Required reading. The most important book to read is The Millionaire Next Door. Indeed, Jonathan references this book in his column I mention above. The book profiles typical American millionaires, and their habits and lifestyles. It also profiles typical high spending-low net worth Americans, whose goals are opposite of the wealth builders. These people seek status at all costs.
6. Suggested reading. I’d also recommend The Little Book that Beats the Market by Joel Greenblatt. As your net worth grows, you’ll need to learn to handle your investments. This book will guide you. I have been implementing Greenblatt’s suggestions since 2011.
As they say, “A journey begins with a single step.” Start with No. 1 above—and, after a few years, you’ll see it for yourself.
A native of Hershey, Pennsylvania, Charles Wilson recently retired from his custom homebuilding business of nearly 30 years. He holds music degrees from Pennsylvania’s West Chester University and Boston University, and is a former member of the USMA Band, West Point, New York. Chuck and his wife have two children and reside in Westminster, Maryland.
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Congrats on your success. The only point where I have my changed my position on is #3. We used to be proud of driving our old beater, a 2001 Rav 4 with 160K miles, until it suddenly gave out in early 2023. It was a near death experience: as I accelerated to 40-45 mph on a highway on ramp preparing to merge, the rear differential failed and both rear wheels immediately locked up, sending the car swerving and spinning out. Luckily I was on the on ramp still and the car behind me had enough braking distance. 2 seconds later and I would have been on a busy highway, and likely in a serious car accident.
It’s simply not safe to drive old cars past a certain point. They seem fine until one day, when they aren’t and you can’t predict when it will fail. Not saying new cars can’t fail too but statistically, it’s much higher with very old cars. I don’t have the stat but I recall seeing one quoted where a good majority of car accidents involved old cars (10+ years).
Readers –
Many thanks for taking the time to read my recent column. Your comments make me realize how much content can’t be included in a short column.
Looking back, we bought a 20 year term life policy once we had a house and kids. Of course this is a major topic of major importance and one that I somehow did not even consider including in the column!
My suggestion of starting a Roth account first – I say this not as a substitute for emergency funds but as a way to dive into the markets as soon as possible. And since a Roth is allowed to invest in individual stocks, you can maintain complete control and beat the market (see Greenblatt’s “Little Book that Beats the Market” and also Carlisle’s “The Acquirer’s Multiple”). Their books are short and simple and their stock lists are free and beat the hell out of the market. All it takes is some seed money and desire…then mostly stomach until you get used to the somewhat higher risk level.
Best regards to all!
Chuck
I think cash reserves are much more important for those with minimal financial assets. The “x million Americans who can’t handle a $500 emergency” crowd. Once one is wealthier, they likely keep enough in their checking account float to handle most emergencies. These folks will also have multiple credit cards with high credit limits, but pay off the cards monthly and don’t carry a balance, so a subatantial amount of funds are available immediately. Not to mention various investments, which if allocated properly, it is unlikely that all would be down at any one time, so cash could come out of them. If the cash emergency could not be handled by the above, then you have a black swan event that should have insurance coverage.
I have a different take on prepaying a mortgage. If I prepay and have a crisis or emergency I am going to get absolutely no sympathy, or credit for the prepayment from my mortgage holder. Instead I put the money into my normal investments at my normal asset allocation. If I accumulate enough, I can pay off the entire remainder of the mortgage. If I have a need for money before the mortgage is paid off, I have it available. If I don’t have a need I can pay the entire mortgage off. In most cases this will result in an earlier payoff than pre-payment since market returns are usually higher than mortgage rates.
You’re right about the illiquidity of prepayments — but you can sidestep that with a home-equity line of credit. Meanwhile, in terms of returns, you’d have done better prepaying your mortgage than buying high-quality bonds for most of the past four decades. That calculus changed over the past year, thanks to rising interest rates. Still, if you took out a mortgage today at 6%, you’d be hard pressed to earn a better return in the bond market than you’d get by prepaying. Yes, you should do better in the stock market — but that involves significantly more risk.
