Author David Bach argues that financial freedom doesn’t come from how much you earn, but how you manage your earnings—if you’re not saving your money with your current income, you’re unlikely to save it in the future. This is because people often increase their spending in line with their income and always have an excuse to avoid saving for the future. The result is that many people miss out on a huge opportunity to enjoy financial freedom. Bach’s Automatic Millionaire process, which we’ll call the “automated path to wealth,” will teach you how to make smart financial decisions, automate your finances, and build your wealth using only a few dollars a day.
Why Do We Often Avoid Saving for the Future?
Bach believes that we struggle to save simply because we’re tempted to spend all of our money before we get a chance to save. But, according to Ramit Sethi, author of I Will Teach You to Be Rich, there’s a more complicated psychological reason underlying this tendency. Sethi argues that people tend to avoid planning their future finances due to:
Decision paralysis: When they’re presented with too many options for how to save, they feel too overwhelmed to make a decision.
Blaming the system: They choose to focus on economic disadvantages that they can’t control. For example, they believe that those born into privilege have more financial advantages than they do.
Sethi advises you to switch your focus and start taking small proactive steps towards financial success.
If you’re wondering if you can spare a few dollars every day, this first step of the process will help you to examine and understand how much money you’re currently wasting and the savings you’re missing out on.
Bach claims that we all waste money on small expenses that add up over time. For example, a Netflix subscription might seem like a small expense because you’re only paying $8.99 a month, but it adds up to $107.88 per year.
The sooner you identify your unnecessary expenses, the sooner you can eliminate them and put the money you save towards building long-term wealth. Bach suggests the following exercise: Track all of your expenses over the next few days and identify where you’re spending your money. Once you’ve collated all of your expenses, consider if there are any expenses that you can cut out or reduce.
Choosing the Right Expense-Tracking Practice for Your Needs
In his book, Bach suggests you track your expenses for a few days to figure out where you're wasting your money. However, this isn’t going to give you a complete picture of how you spend your money month by month, especially if you have irregular spending habits. To track all of your expenses over the long term, he recommends the Mint app.
Sethi also recommends that you use similar apps to track your spending. However, in contrast to Bach’s argument that you should track with the goal of eliminating all unnecessary expenses, Sethi suggests that you track with a focus on spending mindfully. Split your expenses into four areas (fixed costs, investments, savings, and guilt-free spending), decide in advance how much you want to spend in each area, then allocate a portion of your income to each.
The core principle of the automated path to wealth is that you must automate your savings and investments to ensure financial success—the more you automate your finances, the more likely you are to grow your wealth because you won’t have to rely on willpower and discipline to avoid wasteful spending.
Bach explains that the only way to improve your financial security is to arrange to automatically save 10-15% of your income before you even have a chance to spend it. He claims that you’ll quickly get used to living without this money, and you won’t need to rely on sticking to a budget to build your financial security.
(Shortform note: Dan Ariely, behavioral economist and author of Predictably Irrational offers clarity on why you’re more likely to achieve financial security by automating your finances. His research reveals that you’re more likely to make irrational spending decisions when you feel emotional—you see something you really want and feel an emotional urge to possess it. This is because your emotional side overpowers your rational side, and you’re less able to think about the consequences of your decisions. Automating your finances eliminates this possibility: Your emotional side can’t “commandeer” money that’s automatically managed.)
Bach argues that putting a few dollars aside every day by itself won’t make you a millionaire, but investing those dollars in the right type of account will. When you invest your money in an account that pays compound interest, you leverage your money—that is, you use it to generate further income in the form of interest payments. For example, if you invest your money in an account that pays you 10% annual interest, this means that you’ll receive an extra 10% of what you invested after one year: Invest $100 and after a year, your money will be worth $110.
Thanks to compound interest, the interest you earn also earns interest—the $110 after another year will be worth $121 ($110 + 10%). The more money you continue to add to this account, the more interest you’ll earn. This is how compound interest transforms small, consistent amounts of money into free money over the course of time.
(Shortform note: Calculating compound interest as Bach suggests can seem daunting if you’re not mathematically-minded. Use a compound calculator to figure out how much money you could earn from the small, wasteful expenses you chose to cut earlier in this chapter.)
What Is Wealth?
Bach’s advice here isn’t revolutionary: The majority of finance books, including I Will Teach You to Be Rich and The Barefoot Investor, also discuss the benefits of applying compound interest to grow your savings. The general consensus is: If you want to create wealth, take advantage of compound interest to grow your money.
But what exactly is wealth and how do you differentiate it from having a high income? According to the authors of The Millionaire Next Door, wealth is defined by what you accumulate. So even if you earn millions, you’re not considered wealthy if you spend it all and don’t invest any of your money. On the other hand, if you earn a modest income but invest a portion of your income, you can accumulate great wealth.
Another way to define if you’re wealthy is to figure out how much you need to work to survive and maintain your lifestyle. Do you need to work every day just to keep up with all of your expenses or do you have breathing room in the form of savings and passive income? Compound interest is a form of passive income because it earns money for you even when you’re not actively working.
The next step in Bach’s automated path to wealth is deciding on your retirement plan, where you’ll benefit most from compound interest—the earlier you invest, the more your money will grow, and the better off you’ll be once you stop working.
Bach argues that you need to contribute to your retirement account before you pay your taxes to make the most out of your income. This is because the government takes approximately 30 cents per dollar of your salary as tax before the money is even sent to your checking account. This means that if you intend to contribute 10% of your income towards your retirement, the amount you end up contributing after you pay your taxes is considerably lower than the amount you’d contribute before you pay your taxes.
You can legally bypass the government’s taxation to maximize the earning potential of your retirement fund and get the most out of your earned dollars by using a tax-deferred retirement plan—a plan that allows you to send money to your retirement account without having to pay tax on it.
The Disadvantages of Tax-Deferred Retirement Plans
While using a tax-deferred retirement plan does offer the immediate advantage of paying less tax now so that you can save more money, it may end up costing you more once you retire.
When you withdraw money from a tax-deferred account, it’s taxed as income for the year in which you make the withdrawal—the tax you pay depends on how much you withdraw, the same way that the amount of tax you pay depends on your income.
This means that the more money you withdraw from your tax-deferred account, the more tax you pay after you retire. If you intend to withdraw large amounts of money to fund a dream vacation, pay for a family wedding, or cover unexpected expenses, you may end up paying more tax than you would’ve when you originally earned the money.
Bach suggests various retirement plans depending on whether you’re employed by a company, or self-employed.
There are two types of self-directed retirement accounts your employer might offer: 401(k) and 403(b). According to Bach, one out of every four American workers don't sign up for the retirement accounts their companies offer—he claims that most people just assume that they’re automatically signed up to benefit from their company’s retirement plan.
(Shortform note: Bach mentions that people often don’t enroll in their company’s retirement plans, but he doesn’t offer in-depth explanations for why this reluctance exists. According to some psychologists, one reason we avoid planning for our retirement is that we find it difficult to imagine ourselves getting older—while we understand that old age is inevitable, the concept doesn’t feel real. As a result, we’re more inclined to seek gratification here and now than save for our future needs.)
If your employer doesn’t offer self-directed retirement accounts, you’ll need to open an Individual Retirement Account (IRA). You can choose from one of three options: the Traditional IRA, the Roth IRA, or the Roth 401(k), which is similar to the Roth IRA but allows you to contribute more each year. The difference between the Traditional IRA and the Roth IRAs is when you pay tax on your retirement money: when you withdraw money in the case of the Traditional IRA, and when you contribute in the case of the Roth IRAs. This means that the Traditional IRA has the benefit of allowing you to contribute more money upfront, as it won’t be taxed; meanwhile, the Roth IRAs provide tax-free income after you retire.
Additional Retirement Account Options
The three IRA accounts Bach mentions are standard options for people who need to open up their own retirement accounts. They’re recommended in a number of financial books including I Will Teach You to Be Rich and The Simple Path to Wealth. However, Bach doesn’t mention additional options you may want to consider.
In The Simple Path to Wealth, J.L. Collins suggests Thrift Saving Plans as an option. These plans have extremely low fees and are aimed at federal employees, including members of the military.
In addition, if you’re on a low to moderate income, you may be able to take advantage of the Saver’s Credit. This option offers additional benefits beyond tax-deferred savings because it offers tax deductions based on your income and circumstances. If you qualify, you’ll receive a tax credit for the first $2,000 you contribute each year.
Business owners can take advantage of many different types of retirement accounts and benefit from many tax breaks. Bach claims that the simplest options to choose from are: the Simplified Employee Pension (SEP-IRA) and the One-Person 401(k) Profit Sharing Account, otherwise known as the “Solo 401(k)”.
(Shortform note: Bach briefly explains the benefits of both plans, but doesn’t elaborate on some details needed to make an informed decision about which to choose. For example, he doesn’t mention that the SEP IRA has no catch-up contributions—employees aged over 50 cannot make additional contributions. Furthermore, Bach claims that you can qualify for the One-Person 401(k) plan if you only have family members working for you. However, that’s not the case. You can qualify for this plan if you don’t have employees or if your spouse is your only employee.)
Once you’ve chosen your retirement account, you’ll need to select investment options that determine how your money will grow—retirement accounts can only earn interest on and grow your money if that money is invested into stocks and bonds. As we’ll see, these options will cover how long you intend to invest your money, and how aggressively you want to invest.
Bach explains that to ensure that you get the best return from your retirement plan, you need to diversify your investments—this means that you need to invest your money in a combination of cash, bonds, and stocks. The more diversified your investments, the safer your money—stocks may lose their value, but if your money is diversified, the overall value of your plan will stay consistent. However, the safer your investments, the less likely you are to make money on your plan.
What Does It Mean for an Investment to Be “Safe”?
Bach explains that you need to diversify your investments to ensure that your money is safe, but he doesn’t elaborate on why some investment options are “safer” than others. We’ll therefore explain the difference between “safe” and “aggressive” investments.
Safer investments (cash and bonds) make less money because they are based on short-term investments with minimal risk. They are less risky because the value of cash and bonds don’t change according to the whims of the stock market—their value remains stable.
