8 Laws of Investing from the Millionaire Next Door

• 
  
• Tweet

A nice primer to beginner investors by  David Young

In the year 2000, my personal life and financials were in the toilet. I was in my early thirties, my marriage was breaking up and I had to borrow against my meager 401(k) funds to settle with my ex. My net worth was right around zero. Since 2000, I’ve managed to increase my net worth around $1 million during one of the worst investment periods in recent memory. And no, I didn’t get lucky with company stock options, win the lottery, receive an inheritance or even rob a bank.

I’m one of those “millionaires next door” who you may have heard about. My wife and I (yes, I eventually re-married, and it’s definitely better the second time around) have two kids, ordinary white collar careers and a shared financial philosophy that has enabled us to build wealth even during difficult economic times. We call these our “Eight Laws of Investing.”

1. Live BELOW Your Means – With everyone under the sun sending you pre-approved credit cards and offering special financing on homes, cars, appliances and furniture, it’s frighteningly easy to obtain a lifestyle that’s richer than your actual income. At our house, we carry no credit card debt and make sure at least 20 percent of our net income is left over to save and invest. If that means we can’t have that huge pool or we have to buy a Toyota instead of a 5-series BMW, so be it.

2. Keep a “Rainy Day Fund” – It’s almost inevitable that at some point you’ll face an income disruption, whether it’s from an illness, corporate downsizing, divorce or other unforeseen event. Having a rainy day fund in a liquid asset (an interest-earning money market account is a good option) that covers six months of expenses will help you avoid a nightmare scenario of racking up credit card debt to pay the electric bill or incurring huge penalties by cashing in other investments like 401(k)s, IRAs or CDs. It may take awhile to build up this fund, but when you do, you’ll definitely sleep better knowing it’s there.

3. Take Advantage of Your Company’s 401(k) Match – Though less companies do it these days compared to a few years ago, a 401(k) match from your employer is literally free money you should take full advantage of. At a minimum, you should contribute at the company matching level (for example, if your company matches the first 3 percent contribution dollar for dollar, your minimum contribution should be 3 percent). The compounding impact of this “free money” over time can mean tens of thousands of extra dollars in your retirement fund.

4. Dollar Cost Averaging – Simply put, dollar-cost averaging means making measured investments consistently over time. This allows you to create a kind of built-in hedge in your portfolio so you have less exposure to short-term market fluctuations. And avoid “market timing” at all costs. You might get lucky a few times (especially during rising market periods), but in the long-term, no one’s smarter than the market.

5. Diversify! – Remember the saying about all your eggs in one basket? A good investor probably came up with that! Diversifying your investments across domestic stocks, bonds and international stocks spreads out risk and stabilizes your portfolio. There are lots of great articles on investment websites about how you can diversify based on your age and risk tolerance, one of my favorites being The Coffeehouse Investor (and just so you know, I have no financial connection to the author or the site, it’s just a great common sense approach to investing).

6. Investing in Index funds – I love index funds. You get the benefit of diversification coupled with low-cost “passive” management. The most popular index funds carry investments that track to well-known market indices (e.g., an S&P 500 Index fund carries the stock of companies that make up the S&P 500), enabling you to instantly diversify across the spectrum of companies in a particular market or industry. And many index funds these days have initial investment requirements as low as $1,000.

7. Take a Long-Term View – Over the long-term (meaning many years, not weeks or months), a diversified, consistent and disciplined approach to investing in low-cost index funds can reap great rewards. You won’t see quick results, but by following the guidelines described in this article, doing a bit of homework and living below your means, over time you can build a portfolio that will weather short-term storms in the market and build wealth and security for you and your family.

8. Let Yourself Splurge, Within Reason – Just because you’re financially responsible doesn’t mean you have to live like a monk who’s taken a vow of poverty! As long as you stay on track, with your spending, saving and investing reflecting your long-term goals, it’s okay to splurge on the occasional ski trip, tennis lesson or new gadget from Apple you simply must have.

So there you have it, eight simple laws. Not exactly rocket science, is it? And it shouldn’t be. With a sound long-term strategy and a consistent, disciplined approach to managing your money, building wealth can be achieved even during challenging times.

For more ideas on how to bolster your finances, check out Quizzle.com, where you’ll learn how to achieve your credit potential and get home loan recommendations tailored to your unique situation. And check out these other, great money-saving articles:

No related posts.

Related posts brought to you by Yet Another Related Posts Plugin.