It’s my understanding that the purpose of an emergency fund is to provide liquidity to pay unexpected bills so you aren’t forced to sell stocks to raise cash. For this purpose, an emergency fund is not an investment, but a form of insurance.
I agree that there should be limits to the size of an emergency fund — you don’t want to over-insure.
Certainly, the cash sitting in an emergency fund can give some people an incentive to spend it. But if you are a serious saver, buy used cars, and prepay your mortgage, I can’t believe that raiding your emergency fund for discretionary expenses is a significant risk. You already have the discipline to use it responsibly.
Automated savings – and as much as possible. Check. Hi miler, low cost, reliable vehicle. Check. Reading the words of wisdom from those who have already treaded the same trodden trails. Check.
Now – about cash reserves and prepaying your mortgage. To me, those two are very situational, in part based on life stage, and in part based on the amount of investable assets one has.
We never really thought about cash reserves while working because we usually had more than enough in our checking account at any given time to pay for an unexpected expense. Now at retirement, though, sequence of returns risk (SORR) has made us rethink how much cash we want to keep on hand. And I’m glad we did due to the historic market declines of the last 12 months.
LTC insurance is similar. Once one’s net worth exceeds a certain amount, it makes more sense to “self insure” than it does to pay now for coverage one may not ever need.
Prepaying the mortgage can make sense – and we’ve done it a lot over the years. But with interest rates rising quickly, and our last refi done a couple years ago for around 2% fixed, it makes more sense to stop prepaying it and just let it ride. After all, Treasury bonds are paying twice that – so why pay off what in effect is free money when it’s better to leave extra funds where they can work harder?
Ironically, we have a large emergency fund, mostly acquired after selling our long-time home in 2019.
Sorry—I hit “post” accidentally. Anyway, the ironic part is that we really don’t need it right now. When we needed it, we couldn’t really afford it, and so we did do the Roth IRA thing, plus a HELOC as someone below suggested.
At the moment we are not prepaying our mortgage. We bought our home in 2019, refinanced in 2020 when the rates were great, and with the way they’ve jumped up again, we’re happy with what we have. When we retire, we will easily be able to pay our mortgage, so it doesn’t make sense to prepay such an efficient ezones e.
I have two alternative ideas:
1) Instead of a large emergency fund, we had a small one, invested most of our savings. Then since we owned a house we had a home equity line of credit (HELOC) as my job in later years was with a company who worked under contracts so I was laid off a few times. The plan is to never use for wants only to cover loss of employment. With a HELOC you only have to pay the interest until one is re-employed, then you can pay off the balance over time when re-employed. Luckily this was never necessary.
2) Buy new good quality cars and keep them until they die. Bought a 2002 standard cab two wheel Toyota Tacoma pickup for 13K, owned for 17 years, sold for a few K. Maintenance always performed per the owner’s manual. Other than regular repairs like new brakes only spent a few thousand on unexpected failures.
BTW, bought a loaded 4WD Tacoma with all the whistles at retirement at 63 at my wife’s urging which I plan to drive until I’m no longer able.
PS Also live close to work which decreases maintenance and commuting expenses.
Instead of a cash emergency fund I always had an emergency plan. Every 6 to 12 months we would consider what to do if we needed 2 months income immediately. Then we would think about what if we suffered a loss in income (job loss, injury, etc.). Essentially we listed our assets by which would be the least painful to sell. We kept enough cash in the bank to make ordinary payments, and maybe another month or so of income, but nothing big enough to encourage a splurge on some marginally necessary luxury. When we had a job loss, the plan prevented panic and we immediately shifted to a lower standard of living. Came out smelling like roses and with an even higher saving percentage when a new job came along.