Growth investments (stocks equate to a share of ownership in a company) create more money but are also susceptible to income fluctuations that impact the value of your investment. A company’s value fluctuates according to how well it’s performing and the economy in general. Therefore, stocks are ranked by how safe they are, or in other words, how likely the company is to grow in value.
The riskier the investment, the more aggressive it is. For example, an investment in an established company such as Netflix is classed as a growth investment because the company is expected to continue to perform well. However, if you invest in an unknown start-up based on the assumption that it will eventually become as valuable as Google, this is classed as an aggressive growth investment: If your prediction is right, your shares in the company will be worth a lot more than what you initially invested. But, if the company fails, your investment will lose value.
Bach recommends that you build a safety net—a savings account with money you can use for emergencies. Bach states that the average American has less than three months’ worth of expenses saved—these people are financially unprepared for the bad, unexpected things that could happen such as isolating at home and quitting work due to a pandemic.
(Shortform note: In addition to a safety net to see you through hard times, many experts argue that you should also invest in health insurance to ensure that you’re covered for unexpected medical costs.)
Bach outlines two steps to create your safety net: assess how prepared you are and grow your savings.
Bach explains that financially secure people aim to save at least 3 to 24 months’ worth of savings. To figure how many months you could survive on your current savings, divide the amount of money you have saved by the sum of your monthly expenses.
(Shortform note: Bach doesn’t explain how to accommodate irregular salaries—income that varies from month to month. Sethi suggests that, in addition to your savings accounts, you also set aside three to six months’ worth of living expenses to cover you during the months when your income doesn’t cover all of your expenses. This way, you can simulate a stable income and you won’t have to dip into your savings accounts to cover your expenses during low-income months.)
Bach recommends that you keep your emergency savings separate from your checking account so that you’re not tempted to spend the money. Further, he advises that you invest the money in high-yield savings accounts so that it can earn interest and grow.
(Shortform note: Bach’s process focuses on creating a single savings account and doesn’t accommodate the large expenses you’ll have outside of unexpected emergencies. In contrast, in The Barefoot Investor, Pape recommends that you allocate a percentage of your money to a “happy” savings account—an account used for large expenses that you want to save up for such as a holiday or a car, and a “grow” savings account—an account for long-term investments and savings goals. This way, you don’t need to dip into your long-term savings accounts to fund your large expenses.)
Bach argues that, if you’re in debt, you should prioritize clearing the amount before you build your savings account. This is because the interest you earn in your savings account is far less than the interest you pay towards your debts. To clarify, if you owe $2,000 in credit card debt and just make the minimum monthly payments, it will take you more than 18 years, and a total of $4,600 to pay off your balance. The same $2,000 held in a savings account earning 1% will only total $2,392.29 after 18 years. Therefore, you’ll save far more money if you clear your debts first.
(Shortform note: It’s true that clearing debts before you build your safety net will save you more money in the long term. However, if your job situation is insecure, some financial experts advise that you should prioritize your savings before you clear your debts. This way, you’ll avoid getting into further debt if you do lose your job—you won’t have to rely on your credit cards to survive because you’ll have savings to fall back on.)
We’ve broken the process down into four distinct steps: total up your balances and interest, make commitments, reduce your payments, and prioritize your debts. (Shortform note: Sethi’s debt-clearance plan differs from Bach’s method and provides some contradictory advice—we’ll compare Sethi’s process to Bach’s throughout each of the four steps.)
Step 1: Total up your balances and interest: If you’re currently in debt, you’ll need to total up the balances you owe and the amount of interest you’re paying on top of this balance.
(Shortform note: Sethi advises that you should call up your credit companies to find out how much debt you owe, how much interest you’re paying, and the minimum monthly payment. He claims that many people are unaware of exactly how much debt they’re in so need to speak to their debtors before they can come up with a plan to clear their debts.)
Step 2: Make commitments: Don’t buy things you can’t afford (property is the only exception as it tends to appreciate in value), and refuse to use credit cards—cancel them and remove the temptation to use them.
(Shortform note: Both Bach and Sethi advise that you don’t buy things you can’t afford, but they differ on what methods you should use to pay for what you buy. In contrast to Bach, Sethi suggests that you keep your credit cards as they’ll improve your credit history—make use of them but always pay your balance off in full. This way, you show lenders you can be trusted to pay back the money you borrow.)
Step 3: Reduce your payments: Contact your credit card company and ask if they can lower the rate of interest you’re paying, or consolidate all of your payments—move multiple debts to a single low-interest account. In addition, automate your payments to avoid paying late fees.
(Shortform note: In addition to consolidating and automating your payments, Sethi argues that you should negotiate lower interest rates regardless of whether you’re in debt or not. This will reduce your chances of getting in debt if you ever fail to pay off your balance.)
Step 4: Prioritize your debts: If you choose not to consolidate your payments, pay off your debts one by one. Bach suggests you divide the balance of each debt by the minimum payment required—this will show you the number of payments you need to make to pay off the debt. Next, rank your debts so that the lowest number of payments is on top. Prioritize paying off the debt at the top of your list while you continue to pay the minimum balance for your remaining debts.
(Shortform note: Sethi also suggests that you commit to paying off one card at a time while using automated payments to pay the minimum balance for the rest of the debts. However, he believes you have two options for doing this: prioritize the cards with the highest interest, or use Dave Ramsey’s “snowball method” to prioritize paying off cards with the lowest balance (regardless of the interest they charge). He advises that you should plan to make more aggressive payments until you clear your debts.)
According to Bach, the average American homeowner is more than 35 times richer than the average renter. This is because homeowners end up spending less money than renters in the long run. Let’s say you rent an apartment at $1,500 a month over 30 years—at the end of this period you’ll have spent $540,000 and have to continue to pay rent. On the other hand, if you buy a house and you pay $1,500 on your mortgage for 30 years, at the end of this period you’ll own your own home (no more payments) and be free of debt.
In addition, buying a home will also provide financial security in the form of equity—over the long term, the value of real estate investments always increases (the average annual return since 1968 is 5.3%).
The Disadvantages of Owning a Home
In contrast to Bach, Sethi argues that you shouldn’t think of your home as an investment as the expenses involved will make it difficult for you to make any money from it. He claims that:
Your costs will be higher than they are when you rent because you’ll be responsible for insurance, property taxes, and maintenance.
You’ll only gain an average of 0.6% a year on this asset compared to an average annual return of 8% on the stock market.
You’ll end up paying additional taxes and fees when you sell your home.
You’ll miss out on the amenities and perks offered by rentals in the same price range as it works out far more expensive to buy properties in convenient areas (close to public transport, local schools and shops, and so on) than it does to rent them.
So, while Sethi doesn’t discourage you from buying a home, he does insist that it’s not for everyone—consider whether you’re happy with the costs (not just financial) involved in owning your own home before you take the leap.
Bach suggests you follow three steps to buy a house: pay your down payment, choose the right mortgage payment plan, and accelerate your mortgage payments.
The main reason that people don’t buy a home is that they think they need to pay thousands of dollars upfront to get a mortgage. Bach argues that these people are wrong—there are many programs designed to enable first-time homebuyers to finance up to 100% of the down payment for the home they want to purchase. Bach suggests that you research housing finance agencies if you need help putting together a down payment.
(Shortform note: Bach doesn’t provide information regarding why companies would offer to provide you with a loan for a deposit, and it’s unclear whether these loans would incur additional costs or have strings attached—such as whether you’ll be restricted to buy specific types of houses or limited by location.)
Bach claims that you should be able to spend between 29-41% of your gross income on housing expenses—which include your mortgage, taxes, and insurance. Aim for the minimum if you still have debts to clear and more if you don’t have any debts to pay off.
(Shortform note: In addition to Bach’s suggestions, Pape claims that it’s crucial to also factor lifestyle changes into your housing expenses before you decide to buy a house. For example, if you have children, your expenses will increase significantly—you’ll either have to pay for childcare or reduce your working hours to care for the children, and this will impact your ability to keep up with mortgage payments.)
Overall, Bach recommends fixed-rate mortgages, as he believes these have the most benefits. However, he notes that a drawback of these plans is that you’ll end up paying a huge amount of interest over the full mortgage term (and at the beginning of the term, you’ll pay mostly interest, accruing minimal equity in your home).
However, he insists that you can avoid the disadvantages of fixed plans if you accelerate your mortgage payments: in other words, pay more towards your mortgage each month or year than you need to. This enables you to cut years off your payment plan, thus reducing the amount of interest you pay in total (since interest accrues exponentially over time—cut the time spent paying your mortgage, and you cut the amount of interest you pay).
The Disadvantages of Paying Off Your Mortgage
Bach strongly believes that paying off your mortgage will lead to more wealth so he doesn’t cover the disadvantages of taking this route. While accelerating your mortgage payments will save you thousands of dollars in interest, there are a few possible drawbacks you need to consider before you decide to proceed with this plan:
Access to cash: Even with accelerated payments, it will take years to pay off your mortgage. During this time, you won’t be able to access the additional money without refinancing or selling your home—make sure you have enough money in savings accounts to cover emergencies.
Tax breaks: The interest you pay on your mortgage is tax-deductible (you receive a tax rebate for these payments). Once you pay off your mortgage, you won’t be able to receive this tax benefit. If you’re a landlord, this could have a massive impact on your tax payments.
Credit score: Your credit score hinges on proof of your ability to reliably make regular payments to pay off your loans. Once you pay off your mortgage, this loan will no longer be factored into the equation used to determine your credit score and could lead to a slight drop (this impacts your ability to get a new loan).
Pay-off: The money you invest into your home would earn substantially more if you invested it into stocks (4.5% for a home and 10% for stocks based on the average rate of return for the last 90 years).
Bach insists that the point of building wealth is not just to have more money, but to use the money to do things that make you feel good. He suggests donating a portion of your income to a cause you care about—not only will you feel good about yourself, but you’ll also actually feel wealthier and your pursuit of money will feel more meaningful.
(Shortform note: In addition to making your pursuit of wealth more meaningful, philanthropy helps define your legacy. Pape (Barefoot Investor) claims that, after you’re gone, people are only going to remember you for the contribution you made to the world, not for the amount of money and material things you possessed. Along with donating money, Pape suggests that you could use your money to create your own charitable organization, or to fund a product or service to help your community.)
