How we build wealth

Building off one of the best books I’ve ever read – The Psychology of Money by Morgan Housel, here are some personal rules for building wealth.

Note these rules aren’t perfect and if you create your own, they won’t be either. What you want to strive for is repeatable rules you can stick with 100% of the time. 

Please feel free to use any here for yourself

Investing assets

1. Always have emergency savings
   • Life throws us more curveballs then we’d expect so we view savings as an investment to respond to an uncertain future
   • My wife and I aim for 6-12 months of our combined salaries. This may seem like a lot, but it’s worth it to help us sleep better at night
2. Build in a margin of safety 
   • Paraphrasing Warren Buffett, Morgan shares never “risk what you have and need for what you don’t have and don’t need”
   • We prepare for most assets we buy to go down by 50% and more volatile assets like crypto-currencies to go down by 95%
3. Dollar cost averaging
   • Because we’re uncertain on where the world will go, we dollar cost average
   • We invest the same amount every month rain or shine, market up or down
   • Yes we’ll invest during peaks, but we’ll also invest when the market is at its lowest and this is when you’ll make the biggest returns
   • Because we don’t know if the market will go up or down in the short term, dollar cost averaging is the best way to be set up for future growth
4. Invest for the long term
   • US equities have gained ~10 % yearly over the past 50 years (1971-2020) meaning $1 invested in 1971 would result in $177.33
   • Yet the average investor hasn’t gained nearly this much as they constantly pull out money when they’re afraid of falling prices and put more in when prices are up
   • In addition to dollar cost averaging, we keep our money in for long time horizons. Our assets will undoubtedly go down at times, but we’re betting on ~5%+ yearly growth over a multi-decade time horizon
5. Diversify your assets
   • Index funds investors’ greatest gift to as they allow to diversify in a low cost way
   • We invest ~80% of our money in VT, VTI, and VWO as we aim to be diversified across US and international markets
6. Beware who you’re investing against
   • When actively investing, remember there’s someone on the other side of trade. If you don’t understand their motivation entirely, ask yourself what am I missing?
   • As Patrick O’shaugnessy jokes, his podcast Invest like the best full of brilliant investors could better be called this is who you’re up against

Spending 

As Morgan says, remember “wealth is what you don’t spend”

• Regardless of income, you cannot build wealth without spending less than you make 
• Also, a penny saved is not a penny earned anymore. It’s actually more valuable to save!!
  • When Benjamin Franklin originally coined this phrase, income taxes didn’t exist. 
  • Now because every new penny you earn is subject to income tax, saving is actually worth significantly more than earning
  • For myself with a 37.4% combined tax rate across state/federal taxes, an additional $1 saved = $1.60 earned 
  • This means I could build as much wealth saving $5,000 by not buying a new couch, bed, and TV as I could by getting an $8,000 raise

When we do spend, here’s some rules we use

1. Pay for experiences rather than items
2. Pay for items that save you time and energy vs items signaling your status
3. Invert the discarding process from the life changing magic of tidying up. Never buy any clothes, furniture, consumables that you don’t immediately love and doesn’t spark joy
4. For consumable items that don’t spoil (toiletries, canned goods, alcohol) buy them in bulk (we love Costco)
5. Buy high cost items when they’re cheapest (flights months in advance, cars during holiday sales, etc.)
6. Don’t worry about the cost of high quality healthy food from the grocery store (fruits, vegetables, salmon, that avocado you want). These foods will make you feel better and by living a healthy life you’ll reduce your healthcare costs

For those who are already frugal – Beware of what has a low cost vs what is cheap 

• If you buy cheap sunglasses that keep breaking every two months, the “more expensive” option may be buying the cheap sunglasses
• While cost is low, always beware of the quality that comes with it

Final Thoughts

While all this was about building wealth, remember to think through what your purpose is when investing and saving.  

My wife and I stick to the following

1. Building wealth gives us the freedom to live the life we want. Ideally in a few years we will choose our jobs or volunteering not based on salaries, but instead on if it makes us feel fulfilled
2. We use wealth in a way that makes us happy. For us, this includes donating and spending money on friends (which research shows is better than spending on yourself)