I would add 1 more to your list. And that is to make sure that the family has an appropriate amount of insurance(life, umbrella and LTC) to cover the uncertainties of life. An early in life unexpected passing of a spouse can seriously deter any kind of financial plan. I know that everyone does not like LTC insurance because of the uncertainties of premiums later on. The best way to buy this type of insurance is to use a good insurance broker who can steer you to a state LTC insurance partnership plan.
When I got out of college and started my professional career, I continued to drive the old hand-me-down family car. I could not understand the thinking of many of my friends who immediately bought a new car with huge car payments. I was able to start saving & investing 20% of my income (thanks to sound advice from dad). Fast forward to today – I’m comfortable retired and enjoy reading Humbledollar.
Love the article. Much like your initial reaction to Jonathan, I am wondering if you have been talking to my wife.
I have even gotten pushback here on Humble Dollar to buying cars in the 80,000-100,000 range and driving them until the wheels fall off. (Or, the odometer breaks, as you put it.) The financial rewards are so big for doing so.
Thanks again for the wonderful article.
Never ever had an emergency fund; fully invested always
Your investments are liquid if you get in to a bind
I like this approach and have been tending towards it myself. We keep around 2x our average monthly spending in a high yield savings account to pay our monthly bills and keep the remaining “emergency fund” (if you can even call it that) in a standard taxable brokerage. It is around 2x what we would spend in 6 months, so even if it fell by half we could still utilize it for 6 months.
#2 I disagree. Many employer 401k plans have more choices than necessary and the average worker does not need more than basic funds. What happens if the emergency occurs in a market downturn? Cash is desirable.
#3 250,000 miles on a 2019 car, wow that’s a lot of driving. My 2014 has 108,000 miles and that’s after three trips around the US and a dozen trips from NJ to Florida- and it just needed $4,000 in engine repairs. You sure aren’t a car guy, I’ll say that.
The suggestion to use a Roth IRA as an emergency fund may be good for many people, but it should also caution that you can only withdraw your contributions for use in an emergency, not any of the growth. Otherwise there are significant tax implications (prior to age 59.5 and barring certain special circumstances). Series I Savings Bonds are another good option for emergency savings (assuming you can get past the initial 12 month required holding period).
Charles, I could not agree more with the practices above. Especially starting with saving 15% of earnings. It’s important to pay yourself first. Ensuring you have security and peace of mind in your financial health. I believe it goes hand in hand with the status seekers versus wealth builders. It takes very little effort to invest in an index fund or start an IRA. Depending on your IRA balance, there are free “robot advisors” for an even more hands-off approach. My friends and I often joke about the net worth of an older adult with questionable fashion sense. Especially in comparison to younger adults with jewelry and designer clothing.
I disagree with skipping big the cash reserve. This may be currently influenced by the very high yields on high yield savings accounts. However, I find it psychologically comforting to hold onto a decent chunk of cash. Thats not to say this cash couldn’t be used to buy short length treasury bills or CDs. I do agree however that you need to be responsible holding onto that much cash. Seeing a high balance in the bank may boost your ego in the wrong way and cause erratic spending.
Just as the psychological advantage of paying down your mortgage over investing cited in the article, I feel a huge psychological advantage of holding my emergency savings in cash.
I also agree though that there are great ways to maximize return on the cash, with very little or no risk. High yield savings, I Bonds, Treasury Bills, etc.
Heck, a 4-week T-Bill is currently yielding 4.5%. Strikes me as a not so terrible way to store cash for a rainy day and when circumstances change, it’s easy to get your money back and seek alternatives.
I concur, Brent. I think the psychological aspects of personal finance are as relevant as the math. I find holding ample amounts of cash and paying off my mortgage psychically reassuring, but wouldn’t argue with those who achieve the same sense of security using credit lines and carrying mortgage debt to maximize their stock investments.
Charles, thank you for good, straight-forward advice about saving and building wealth.
Charles, congratulations on your retirement. Your first suggestion is one of my favorites – automate your savings and go from there.