Bach suggests that you research and identify charities that are meaningful to you. Once you’ve chosen your cause, your recipient should be able to contact your bank to set up an automatic payment plan on your behalf (with your permission) so that you can make regular monthly contributions.
Bach urges you to keep track of your donations—many charitable donations are tax-deductible so you may save taxes on your contributions (if you donate $100, you can claim back the tax you’ve paid for that $100 on your tax return). You can check with the IRS and request #526 (Charitable Contributions) to confirm whether your chosen charity is tax-exempt.
Should Charitable Donations Benefit From Tax Deductions?
Some politicians are calling for an end to tax deductions on charitable contributions. They argue that these deductions:
Only benefit wealthy donors (they can already afford to give without the tax break)
Generally don’t increase donor contributions (compassion, not financial incentive, leads to giving)
Definitely harms the economy (the government subsidizes charities every time they offer a rebate)
In addition, unless you itemize your tax return and provide proof of your charitable donations, you won’t get the rebate. This additional paperwork means that millions of Americans already contribute without applying for a rebate, and strengthens the argument that these tax deductions should come to an end.
The Automatic Millionaire provides a simple but powerful action plan for you to quickly automate your finances, build your wealth, and achieve financial freedom. David Bach argues that, with just a few dollars a day, you can immediately benefit from this book’s advice and start growing your finances.
David Bach is an American financial consultant and New York Times bestselling author. He’s featured on countless TV programs including The Oprah Winfrey Show, NBC’s Today, CBS’s Early Show, and CNN’s American Morning. His website, FinishRich.com, offers financial guidance and further resources to millions of Americans.
Bach’s bestselling books include:
Connect with David Bach:
Publisher: Crown Business, Penguin Random House LLC
The book was first published in 2003. This guide is for the 2016 edition, which includes new and updated information on topics such as financial apps and taxes.
Within weeks of its publication, the first edition of The Automatic Millionaire had ranked as the bestselling title on The New York Times, The Wall Street Journal, USA Today, and BusinessWeek.
Bach’s thousands of media appearances—including features on NBC’s Today Show and The Oprah Winfrey Show—combined with profiles in many major publications, including The New York Times, People, and The Wall Street Journal, greatly contributed to the book’s success. His frequent media exposure, coupled with powerful endorsements, enabled Bach to inspire millions of people, build trust with American audiences, and quickly spread his simple and actionable wealth strategies.
As a result of his popularity with American audiences, The Automatic Millionaire spent 31 weeks on the New York Times bestseller list and sold over 1.5 million copies. It’s since been translated into over 12 languages.
Bach continues to help people of all ages and income levels make sense of their finances, and he enjoys enormous success: 12 of his books have become Wall Street Journal bestsellers, and he’s had 10 consecutive books appear on the New York Times bestsellers list.
Many reviewers agree that, while The Automatic Millionaire doesn’t include any new ideas about personal finances, Bach’s practical and simple presentation of financial concepts makes the steps easy to understand and follow. Reviewers generally regard the book as an encouraging and motivating resource for beginners, and many reviewers gift it to teenagers to foster financial awareness.
However, the simplicity of the book also puts many reviewers off—some have remarked that Bach writes in a “cheesy” and “patronizing” way and over-explains the concepts. These reviewers feel that the book’s length doesn’t justify the material covered.
There are nine chapters in this book. The first and last chapters summarize the material within the book. The remaining chapters focus on how you can automate your finances in the following areas: cutting your expenses, funding your retirement, investing your money, saving for emergencies, buying a home outright, clearing your debts, and donating your money to good causes.
Strangely, Bach provides advice on how to tackle your debts in his seventh chapter, after he encourages you to buy a home. Some reviewers have questioned the logic behind his decision since buying a home before you clear your debts would not only incur additional debt but also increase your financial worries.
Bach offers simple explanations throughout his book and provides real-life examples of successful “automatic millionaires” to motivate you, as well as links to resources so that you can take immediate action on his suggestions.
This guide explores Bach’s key ideas about automating your personal finances and building wealth, but we’ve condensed and reorganized the concepts to flow in a more logical sequence. For instance, we’ve reordered the chapters to cover debt clearance before we explain how to buy a home.
We also compare and contrast Bach’s process with those of other popular financial authors like Ramit Sethi (I Will Teach You to Be Rich) and Scott Pape (The Barefoot Investor). Furthermore, we discuss psychological research underlying why people fail to prepare for their financial futures, possible caveats to Bach’s recommendations, and updated resources.
The Automatic Millionaire provides a simple but powerful action plan for you to quickly automate your finances, build your wealth, and achieve financial freedom. Author David Bach argues that financial freedom doesn’t come from how much you earn, but how you manage your earnings—if you’re not saving your money with your current income, you’re unlikely to save it in the future. This is because people often increase their spending in line with their income and always have an excuse to avoid saving for the future. The result is that many people miss out on a huge opportunity to enjoy financial freedom.
Why Do We Often Avoid Saving for the Future?
Bach believes we struggle to save money simply because we’re tempted to spend all of our money before we get a chance to save. But, according to Ramit Sethi, author of I Will Teach You to Be Rich, there’s a more complicated psychological reason underlying this tendency. Sethi argues that people tend to avoid planning their future finances due to:
Decision paralysis: When someone is presented with too many options for how to save, they feel too overwhelmed to make a decision.
Blaming the system: They choose to focus on economic disadvantages that they can’t control. For example, they believe that those born into privilege have more financial advantages than they do and develop a “what’s the point” mentality.
Sethi advises you to switch your focus away from information-gathering or your disadvantages and start taking small proactive steps towards financial success.
Bach’s Automatic Millionaire process, which we’ll call the “automated path to wealth,” will teach you how to make smart financial decisions, automate your finances, and build your wealth using only a few dollars a day.
In Part 1 of this guide, we’ll focus on how you can save more money than you think, and explain why you should automate your finances and invest in your savings before you pay for anything else. We’ll also discuss how you can use the power of compound interest to grow your money.
In Part 2, we’ll explain the specific steps you need to take to automate your savings and investments so that you can:
If you’re wondering if you can spare a few dollars every day, the first step of the process, which we explore in this chapter, will help you to examine and understand how much money you’re currently wasting and the savings you’re missing out on.
We’ll first focus on how you’re spending your money and what unnecessary expenses you can redirect towards your savings accounts. Next, we’ll explain why you need to prioritize paying for your financial security before you pay for anything else, and how much of your income you should aim to contribute towards that goal. Finally, we’ll explore how compound interest helps to grow your money and why you’re better off investing sooner rather than later.
Bach explains that the first step to saving millions over the course of your life is focusing on how much you spend—specifically, where you’re currently wasting your money.
(Shortform note: Bach understands that it’s not easy for everyone to increase their income, which is why he encourages you to focus on saving money regardless of your current income. If you do increase your earnings, Bach suggests that you funnel this extra money into your savings accounts instead of spending it. In contrast, Sethi advises that you maximize your earning potential so that you can spend more money on what you want while you increase your savings.)
Bach claims that we all waste money on small expenses that add up over time, such as the snacks you buy on your way to work, the unnecessary items you pick up when you go shopping, or the subscriptions you pay for but don’t need. For example, a Netflix subscription might seem like a small expense because you’re only paying $8.99 a month, but it adds up to $107.88 per year.
The sooner you identify your unnecessary expenses, the sooner you can eliminate them and put the money you save towards building long-term wealth. Bach suggests the following exercise: Track all of your expenses over the next few days and identify where you’re spending your money. If you tend to use your bank card more than cash, examine your bank statements.
Once you’ve collated all of your expenses, consider if there are any expenses that you can cut out or reduce. For example:
Choosing the Right Expense-Tracking Practice for Your Needs
In his book, Bach suggests you track your expenses for a few days to figure out where you're wasting your money. However, this isn’t going to give you a complete picture of how you spend your money month by month, especially if you have irregular spending habits. To track all of your expenses over the long term, he recommends the Mint app.
Sethi also recommends that you use similar apps to track your spending. However, in contrast to Bach’s argument that you should track with the goal of eliminating all unnecessary expenses, Sethi suggests that you track with a focus on spending mindfully. Split your expenses into four areas, decide in advance how much you want to spend in each area, then allocate a portion of your income to each:
Fixed costs (rent, living expenses)
Investments (savings and retirement)
Savings goals (vacations and large expenses)
Guilt-free spending (anything that makes you happy)
He argues that this process is more effective than budgeting or eliminating expenses because you don’t waste time tracking where each dollar goes. In addition, you give yourself permission to spend a portion of your income in any way you wish, even if that includes unnecessary expenses. While this goes against common financial advice, you’re more likely to stick to your financial goals if you don’t feel like you’re constantly depriving yourself.
Before you continue reading, you should have a clear idea of how you’re currently spending your money, a plan to eliminate unnecessary expenses, and have decided on a specific amount you’re willing to redirect towards your savings accounts. Now, we’ll explore why you should prioritize paying towards your savings before you pay for anything else.
According to statistics, the average American saves less than 5% of her earnings and one in five Americans don’t save at all. Why is it so difficult to save money? Many people add to their savings accounts as and when they have unspent money in their checking accounts. Bach argues that this doesn’t work because no matter how well-intentioned you are, more often than not you’ll find reasons to spend your money and won’t have anything left to put into your savings accounts.
(Shortform note: Furthermore, and perhaps even more worryingly, people tend to increase their spending the more they earn due to a phenomenon called “lifestyle creep.” The more they earn, the more entitled they feel to spend their money on things they formerly viewed as treats or luxuries. This increase in spending happens incrementally, so it’s often difficult for people to realize that they’re spending more and more on things they once found unnecessary. This is why Bach insists you should start saving regardless of your income.)
Bach explains that the only way to improve your financial security is to arrange to automatically save a portion of your income before you even have a chance to spend it. He claims that you’ll quickly get used to living without this money, and you won’t need to rely on sticking to a budget to build your financial security.
