Free Family Finance

There is, what I believe to be, a common misconception in the world of personal finance. For years, there has existed a notion that ‘a person’s income is their greatest wealth-building tool’. To this notion, I must humbly disagree. I feel that this statement is a half truth, much like saying that the engine is responsible for the operation of a sports car. Certainly a car could not run without an engine. But there is much more to a car, than the engine alone (i.e. brakes, transmission, suspension, etc).

It is easy to dispel this misconception. One could simply look at a selection of people who have substantially high incomes. In theory, they should all be substantially wealthy. Right? But you don’t have to look far before you find high-income individuals who are not wealthy. In fact you could easily find a high-income individual who is flat broke. How could this be? They make tons of money!

There must be more to the equation, than income.

In its most simplistic form, why did these high-income individuals end up broke? They also had high-outgo’s. They spent to excess. They gave to excess – to friends & to family. They disposed of money at a greater rate than they earned it. Thus, the outgo is as fundamental as the income.

So what then, is the single greatest wealth-building tool? We have established that it isn’t income. And common sense would tell you that outgo alone isn’t the key. So what could it be?

I would suggest the single most important wealth-building tool is ‘the margin’. The what?! The Margin – the difference between the income and the outgo.

Income   -   Outgo   =   The Margin

It might be fair to call The Margin a personal net profit. For some people, their margin is a negative number. Those people are in trouble. For almost everyone else, the margin is a positive number, but statistics say it is a quite small number.

Why is it important to make the distinction between the income and the margin? Because if you believe that your income is your greatest wealth-building tool, then the answer to too many of your financial problems is, “make more money”. If your outgo is being neglected, “make more money” becomes a unicorn. It is unobtainable. You make more and inherently spend more, never truly addressing the financial issue at hand. You can work harder & harder, making more & more money, with no positive result.

The fact is, our greatest opportunity for building wealth lies within the margin. Subsequently, the key to maximizing wealth-building is maximizing the margin. As we raise our income and keep the reigns on our outgo (i.e. get out of debt & save money), we expose our greatest wealth-building tool.

When it comes to building wealth, the ‘Magic is in the Margin’.

First & foremost, if you live in a apartment or rental property of any type, you need renter’s insurance. Why? Well, you know that 400 pound man that lives above you? The one that stomps around in the size 15, steel-toed work boots at 3am. The one that plays fetch with his 3 german shepherds inside the apartment and every time he throws the ball, a stampede of footsteps runs from one side of your ceiling to the other (and back again). Well, what if he is cooking meth in his bathroom? Or has an extensive candle-burning shrine to Scott Baio? What if he decides that he can fix his own washer & dryer or doesn’t know the rule about throwing water on a grease fire? The possibilities are endless.

“Only two things are infinite, the universe and human stupidity, and I’m not sure about the former.”
-Albert Einstein

All of this is to say, you need renter’s insurance. There is no magic to it. How much would it cost to replace all of your crap? That is how much coverage you need. Go talk to your insurance guy and have it added. It is pretty inexpensive – roughly $150/year will cover $20,000 of your stuff. Well worth it. If you are reading this and thinking about how little you have to insure, think again. Go home and stop. Look around your apartment. Sure your furniture might be a little crappy, but if your pad burned down, you would still need a place to sit & play X-box. Speaking of X-box, it would be gone too. You would still need to replace your guitar or that closet full of clothes. I don’t know a person in American that doesn’t have $150 bucks worth of clothes in their closet and it is unlikely that you would be wearing them all the day your apartment explodes. All things considered, you probably need the protection.

The one nuance you need to be aware of, as it relates to insurance…you need to have a record of the stuff you are insuring. Just like insuring your car, when you have to show them the title, proving that you own your ride. Renter’s insurance is the same way, as is home insurance for that matter. You must prove that there were things in the apartment that need replacing and what those things were.

In this digital age that we live in, it couldn’t be easier. Just snap some photos of your rooms, closets, etc. Make sure your important stuff is in the photos. If you really want to cover yourself, maybe pull the receipts from some of your big ticket items and scan them on the computer. This way you have proof of ownership and proof of replacement cost, if something were to happen. This extra step would certainly grease the wheel of your claim, were lightning to strike (figuratively or literally). Just make sure you save those files on a computer away from home. Or maybe upload them on your MobileMe account, so that they are stored in the virtual heavens.

If you are not already, make sure you get yourself covered. Soon. Before Johnny Lead-foot upstairs decides to deep fry his Thanksgiving turkey in his living room.

Ok, the average American makes about 45k a year. Uncle Sam forces you to pay 6.2% of your income to Fica, aka Social Security. Uncle Sam also forces your employer to match that 6.2%, also contributing it to Fica on your behalf. Thus, 12.4% of your income is contributed to social security. Assuming you are the average American making 45k per year, you contribute roughly $100 into the social security system each week. That’s alot of dough.

Assuming you work from age 22 to age 62 (40 years of service) and never get a raise, you have contributed $192,000 towards the government’s mandatory retirement plan. Then you retire at age 62 and live to be 77.8 years old, all the while drawing about 30k a year from social security. However, while you are retired, you will probably have to liquidate most of your assets for living & healthcare costs, because 30k per year isn’t much money. When you die, social security stops and your withdraws have totaled approximately $480,000. That calculates out to be a 4% return on the money you have contributed to social security. At the time of your death, whatever assets you have will be held against your debts, and whatever remains is passed on to your heirs.

Now, let’s pretend for a moment that the government did not force you to participate in social security. Instead, you contributed the same money into mutual funds via Roth IRAs & 401(k)s. You invest the money, gaining a 12% annual return (the average of the US Stock Market since its inception), over the same 40 year time period. At age 62, you will have invested the same $192,000 into retirement, however instead of $480,000 in retirement funds, you would have 10 times that – over $4.7 million! Thank you compounding interest. Now you retire at age 62, live off of 5% of your investment ($230,000 per year!!!), and your nest egg remains untouched. Thus, you die leaving your heirs with $5 million buck in inheritance.

To summarize:

• Social Security: $192,000 @ 4% = $480,000 / 30k per year at retirement / $0 left at death.
• Private Retirement: $192,000 @ 12% = $4,752,000 / $230k per year at retirement / $5 million left at death.

That is why Social Security Sucks.