(Shortform note: Dan Ariely, behavioral economist and author of Predictably Irrational, offers clarity on why you’re more likely to achieve financial security by automating your finances. His research reveals that your emotions impact your spending decisions. You’re more likely to make irrational spending decisions when you feel emotional—in other words, when you see something you really want and feel an emotional urge to possess it. Your emotional side overpowers your rational side, and you’re less able to think about the consequences of your decisions. Automating your finances eliminates this possibility: You predetermine how your money is “spent.” so your rational side doesn’t have to fight with your emotional side about it.)
Bach suggests that you should aim to save at least 10-15% of your gross (before tax) income. For example, if you earn $20,000 a year, you should aim to save at least $2,000 a year which works out to $5.48 a day.
(Shortform note: In contrast to Bach, many experts agree that you should aim to save at least 20% of your gross income. So, if you earn $20,000 a year, you should aim to save at least $4,000 a year which works out to $10.96 a day.)
Bach argues that putting a few dollars aside every day by itself won’t make you a millionaire, but investing those dollars in the right type of account will. When you save your money in a checking account, you accumulate money for future use, but the amount doesn’t grow beyond what you put in. However, when you invest your money in an account that pays compound interest, you leverage your money—that is, you use it to generate further income in the form of interest payments. For example, if you invest your money in an account that pays you 10% annual interest, this means that you’ll receive an extra 10% of what you invested after one year: Invest $100 and after a year, your money will be worth $110.
Bach also notes that thanks to compound interest, the interest you earn also earns interest—the $110 after another year will be worth $121 ($110 + 10%). After another year, it will be worth $133.10. In addition, the more money you continue to add to this account, the more interest you’ll earn. This is how compound interest transforms small, consistent amounts of money into free money over the course of time.
To understand how compound interest could be earning money for you at your current income level, reexamine the expenses you chose to cut earlier in this chapter. For example, let’s assume that you’ve been spending $1.45 each day on bottled water, which amounts to $529.25 a year, and $15,877.50 over the course of 30 years. So, over the course of 30 years, you could save almost $16,000 if you eliminated this expense.
Now, if instead of simply saving your bottled water money, say you invested this money for an annual return of 10% and continued to invest $1.45 per day ($44 a month), your money would grow as follows:
| Your Investment | |
| After 10 years | $8,437.85 |
| After 20 years | $30,319.68 |
| After 30 years | $87,075.54 |
This means that in an account that pays compound interest, the money you’re spending on bottled water could actually create over $87,000 for you over the course of 30 years.
(Shortform note: Calculating compound interest as Bach suggests can seem daunting if you’re not mathematically-minded. Use a compound calculator to figure out how much money you could earn from the small, wasteful expenses you chose to cut earlier in this chapter.)
What Is Wealth?
Bach’s advice here isn’t revolutionary: The majority of finance books, including I Will Teach You to Be Rich and The Barefoot Investor, also discuss the benefits of applying compound interest to grow your savings. The general consensus is: If you want to create wealth, take advantage of compound interest to grow your money.
But what exactly is wealth and how do you differentiate it from having a high income? According to the authors of The Millionaire Next Door, wealth is defined by what you accumulate. So even if you earn millions, you’re not considered wealthy if you spend it all and don’t invest any of your money. On the other hand, if you earn a modest income but invest a portion of your income, you can accumulate great wealth.
Another way to define if you’re wealthy is to figure out how much you need to work to survive and maintain your lifestyle. Do you need to work every day just to keep up with all of your expenses, or do you have breathing room in the form of savings and passive income? Compound interest is a form of passive income because it earns money for you even when you’re not actively working.
Creating wealth is a choice—it often involves having to make sacrifices now to earn more later. But, it’s worth the payoff if you can set yourself up to become financially independent.
Bach claims that the sooner you start investing, the more compound interest will earn for you and the more likely you'll be to achieve financial security. The following chart illustrates how much you can earn based on what age you start. It’s based on an investment of $3,600 a year (less than $10 a day) and an annual return of 10%.
| Investment Earnings | Start investing at age 25 | Start investing at age 35 | Start investing at age 45 |
| Age 35 | $66,712.20 | $0 | $0 |
| Age 45 | $230,409.00 | $66,712.20 | $0 |
| Age 55 | $654,996.33 | $230,409.00 | $66,712.20 |
| Age 65 | $1,756,266.52 | $654,996.33 | $230,409.00 |
The chart clearly illustrates the benefits of investing early—in the example above, the 25-year-old investor ended up with over $1.5 million more than the 45-year-old investor. Further, even if your investments earn less than 10% a year, your money will still grow more than it can if it remains static in your checking account.
If You’re Feeling Behind, You’re Not Alone
If you haven’t yet started to invest your money, this section may make you feel a little uncomfortable about the thousands of dollars you’ve lost in potential investment gains. You’re not alone—according to polls, many Americans feel guilty about financial decisions they’ve made (or not made):
31% of Americans regret not saving for their retirements earlier.
24% of Americans regret not investing in stocks earlier.
This sentiment holds true regardless of age: 77% of millennials and 76% of baby boomers wish they’d started to invest earlier. Surprisingly, even 69% of respondents aged between 18-22 share this regret.
Bach provides helpful advice to overcome these feelings and dive into investment, no matter your age, in Start Late, Finish Rich. His suggestions include exploiting your earning potential to maximize your earnings and increasing your savings goals to 25% of your income so you can make up for the lost time.
Identifying where you can cut your spending will help you to build more wealth in the long term. This exercise will help you understand just how much wealth your small expenses can add up to.
What have you spent your money on during the past five days? Remember to include in-store purchases (no matter how small), bills, and automatic subscriptions.
Which of these purchases could you categorize as non-essential and cut from your expenses?
If you cut this expense, how much would you save over the course of a year?
What’s an action you can take to work toward eliminating this expense? For example, if you want to cut down on how much you’re spending on fast food, you might plan to start preparing your meals in advance.
You should now have a clear idea of how much of your income you should aim to save and how you can benefit from investing your money. We’ll now explain what specific steps you need to take to automate your investments and build your wealth.
The core principle of the automated path to wealth is that you must automate your savings and investments to ensure financial success—the more you automate your finances, the more likely you are to grow your wealth and create millions without relying on willpower and discipline. Over the remaining chapters, we’ll explain the specific steps you need to take to automate your savings and investments so that you can:
(Shortform note: Sethi also recommends that you automate all of your finances to make it as easy as possible to meet your financial goals. In addition to Bach’s goals outlined above, he also suggests that you invest in a Health Savings Account (HSA) to receive the following benefits: tax-free health spending—you can spend this money without ever paying taxes on it— and tax-free retirement investing—you can invest this money to create more income.)
In this chapter, we’ll focus on your retirement plan, as Bach argues that this is where you’ll benefit most from compound interest—the earlier you invest, the more your money will grow, and the better off you’ll be once you stop working. We’ll first discuss why you need to invest in your retirement before you pay your taxes. Next, we’ll focus on the specific steps you need to take to automate your retirement plan so that you can relax knowing that you’ve prepared yourself for a prosperous future.
Bach argues that you need to contribute to your retirement account before you pay your taxes to make the most out of your income. This is because the government takes approximately 30 cents per dollar of your salary as tax before the money is even sent to your checking account. To illustrate how this impacts you, the following chart lists what you earn both before and after-tax (assuming you pay 30% tax):
| Your Salary | |||
| Earnings before tax | $20,000 | $30,000 | $40,000 |
| Earnings after tax | $14,000 | $21,000 | $28,000 |
This means that if you intend to contribute 10% of your income towards your retirement, the amount you end up contributing after you pay your taxes is considerably lower than the amount you’d contribute before you pay your taxes.
Bach argues that you need to legally bypass the government’s taxation to maximize the earning potential of your retirement fund and get the most out of your earned dollars. You can achieve this by using a tax-deferred retirement plan—a plan that allows you to send money to your retirement account without having to pay tax on it. The following table demonstrates how much you can save and then earn per dollar (based on an annual return of 10%) by choosing to contribute to your retirement before you pay your taxes:
| Pre Tax Retirement Contributions | After-Tax Retirement Contributions | |
| Gross Income | $10 | $10 |
| Minus taxes = | $10 - 0% = $10 | $10 - 30% = $7 |
| + 10% annual return | $10 + 10% = $11 | $7 + 10% = $7.70 |
| Is the investment taxable? | No | Yes |
The Disadvantages of Tax-Deferred Retirement Plans
While using a tax-deferred retirement plan does offer the immediate advantage of paying less tax now so that you can save more money, it may end up costing you more once you retire.
When you withdraw money from a tax-deferred account, it’s taxed as income for the year in which you make the withdrawal—the tax you pay depends on how much you withdraw, the same way that the amount of tax you pay depends on your income. The following list, based on the tax brackets for 2021, shows the amount of tax you’ll pay for withdrawals from your tax-deferred account:
10%: up to $9,950
12%: up to $40,525
22%: up to $86,375
24%: up to $164,925
32%: up to $209,425
35%: up to $523,600
37%: over $523,600
This means that the more money you withdraw from your tax-deferred account, the more tax you pay after you retire. If you intend to withdraw large amounts of money to fund a dream vacation, pay for a family wedding, or cover unexpected expenses, you may end up paying more tax than you would’ve when you originally earned the money.
If you expect to have high expenses after you retire, there are other options to avoid paying taxes on your withdrawals—we’ll cover these later on in this chapter.
Now that you understand the benefits of contributing to your retirement fund before you pay your taxes, we'll look at the various options available to you depending on whether you’re employed or self-employed. We’ll start with employer-offered, self-directed retirement accounts.
There are two types of self-directed retirement accounts your employer might offer: 401(k) and 403(b). Both plans offer the following benefits:
One out of every four American workers don't sign up for their retirement accounts—Bach claims that most people just assume that they’re automatically signed up to benefit from their company’s retirement plan. While some companies do offer automatic enrollment, you still need to check what percentage of pay you’re contributing towards your retirement plan. Bach explains that the companies that offer automatic enrollment tend to set your contributions at a very low rate, between 1-4%.
(Shortform note: Bach mentions that people often don’t enroll in their company’s retirement plans, but he doesn’t offer in-depth explanations for why this reluctance exists. According to some psychologists, one reason we avoid planning for our retirement is that we find it difficult to imagine ourselves getting older—while we understand that old age is inevitable, the concept doesn’t feel real. As a result, we’re more inclined to seek gratification here and now than save for our future needs.)
If you’re not enrolled in your company’s retirement plan:
If you’re already enrolled in your company’s retirement plan:
Factors That Impact Your Retirement Plan
Bach instructs you to implement these steps to set up and automate your retirement accounts before you work on automating the rest of your finances. However, it may be worth walking through the rest of Bach’s ideas before you finalize your decisions about your retirement plan for the following reasons:
You may decide to opt for an IRA to avoid paying taxes on your withdrawals (we cover IRA accounts in the next section).
You need to set up investment options so that your retirement fund can grow (chapter 3).
You may decide to change the percentage of your retirement contributions if you have debts (chapter 5).
Reading through the entire guide will ensure that you make informed decisions about your retirement plan.
If your employer doesn’t offer self-directed retirement accounts, you’ll need to open an Individual Retirement Account (IRA). You can choose from one of three options: the Traditional IRA, the Roth IRA, or the Roth 401(k), which is similar to the Roth IRA but allows you to contribute more each year. The difference between the Traditional IRA and the Roth IRAs is when you pay tax on your retirement money: when you withdraw money in the case of the Traditional IRA, and when you contribute in the case of the Roth IRAs. This means that the Traditional IRA has the benefit of allowing you to contribute more money upfront, as it won’t be taxed; meanwhile, the Roth IRAs provide tax-free income after you retire.
Bach suggests that if you’re at least 15 years away from your retirement, the Roth IRA is the most beneficial option for you—you’ll pay your tax for your contributions during these 15 years but benefit from tax-free withdrawals for the rest of your life.
Additional Retirement Account Options
The three IRA accounts Bach mentions are standard options for people who need to open up their own retirement accounts. They’re recommended in a number of financial books including I Will Teach You to Be Rich and The Simple Path to Wealth. However, Bach doesn’t mention additional options you may want to consider.
In The Simple Path to Wealth, J.L. Collins suggests Thrift Saving Plans as an option. These plans have extremely low fees and are aimed at federal employees, including members of the military.
In addition, if you’re on a low to moderate income, you may be able to take advantage of the Saver’s Credit. This option offers additional benefits beyond tax-deferred savings because it offers tax deductions based on your income and circumstances. If you qualify, you’ll receive a tax credit for the first $2,000 you contribute each year.
You can choose to open your IRA account through a bank, a brokerage firm, a mutual fund company, or an online investment firm. To set this up quickly and efficiently, Bach recommends you choose from one of the following online investor firms:
If you’d prefer to speak to a financial advisor face to face, Bach provides information for full-service brokerage firms and banks that are more likely to have local branches near you:
The Difference Between Free and Paid IRA Accounts
Both Bach’s and Sethi’s recommendations for banks and brokerage firms hinge on the discounts or perks you receive—for example, free accounts and small minimum investment fees. Like Bach, Sethi also recommends that you use Vanguard, Charles Schwab, or Fidelity—established firms with a good reputation.
However, keep in mind that these accounts tend to be free because they require more of a do-it-yourself approach: You need to do the research about what options are available and decide what suits your lifestyle before you sign up with them. If you require a more personalized service—one that’s tailored to your specific needs—you’ll need to pay management fees that will eat into your contributions.
So, before making a choice, consider realistically how involved you want to be with your plan and shop around for the bank or brokerage firm that best suits your needs.
Once you’ve chosen your IRA plan, make sure you set up a systematic investment plan so that your money is automatically transferred into your IRA account. You can ask your employer if they can transfer the money automatically to your IRA, or you can arrange a direct debit from your checking account(you’ll need to fill out an ACH debit authorization form to authorize this). You can also use an online bill payment service, such as PayTrust, to manage these payments for you, but you will need to pay fees for this service.
(Shortform note: While systematic investment plans do offer many advantages—most notably, that automated payments require zero discipline—there are disadvantages for those who have unpredictable earnings, such as freelancers or small business owners. It’s difficult to automate your payments if you don’t know how much you’ll be earning from month to month. If you instruct your bank to send money that you don’t have, you could end up with extra overdraft fees. So, if you intend to use this plan, ensure that you always have the funds available to make your payments—it’s notoriously difficult to amend the payment dates once the plan’s in motion.)
Business owners can take advantage of many different types of retirement accounts and benefit from many tax breaks. Bach claims that the simplest options to choose from are the Simplified Employee Pension (SEP-IRA) and the One-Person 401(k) Profit Sharing Account, otherwise known as the “Solo 401(k)”.
| SEP IRA | One-Person 401(k) | |
| How much you can contribute | Up to 25% of your gross income or $53,000 | -100% of your first $18,000
-An additional 25% of your gross income if you use the profit-sharing plan -A combined total of $53,000 |
| Example of tax-deductible savings for an annual income of $100,000 (tax-deferred until you take the money out) | Total of $25,000 | -$18,000 into 401(k) plan
-$25,000 into a profit-sharing plan -Total of $43,000 |
| Best for you if: | You don’t have employees | Your employees are family members |
What You Need To Know About SEP IRAs and One-Person 401(k)s
Bach briefly explains the benefits of both plans but doesn’t elaborate on specific details you should be aware of to make an informed decision about which to choose. Here’s some additional information about each type of plan:
You’ll reach the 25% or $53,000 limit if your income is more than $212,000 a year. In this case, you may want to look at multiple retirement accounts so that you can contribute more.
All of your employees must be included in the plan if they are eligible.
Bach claims this plan is best if you don’t have employees because, if you intend to match employee contributions, you must pay the same percentage for each. For example, if you intend to contribute 10% of one employee’s retirement contribution, you need to contribute 10% of every employee’s contribution. The percentage you decide to contribute will impact your expenses.
There are no catch-up contributions—employees aged over 50 cannot make additional contributions.
Bach claims that you can qualify for this plan if you only have family members working for you. However, that’s not the case. You can qualify for this plan if you don’t have employees or if your spouse is your only employee.
While you can contribute a larger percentage of your income than you can for the SEP IRA, this does come with disadvantages. If your retirement funds total more than $250,000, you’ll have to submit more paperwork to the IRS to justify these additional contributions.
You need to contribute regularly for your plan to stay active—if the IRS considers your contributions too low, they will discontinue your plan.
Despite these caveats, both tax plans are often worth it—Bach’s right that there are huge tax-deductible savings, even if you don’t make $100,000 a year. The average annual income of a self-employed person is $62,300 a year: This means that the majority of self-employed people could max out their pensions using either of these plans.
Once you’ve chosen a plan, Bach suggests that you decide upon a salary amount that you will allocate for yourself and set up an automated system—through your payroll company or checking account— to transfer contributions directly to your plan.
If you have additional questions about retirement accounts, Bach recommends that you download the following pamphlets from the Internal Revenue Service:
(Shortform note: This step can be a bit tricky, even if you download the pamphlets Bach recommends, because self-employed people often find it difficult to know how much of a salary to pay themselves. Unfortunately, there isn’t an easy answer to this question. There’s no “best” way to define the amount—you can either determine your living expenses and take the same amount every month to cover them (this could hurt your business if your profits vary month to month), or decide upon what percentage of your income you’ll take as salary (this could impact the amount you take home each month).)
Once you’ve chosen your retirement account, you’ll need to select investment options that determine how your money will grow—retirement accounts can only earn interest on and grow your money if that money is invested into stocks and bonds. The firms you choose for your IRA or self-employment needs will build your investment portfolio based on the investment options you select. As we’ll explore in this chapter, these options will cover how long you intend to invest your money and how aggressively you want to invest.
In this chapter, we’ll explain how to balance your investments for maximum returns—read this before you fill out your retirement plans to ensure you pick the most suitable options for your situation.
Bach explains that to ensure that you get the best return from your retirement plan, you need to diversify your investments—this means that you need to invest your money in a combination of cash, bonds, and stocks. The more diversified your investments, the safer your money—stocks may lose their value, but if your money is diversified, the overall value of your plan will stay consistent. However, the safer your investments, the less likely you are to make money on your plan.
What Does It Mean for an Investment to Be “Safe”?
Bach explains that you need to diversify your investments to ensure that your money is safe, but he doesn’t elaborate on why some investment options are “safer” than others. We’ll therefore explain the difference between “safe” and “aggressive” investments:
Safer investments (cash and bonds) make less money because they are based on short-term investments with minimal risk. They are less risky because the value of cash and bonds don’t change according to the whims of the stock market—their value remains stable.
Growth investments (stocks equate to a share of ownership in a company) create more money but are also susceptible to income fluctuations that impact the value of your investment. A company’s value fluctuates according to how well it’s performing and the economy in general. Therefore, stocks are ranked by how safe they are, or in other words, how likely the company is to grow in value.
The riskier the investment, the more aggressive it is. For example, an investment in an established company such as Netflix is classed as a growth investment because the company is expected to continue to perform well. However, if you invest in an unknown start-up based on the assumption that it will eventually become as valuable as Google, this is classed as an aggressive growth investment: If your prediction is right, your shares in the company will be worth a lot more than what you initially invested. But, if the company fails, your investment will lose value.
Further, Bach argues that your diversification strategy needs to change over time to reflect your age and your income goals—the younger you are, the more you can afford to take risks with your money because you have more time on your side. However, the closer you get to retirement age, the more you need to play it safe and protect your money.
The table below illustrates the recommended balance for each age group to invest their retirement money.
| Order of Risk | Your Age and How Much to Invest in Each Option | |||
| (Safest first) | Under 30 | 30-50 | 50-60 | 60 Plus |
| Cash | 5-10% | 5-10% | 5-10% | 10-15% |
| Bonds | 5-15% | 15-25% | 20-30% | 25-35% |
| Growth & Income Investments | 30-40% | 35-45% | 30-40% | 30-40% |
| Growth | 40-50% | 25-35% | 15-25% | 10-20% |
| Aggressive Growth Investments | 5-10% | 5-10% | 0-5% | 0-5% |
Further Advice for Diversifying Your Investment Portfolio
If you’re looking to learn more about applying Bach’s suggestions and diversifying your investments, Sethi provides a lot more information in I Will Teach You to Be Rich about how stocks are classified and what should be included in a diverse investment portfolio. According to Sethi, stocks are categorized by the amount current shareholders are investing into the company:
Large-Cap: More than $10 billion
Mid-Cap: $1-5 billion
Small-Cap: Less than $1 billion
In addition, he explains that stocks fall under the following categories:
International: Stocks from companies in other countries
Growth: Stocks expected to grow in value
Value: Stocks that are low priced compared to their actual value
Sethi suggests that you invest in each of the six types of stocks, as well as bonds, to create a diversified investment portfolio. In contrast to Bach, Sethi suggests you avoid investing in cash as it will lose value over time due to inflation.
As a result, his advice for asset allocation by age differs slightly from Bach’s recommendation:
Age 35-45: 10% bonds and 90% stocks
Age 55: 31% bonds and 69% stocks
Age 65: 47% bonds and 53% stocks
Socially Responsible Investing
When you invest in stocks, you buy a share of a company—this share supports the company’s growth. For this reason, it’s important to consider who your growth and aggressive growth investments really support. Many investors actively avoid investing in companies that conflict with their values—for example, they might avoid investing in a tobacco or firearm company because they don’t want to support those industries.
As well as looking at what investments you want to avoid, consider choosing to invest in industries that you want to support—this type of investment is called socially responsible investing (SRI). When you use this strategy, you choose investments that align with your values—you benefit causes you care about while investing in your future.
If you don’t feel comfortable managing these combinations, Bach suggests that you invest in mutual funds or exchange-traded mutual funds (ETFs) as they automatically manage and diversify your money for you based on your requirements (how much risk you’re willing to take). They’re also easy to use. Alternatively, employee and individual retirement plans offer “asset allocation funds” or “balanced funds”—these funds also manage your combinations for you.
In addition, many employee and individual retirement plans manage these diversified combinations for you based on your age and the date you expect to retire—they are commonly referred to as “targeted-date funds”. These plans automatically balance your investments to reduce risks the closer you get to retirement age. The main difference with these plans is how they continue to be managed once you reach your retirement date. There are two options:
What You Need to Know About Mutual Funds, ETFs, and Targeted-Date Funds
Mutual funds, ETFs, and targeted-date funds are popular choices thanks to the way they conveniently manage your retirement investments for you. However, while Bach mentions the benefits of each fund, he doesn’t include important information you need to consider before you make your decision:
The fees you’re charged vary quite significantly depending on which fund you choose—the higher the fee, the less you earn on your investments.
Your results depend on how efficiently the people in charge manage your fund.
You may be subjected to additional tax payments depending on how your fund is managed.
Your investments may be limited to large-cap stocks (companies with over $10 billion worth of investments)—this reduces the diversity of your investment portfolio.
You’re more likely to pay higher fees and earn less than if you invest directly into stocks.
The tax rules vary according to what type of investment options you choose so you’ll need to ensure that you’re well informed before you sign up.
While various banks and brokerages might offer a retirement plan for a specific year, each plan will consist of different investments and will produce different results depending on the diversity ratio used. For example, you may have a 2050 plan that earns significantly less than your friend’s 2050 plan because both plans follow different investment ratios.
In addition, each fund will have different fees that impact the value of your earnings. So, though targeted funds are a convenient way to set up your retirement plan, you’ll benefit more if you shop around and compare the way the different funds are managed.
Here’s some additional information about each type of targeted-date fund:
Plans that take you through retirement: Your investments continue to adjust and rebalance throughout your retirement. This means that your investments are likely to grow during the early years of your retirement. Growth investments do come with risks—if you don’t have additional income to fall back on, this plan may be too risky for you.
Plans that take you to retirement: Once you reach your retirement date, the diversity of your portfolio remains static. This means that your investment options are limited from the date of your retirement. While this plan limits the growth of your investments after your retirement date, it is the safest option if you don’t have additional income to rely on.
If you work for a publicly-traded company and sign up for a 401(k) with them, your plan may offer you options to invest in your company’s stock. Bach urges you to consider your company’s stock as an aggressive growth investment: You should not invest more than 5-25% of your retirement money into your company’s stock, no matter how successful and stable they are. This is because you’ll reduce your diversification and increase your risk if you invest too much—if your company fails, you could lose your investment!
(Shortform note: If you work for a stable, established company, you may question why Bach urges you to consider all company stocks as aggressive growth investments. However, all company stocks are susceptible to unexpected fluctuations. For further clarification, refer to The Smartest Guys in the Room—this book offers a detailed explanation of how established companies can fail, create losses for shareholders, and wipe out employee retirement accounts.)
If you choose to work with a financial advisor, specify that you would like to look at targeted-date funds, asset allocation funds, and balanced fund options.
Do You Need a Financial Advisor?
Bach suggests that you work with a financial advisor if you don’t feel comfortable managing your investment options—however, his suggestions indicate that you can achieve the results you want without additional help.
According to Burton Malkiel, author of A Random Walk Down Wall Street, you shouldn’t need to rely on a financial advisor to actively manage your investments. He argues that fund managers rarely beat the average market return over the long term, regardless of their track record. However, if you decide to use a financial advisor, Malkiel advises that you choose one with:
A low expense ratio—the higher the expenses, the more of your investments go towards paying your advisor.
A low turnover rate—the higher your turnover rate, the more tax you have to pay.
Review how your investment strategies need to change to reflect your age and help you achieve your income goals.
How many years do you have left until you hope to retire?
Considering your age and the time you have until retirement, how would you balance your investment portfolio? Explain your answer.
Now imagine a decade has passed. According to your age and your imagined career path, how would you rebalance your investments? Why would you choose this new balance?
Once you’ve taken care of your retirement and investment options, Bach recommends turning your focus towards building a safety net—a savings account with money you can use for emergencies. In this chapter, we’ll explore how to automate contributions toward your safety net to ensure that you’re prepared for worst-case scenarios.
There are two reasons to create a financial safety net. The first is to prepare for worst-case scenarios. Bach states that the average American has less than three months’ worth of expenses saved—these people are financially unprepared for the bad, unexpected things that could happen such as if they have to isolate at home and quit work due to a pandemic.
(Shortform note: In addition to a safety net to see you through hard times, many experts argue that you should also invest in health insurance to ensure that you’re covered for unexpected medical costs specifically. This will help prevent you from needing to dip too much into your emergency fund if a medical event comes up.)
The second reason to build a safety net is to improve the quality of your life here and now. Bach argues that with extra money in the bank, you give yourself space to breathe and decide how you actually want to spend your time. For example, you’re less likely to put up with a job that doesn’t suit you if you have enough money to support yourself while you look for a more satisfying job.
(Shortform note: A recent study confirms Bach’s belief that saving money improves lives. The research revealed that people who save money tend to enjoy more happiness and satisfaction than those who don’t save. This is because saving money increases your peace of mind and decreases your psychological distress—with extra money, you feel more prepared to handle uncomfortable situations.)
Bach outlines two steps to create your safety net: assess how prepared you are and grow your savings.
Bach explains that financially secure people aim to save at least 3 to 24 months’ worth of savings. To figure how long you could survive on your savings without additional income, answer the following questions:
Once you’ve answered these questions, you’ll have a better idea of how financially secure you are and how much more you’d like to save to feel like you’re on solid ground.
(Shortform note: Bach doesn’t explain how to accommodate irregular salaries—income that varies from month to month—when safety net building. If your income is irregular, first follow the steps above to figure out how long your savings will last if you lose your income. Next, consider creating a buffer to protect your safety net. Sethi suggests that, in addition to your savings accounts, you also set aside three to six months’ worth of living expenses to cover you during the months when your income doesn’t cover all of your expenses. This way, you can simulate a stable income and you won’t have to dip into your savings accounts to cover your expenses during low-income months.)
Bach recommends keeping your emergency savings separate from your checking account so that you’re not tempted to spend the money. Further, he advises that you invest the money in high-yield savings accounts so that it can earn interest and grow. While interest rates have dropped over the past twenty or so years (12% in 1990 to 1% in 2016), your money will still grow more than if it sits in a normal checking account.
(Shortform note: Bach’s process focuses on creating a single savings account and doesn’t accommodate the large expenses you’ll have outside of unexpected emergencies. In contrast, in The Barefoot Investor, Pape recommends that you allocate a percentage of your money to an additional “happy” savings account—an account used for large expenses that you want to save up for such as a holiday or a car—and a “grow” savings account—an account for long-term investments and savings goals. This way, you don’t need to dip into your long-term savings accounts to fund your large expenses.)
Bach suggests that you research what interest rates and fees different savings accounts offer and check the following points before you decide on the account best suited to your needs:
You can find this information in financial publications (Barron’s, Investor’s Business Daily, or Wall Street Journal), or through Bankrate.
What You Need to Know Before You Open a Savings Account
Is Bach’s list of criteria for savings accounts exhaustive enough on its own? Ramit Sethi would argue not. In addition to Bach’s criteria, Sethi recommends that you:
Research whether the bank or brokerage is trustworthy: Check to see if they’ve been involved in any scandals or if they offer misleading information regarding the accounts they offer. This is arguably even more crucial than many of Bach’s recommendations; it doesn’t matter if, say, your savings account has automatic deposits if your money isn’t in safe hands.
Make sure their customer service department is available 24/7: You may need to contact them in an emergency.
Ensure that the service they offer is convenient to you: For example, if you intend to deposit cash, you’ll need a bank or brokerage located near you, whereas if you deposit checks, you’ll probably find an app that allows mobile check deposits more useful.
In addition, Sethi suggests that you stick to online banks for your savings accounts as you’ll find it easier to set up the account and you’re more likely to earn more interest.
In addition to creating a separate high-interest savings account for emergencies, Bach suggests investing in U.S. savings bonds—these bonds pay a higher rate of interest and are guaranteed by the U.S. government. However, they’re better suited for creating long-term savings accounts (an extra safety net that you’ll avoid using), as you need to pay a penalty if you withdraw your money before five years.
What You Need to Know About U.S. Savings Bonds
Bach’s advice on U.S. savings bonds is arguably inexhaustive. There are a few additional points you need to be aware of before you make the decision to invest:
Bonds offer a very low rate of return—you’re more likely to grow your money in a high-interest savings account.
You won’t be able to redeem them within a year of purchasing them—this could cause problems if you need to cover unexpected expenses.
Your investments are limited to $10,000 in electronic bonds, and $5,000 in paper bonds each year—you can combine both to invest a total of $15,000 each year.
Figuring out how much you need to save to cover your living expenses will help you decide how much money to set aside each month to build a safety net.
What are your essential monthly expenses? Include your rent or mortgage payments, insurance, food, travel, and so on.
How many months’ worth of savings (to cover your expenses) would make you feel financially secure?
What’s your savings goal? To find the amount, multiply your monthly expenses by the number of months you chose above.
Now that you’re prepared for emergencies, turn your focus to getting out of debt. Like most Americans, you’re probably carrying some debt—Bach claims that the average American family owes $8,400 in credit card debt, and, in total, Americans owe approximately half a trillion dollars in credit card debt. Why is this? Bach claims it’s because people are more focused on looking rich than they are on actually being rich. In other words, they rely on credit to maintain the illusion of a rich lifestyle while they risk their financial security.
(Shortform note: Bach’s conclusion that people are in debt because they’re more focused on looking rich is a little reductive. A recent survey revealed that 37% of low-income and middle-income households rely on their credit cards to cover basic living expenses such as groceries and utilities. Further, these people tend to work longer hours or take on a second job just to cover their debts and survive.)
Further, the average American only pays the minimum balance due every month—for $8,400 charged at 18%, it will cost them $20,615 over the course of 30 years to pay off the balance, and that’s based on the assumption that they pay regularly and don’t add further debt to the balance.
(Shortform note: So many Americans get stuck in the debt trap that Bach describes because of the way they’re targeted by credit card companies. Credit card companies profit from interest payments and penalty fees: Every time you fail to pay your balance off in full, they make a profit. Unfortunately, this business model encourages some disreputable companies to target vulnerable consumers—they offer low-interest rates to entice low-income earners and include hidden fees to maximize their profits.)
Bach argues that, if you’re in debt, you should prioritize clearing the amount before you build your savings account. This is because the interest you earn in your savings account is far less than the interest you pay towards your debts. To clarify, if you owe $2,000 in credit card debt and just make the minimum monthly payments, it will take you more than 18 years, and a total of $4,600, to pay off your balance. The same $2,000 held in a savings account earning 1% will only total $2,392.29 after 18 years. Therefore, you’ll save far more money if you clear your debts first. However, Bach does suggest that you set aside one month’s worth of savings before you focus on clearing your debts.
(Shortform note: It’s true that clearing debts before you build your safety net will save you more money in the long term. However, if your job situation is insecure, some financial experts advise that you should prioritize your savings before you clear your debts. This way, you’ll avoid getting into further debt if you do lose your job—you won’t have to rely on your credit cards to survive because you’ll have savings to fall back on.)
Are You Making Excuses for Your Debts?
Prioritizing getting out of debt in the way Bach describes seems like a no-brainer: Many of us dream of having a debt-free existence. So, why is it that so many people don’t prioritize clearing debt—and, in fact, allow it to grow?
Bach doesn’t explore this question in detail; but, according to Sethi, people allow their debts to get out of control because they often find ways to justify remaining in debt. They:
Accept that being in debt is “normal” and justify it by comparing their debts to the debts that their friends and family owe
Feel defeated by the size of their debts—their debts are so huge that they assume that they’ll never be able to pay them off so they don’t bother trying
Blame credit card companies for “preying” on them instead of taking responsibility for their decisions
Try and stay mindful of the excuses you use to overlook your debts throughout the rest of this chapter. Ultimately, no matter what excuses you tell yourself, getting out of debt is both possible and a good idea.
In this section, we’ll learn how to make a plan for clearing your debts and rebalance your automated payment plans to pay them off as quickly as you can. We’ve broken the process down into four distinct steps: total up your balances and interest, make commitments, reduce your payments, and prioritize your debts.
(Shortform note: Sethi’s debt-clearance plan differs from Bach’s method and provides some contradictory advice—we’ll compare Sethi’s process to Bach’s throughout each of the four steps.)
Bach states that if you’re currently in debt, you’ll need to total up the balances you owe and the amount of interest you’re paying on top of this balance. Ask yourself the following questions:
(Shortform note: Sethi advises that, instead of trying to calculate your debt yourself, you should call up your credit companies to find out how much debt you owe, how much interest you’re paying, and the minimum monthly payment. He claims that many people are unaware of exactly how much debt they’re in, so they need to speak to their debtors before they can come up with a plan to clear their debts.)
Next, Bach recommends committing to two principles:
(Shortform note: Both Bach and Sethi advise that you don’t buy things you can’t afford. However, they differ on what methods you should use to pay for what you buy. In contrast to Bach, Sethi suggests that you keep your credit cards, as they’ll improve your credit history—make use of them, but always pay your balance off in full. This way, you show lenders you can be trusted to pay back the money you borrow. He argues that this is one of the most important things you can do to improve your credit score and your financial situation.)
Next, Bach says it’s time to try to reduce your debt payments:
(Shortform note: In addition to consolidating and automating your payments, Sethi argues that you should negotiate lower interest rates regardless of whether you’re in debt or not. This will reduce your chances of getting in debt if you ever fail to pay off your balance.)
Instead of consolidating your payments, you could choose to pay off your debts one by one. To determine the most cost-effective way to pay off your debts, Bach suggests dividing the balance of each debt by the minimum payment required—this will show you the number of payments you need to make to pay off the debt.
Next, rank your debts so that the lowest number of payments is on top. So, continuing with the previous example, the debt that requires 50 payments will be on top—this is the debt you will clear first. Prioritize paying off this debt as much as possible while you continue to pay the minimum balance for your remaining debts. Once you’ve cleared this, keep working down your list in this way until you’ve cleared all of your debts.
(Shortform note: Sethi also suggests that you commit to paying off one card at a time while using automated payments to pay the minimum balance for the rest of the debts. However, he argues that you have two options for how to do this: prioritize the cards with the highest interest, or use Dave Ramsey’s “snowball method” to prioritize paying off cards with the lowest balance (regardless of the interest they charge). He advises that you should plan to make more aggressive payments until you clear your debts—prioritize your expenses until your debts are cleared. It’s worth making a few sacrifices for the long-term savings you’ll make.)
Bach suggests that you continue to invest in your retirement even while you clear your debts. He notes that if you wait until your debts are paid off before you start saving, you’ll get used to not saving. On the other hand, if you keep investing in your retirement accounts, he says that the progress you make will motivate you to clear your debts so that you can invest even more towards your future wealth.
(Shortform note: Bach suggests that you continue to fund your retirement account so that you can make financial progress. However, Sethi argues there’s another reason for doing this: You can make use of your ever-growing retirement account when you’re faced with a financial emergency. Sethi suggests that, if you end up with unexpected expenses and your only option is to use your credit card, you should consider withdrawing money from your retirement account instead. While this will incur losses on your retirement earnings, you’ll still save more than if you increase your existing credit card balance—and the exorbitant interest rates that come with it.)
Debt is an obstacle to wealth. Prioritize clearing your debts so that you can redirect your money towards saving for your future.
Total up your debts: What outstanding balances do you owe and how much interest are you paying for each balance?
List the minimum monthly payment for each of your debts.
For each of your debts, divide the balance amount by the minimum payment amount—this will show you the number of payments you need to make to pay off the debt.
Rank your payments so that the lowest number of payments is on top—this list will prioritize the order in which you clear your debts.
Once you’ve cleared your debts, you can start thinking about bigger savings goals such as buying a house. This is important because, according to Bach, you’re more likely to build long-term wealth if you own your own home and accelerate your mortgage payments.
(Shortform note: Bach believes that renters are less able to build wealth because they’re funneling the majority of their money towards their rental expenses. However, research shows that renters who invest their money into stocks can build more wealth than homeowners. This is because your money earns more interest from stocks than it does from your home.)
In this chapter, we’ll first explore the benefits of owning your own home. Then, we’ll cover how you can get on the property ladder and automate your payments to pay off your mortgage as quickly as possible.
According to Bach, the average American renter has a net worth of less than $4,000. In contrast, homeowners have an average net worth of $140,000. In other words, homeowners are more than 35 times richer than renters. This is because homeowners end up spending less money than renters in the long run. Let’s say you rent an apartment at $1,500 a month over 30 years—at the end of this period you’ll have spent $540,000 and have to continue to pay rent. On the other hand, if you buy a house and you pay $1,500 on your mortgage for 30 years, at the end of this period you’ll own your own home (no more payments) and be free of debt.
In addition, Bach notes buying a home will provide financial security in the form of equity—over the long term, the value of real estate investments always increases (the average annual return since 1968 is 5.3%).
The Disadvantages of Owning a Home
In contrast to Bach, Sethi argues that you shouldn’t think of your home as an investment as the expenses involved will make it difficult for you to make any money from it. He claims that:
Your costs will be higher than they are when you rent because you’ll be responsible for insurance, property taxes, and maintenance.
You’ll only gain an average of 0.6% a year on this asset compared to an average annual return of 8% on the stock market.
You’ll end up paying additional taxes and fees when you sell your home.
You’ll miss out on the amenities and perks offered by rentals in the same price range as it works out far more expensive to buy properties in convenient areas (close to public transport, local schools and shops, and so on) than it does to rent them.
So, while Sethi doesn’t discourage you from buying a home, he does insist that it’s not for everyone—consider whether you’re happy with the costs (not just financial) involved in owning your own home before you take the leap.
Bach suggests you follow three steps to buy a house: pay your down payment, choose the right mortgage payment plan, and accelerate your mortgage payments. Let’s explore each in detail.
The main reason why people don’t buy a home is the belief that they need to pay thousands of dollars upfront to get a mortgage. Bach argues that these people are wrong—there are many programs designed to enable first-time homebuyers to finance up to 100% of the downpayment for the home they want to purchase. These programs help renters come up with a down payment so that they have more of a chance to apply for a mortgage. Bach suggests that you research housing finance agencies if you need help putting together a down payment.
Save for Your Down Payment
Bach doesn’t provide information regarding why companies would offer to provide you with a loan for a deposit, and it’s unclear whether these loans would incur additional costs or have strings attached—such as whether you’ll be restricted to buy specific types of houses or limited by location.
In addition to researching the options he mentions and seeking advice from the resources listed above, you could also start saving for your down payment while you search for a home to buy. The more you save, the more options you’ll have when it comes to choosing and buying your own home.
Pape (The Barefoot Investor) suggests the following ways to save for a down payment while you’re renting:
Set aside 20% of your monthly income.
Consider living on a single wage (if you have a partner) and set aside the rest.
Cut your rental expenses by living somewhere cheaper.
Earn extra income by taking on freelance work and set aside all of this income.
Finally, calculate how long it will take you to save for your chosen property if you funnel all of these savings and extra income into your down payment fund.
Bach claims that you should be able to spend between 29-41% of your gross income on housing expenses—which include your mortgage, taxes, and insurance. Aim for the minimum if you still have debts to clear and more if you don’t have any debts to pay off. For example, if your salary is $40,000 a year, you can afford to pay from $11,600 a year ($967 a month) to $16,400 a year ($1,367 a month) towards all of your housing expenses.
(Shortform note: In addition to Bach’s suggestions, Pape claims that it’s crucial to also factor lifestyle changes into your housing expenses before you decide to buy a house. For example, if you have children, your expenses will increase significantly—you’ll either have to pay for childcare or reduce your working hours to care for the children, and this will impact your ability to keep up with mortgage payments.)
Bach also suggests that you research mortgage providers to compare interest rates and figure out how much you can afford to spend on a home.
Mortgage Resources and Advice
While Bach recommends some mortgage rate resources in the book, many of these are now out of date. The following list of recommended mortgage loan providers (2021) provides the latest expert recommendations:
In order to receive an accurate quote from these resources—loans are tailored to your credit history and what you can afford—you’ll find it useful to gather the following documents before beginning your research:
Tax returns
Proof of income
Bank statements
Investment statements including savings and retirement plans
Debt records including student loans and car loans
Recent utility payment statements
Renting history
Gift letters to indicate funds that have been gifted towards your home purchase
Child support or alimony documentation
Bankruptcy records
When you research interest rates, make sure you also factor in the following costs as they can add a substantial amount to your overall loan:
Application fee
Credit report fee—non-negotiable
Appraisal fee—non-negotiable
Underwriting fee
Property taxes—non-negotiable
Government fees—non-negotiable
Service fee
There are multiple mortgage payment plans to choose from and each comes with its own advantages and disadvantages:
Other Common Mortgage Plans
Bach’s advice in this section is somewhat minimalist. In addition to the fixed-rate and adjustable-rate mortgages that Bach explores, there are six other common mortgage types that may interest you and better fit your financial situation:
Conventional mortgages: For primary or secondary homes and investment properties. Interest rates are higher but the overall cost of the plan tends to be lower. Look into this if you have a strong credit history, a stable income and employment history, and the funds to put down at least 3% as a down payment for the home you want.
Government-insured mortgages: For borrowers who haven’t saved for a down payment, or meet certain income limits. Look into this if you’re worried about your credit history and your ability to put down a down payment.
Jumbo mortgages: For homes in expensive locations. Interest rates tend to be lower than they are for conventional loans because you need to put down a large payment. Look into this if you have an excellent credit history, a high income, and the funds to put down at least 10-20% as a down payment for the home you want.
Construction loans: For people who want to fund the construction of their homes. Look into this if you want to build your own home and can afford to pay a high down payment.
Interest-only mortgages: For people who are happy to pay only towards their interest, not their equity, for the first few years. Look into this if you want to keep your mortgage payments low for a fixed amount of time (five to seven years) but can commit to higher payments after this period.
Balloon mortgages: For people who want a short mortgage and can afford to pay a large lump sum after a few years. Look into this if you want to commit to a short mortgage (seven to ten years) and then make a large payment at the end of the period to clear the balance.
Overall, Bach recommends fixed-rate mortgages, as he believes these have the most benefits. However, he notes that a drawback of these plans is that you’ll end up paying a huge amount of interest over the full mortgage term (and at the beginning of the term, you’ll pay mostly interest, accruing minimal equity in your home).
However, he insists that you can avoid the disadvantages of fixed plans if you accelerate your mortgage payments: in other words, pay more towards your mortgage each month or year than you need to. This enables you to cut years off your payment plan, thus reducing the amount of interest you pay in total (since interest accrues exponentially over time—thus, cut the time spent paying your mortgage, and you cut the amount of interest you pay).
The Disadvantages of Paying Off Your Mortgage
Bach strongly believes that paying off your mortgage will lead to more wealth so he doesn’t cover the disadvantages of taking this route. While accelerating your mortgage payments will save you thousands of dollars in interest, there are a few possible drawbacks to consider before you decide to proceed with this plan:
Access to cash: Even with accelerated payments, it will take years to pay off your mortgage. During this time, you won’t be able to access the additional money without refinancing or selling your home—make sure you have enough money in savings accounts to cover emergencies.
Tax breaks: The interest you pay on your mortgage is tax-deductible (you receive a tax rebate for these payments). Once you pay off your mortgage, you won’t be able to receive this tax benefit. If you’re a landlord, this could have a massive impact on your tax payments.
Credit score: Your credit score hinges on proof of your ability to reliably make regular payments to pay off your loans. Once you pay off your mortgage, this loan will no longer be factored into the equation used to determine your credit score and could lead to a slight drop (this impacts your ability to get a new loan).
Pay-off: The money you invest into your home would earn substantially more if you invested it into stocks (4.5% for a home and 10% for stocks based on the average rate of return for the last 90 years).
The longer it takes you to pay off your mortgage, the more your mortgage provider benefits—it makes a profit from all of the additional interest you pay. Some providers may penalize you for attempting to pay your mortgage earlier while others may not. Therefore, once you’ve decided on how you intend to accelerate your mortgage payments, Bach suggests that you contact your (current or prospective) mortgage provider to check whether you’ll be penalized for making extra payments.
Why Mortgage Providers Penalize Extra Payments
You may be wondering why mortgage providers penalize you for attempting to clear your debts—don’t loan providers want people to pay them back as quickly as possible? To clarify this, we’ll briefly explain how mortgage providers make a profit.
There are two parts to your mortgage payments: the actual loan amount and the interest fees. Mortgage providers rely upon the interest you pay to make a profit—this profit allows them to provide more loans and make more money.
Mortgage providers are able to offer loans with low interest rates because they accumulate the profit from interest payments during the life of the loan. When you cut the length of your repayment period, you cut their profits—this forces them to offer loans with higher interest rates.
This explains why some mortgage providers penalize you for early repayments, divert the extra money you pay towards interest (their profit) instead of equity (your profit), or delay sending your money towards your mortgage (the longer they hold onto the money, the more interest they can earn by investing it). These tactics give mortgage providers a bad name, especially when they don’t explicitly state these penalties. However, when you understand the business model behind loan providers—they need interest payments so that they can provide long-term loans—it’s easy to see why they need to put such measures in place.
Now that you’ve set yourself up to build wealth and secure your financial future, let’s explore how you can share your good fortune with others and contribute to a better world.
The automated path to wealth allows you to automate your finances so that you can spend less time worrying about your finances and more time enjoying your life. Bach insists that the point of this process is not just to have more money, but to use the money to do things that make you feel good.
While you can choose to “feel good” by spending your wealth on new gadgets and luxuries, Bach argues that the real value of money comes from how you use it to help others. He suggests donating a portion of your income to a cause you care about—not only will you feel good about yourself, but you’ll also actually feel wealthier and your pursuit of money will feel more meaningful.
(Shortform note: In addition to making your pursuit of wealth more meaningful, philanthropy helps define your legacy. Pape (Barefoot Investor) claims that, after you’re gone, people are only going to remember you for the contribution you made to the world, not for the amount of money and material things you possessed. Along with donating money, Pape suggests using your money to create your own charitable organization, or to fund a product or service to help your community.)
Bach suggests that you research and identify charities that are meaningful to you. Once you’ve chosen your cause, your recipient should be able to contact your bank to set up an automatic payment plan on your behalf (with your permission) so that you can make regular monthly contributions.
Bach urges you to keep track of your donations—many charitable donations are tax-deductible so you may save taxes on your contributions (if you donate $100, you can claim back the tax you’ve paid for that $100 on your tax return). You can check with the IRS and request #526 (Charitable Contributions) to confirm whether your chosen charity is tax-exempt.
Should Charitable Donations Benefit From Tax Deductions?
Some politicians are calling for an end to tax deductions on charitable contributions. They argue that these deductions:
Only benefit wealthy donors (they can already afford to give without the tax break)
Generally don’t increase donor contributions (compassion, not financial incentive, leads to giving)
Definitely harms the economy (the government subsidizes charities every time they offer a rebate)
In addition, unless you itemize your tax return and provide proof of your charitable donations, you won’t get the rebate. This additional paperwork means that millions of Americans already contribute without applying for a rebate, and strengthens the argument that these tax deductions should come to an end.
If you have money to contribute but aren’t able to decide on a charity, Bach suggests you consider investing in a charitable fund—this type of fund allows you to set aside money to donate even if you haven’t decided on a specific cause. This way, you receive instant tax deductions based on your annual IRS limit and the money you invest continues to grow tax-free until you decide to contribute it. However, once you’ve invested the money, you can’t get it back—the money has to stay in the fund until you send it to a charitable cause.
(Shortform note: If you’ve already decided on a charity and would like to invest your contribution, receive tax deductions, and earn an income on your contribution before you send it to your cause, consider investing in a Charitable Remainder Trust. This type of trust pays you a share of the profits for a set period of time, and then contributes the remaining amount to your designated charity.)
If you can’t yet afford to donate your money, consider donating your time instead—this will make you feel just as good as donating your money would. Bach suggests that you research opportunities to volunteer your time to a cause that you care about.
(Shortform note: Volunteering your time may create more value than your monetary donations. This is because volunteering allows you to contribute your knowledge and skills to help non-profit organizations effectively deliver their services. Your time has a direct impact on their operation costs—without your help, they would need to use donor contributions to pay people to do the valuable work you’re doing.)