- The Three-Step Financial Plan
- Build Wealth From Nothing Step 1
- Build Wealth From Nothing Step 2
- Build Wealth From Nothing Step 3
You can build wealth from nothing. I know, because I did it. Actually, I started from “less than nothing.” I had debt, few resources, and bad money habits. But with some learning and a generous income, I was able to build wealth. So can you.
The steps to build wealth from nothing are straightforward. They are simple.
That doesn’t mean they are easy.
But there is a plan to follow. Are you ready for this secret path?
Here it is as laid out by JL Collins in his excellent book, The Simple Path to Wealth.
The Three-Step Financial Plan
1. Spend less than you earn.
2. Invest the surplus.
3. Avoid debt.
Keeping it simple boosts returns and saves time. There are plenty more details in JL Collins’ book, but you could just implement this plan and be done.
Build Wealth From Nothing Step 1
Spend Less Than You Earn
Living “below your means” sounds like a sacrifice. It doesn’t have to be. Fortunately, physician incomes are high, so saving is affordable without suffering. Yet the majority of physicians do no save enough.
How much is enough? Since so few Americans save at all, the standard advice is to start saving. That means save anything. Save something. Some recommend starting with 1-2% and then working up to 5% or more. The goal of many financial planners is to motivate their clients to save 10%.
There is just one problem with that: 10% or less isn’t enough. Many of the physician stereotypes are true. We tend to be too trusting, overconfident in areas outside our expertise, and not knowledgeable of financial history.
Doctors start our high-earning and investing later in life. It doesn’t help that we carry high debt loads and aren’t great at negotiating or investing. You must overcome these hurdles in order to build wealth.
We Spend Too Much
All these factors increase our minimum necessary savings rate. Jim Dahle, MD (the White Coat Investor) and others recommend doctors save 20% of their gross income. You don’t need a fixed savings rate. 20% would be a good target for a minimum savings rate. I don’t think that is high enough to be ideal.
The 20% savings rate pretty much guarantees you will have to work at least the standard 30-plus year career to be comfortable in retirement. Although we may choose to work that long, having more options earlier in our career would be a better route.
When Will You be Financially Free?
In general, physicians should shoot for a savings rate between 35-40%. That is based on your gross income. Your gross pay is the “top line” of your salary or paycheck. Figure a third or more of that and consistently sock it away.
Depending on your taxes and deductions my previously recommended 38% gross income savings rate will work out to about half of your net pay. Some find it easier to calculate their savings rate based on their “take-home pay” which is your “bottom line” or net pay.
Net Versus Gross: So Complicated!
Your net pay is after your payroll taxes and deductions. As a result, net pay is much smaller than gross pay. Net savings rates will always be bigger than gross savings rates. Saving 38% or so of gross or 50% of net (equivalent for most of us) would get you to Financial Independence (FI) in about 17 years. Trust me, when you are FI at 50 years old you will be glad to be in the driver’s seat of your financial life. I’m not the only one crazy enough to suggest this level of savings.
JL Collins’ recommended savings rate is 50%. He is (I believe) referring to a gross savings rate. So that is much higher than I’m suggesting. It isn’t required, but if you want to achieve FI closer to 12-14 years, consider his recommendation. You get to choose.
Don’t let me or anyone else try to dictate your savings or spending. Build wealth on your timeline, not mine. Personal finance is personal. Your ideal rate could be higher or lower. It depends on you and your situation.
No, It’s Simple: Shockingly Simple
Divert the money automatically to your investment account. A fixed amount or a fixed percentage can go from each paycheck directly into your mutual funds. The money I invest is the money I never see. I don’t have to decide or feel the sacrifice of not spending. I don’t have to actively transfer money with every paycheck. It is automatic from my payroll. You can do that too.
Build Wealth From Nothing Step 2
Invest the Surplus
So now that you have a “surplus” of cash coming from payroll you need to know how to invest.
What should you invest in?
Collins’ answer: invest in stocks.
Collins is optimistic about long-term equity investing. He cites irrefutable market facts to bolster his case. Throughout history, stocks have always gone up over significant time periods. Stock prices have gone up over most 10-year periods, many 20-year periods, and all 25+ year periods.
Stocks grow and outpace inflation over the long-term. So, let’s say you have been persuaded to invest in equities (stocks). How do you know which ones? Maybe you need an advisor? Or a broker? Should you buy Apple or Amazon shares?
Question: Which stocks should you buy?
Answer: All stocks.
JL Collins recommends VTSAX which is Vanguard’s total stock market index fund. During your working years (Wealth Accumulation Stage), you could put 100% of your investment into that fund. It is low-cost and diversified.
Although some argue you need international investment, many U.S.-based multinational companies (like Starbucks and Wal-Mart) already do business in foreign countries.
But What About a Stock Market Crash?
If you can’t handle the volatility, Collins recommends you toughen up. His advice is a little different from other advisors.
Other advisors would recommend you understand your “risk tolerance” and invest accordingly. He argues your preferences shouldn’t drive investment decisions. Acquire better understanding. Learn how to calm your nerves in a crash. Ignore the screaming panic in the media. Do not sell in a crisis. Learning how to deal with your emotions and investing more in stocks is a more predictable path to build wealth.
His argument is rational. But many of us turn out to be human and we struggle with our own panic. If you cannot tame your emotions during crashes, then you might want to invest more like his Wealth Preservation Stage.
His Wealth Preservation Stage is designed for those not working, but it would work well for those at any stage who can’t stand the volatility. That would mean you invest some portion (say 25%) in bonds.
Question: Which bonds should you buy?
Answer: All bonds.
He recommends VBTLX, Vanguard’s total bond market index fund. This will “smooth out your ride” and help during deflationary times.
If you want some bonds but don’t want to keep messing with percentages, you could pick a Vanguard Target Retirement Fund. You don’t have to pick the one assigned to you based on your age or date of “retirement.” You can select any fund. So, pick one with a high percentage of stocks.
Build Wealth From Nothing Step 3
This is a tough one for most of us. The average medical student loan debt has passed the $200K mark. Also, after years of ceaseless work and sacrifice, we are ready to start a “normal” life. Our long-suffering significant other may be equally tired of waiting. For many of us nearing the end of residency also means a new marriage, new house, new car, and maybe children.
All of these require money at a time when we have precious little. We want big expensive things and we want them soon. Debt seems like the only option. We tell ourselves we will be okay as long as we limit “bad debt.”
Is Any Debt Really Good?
We have heard that some debt may be “good debt.” We want to leverage our investments and good debt can help with that. Nevertheless, Collins’ advice is worth considering.
Debt not only adds leverage and boost upside returns. It magnifies and accelerates losses on the way down. Debt requires us to pay out interest payments in service of the debt. Whether those are small or large, deductible or nondeductible, they are a regularly required cash outflow.
Avoiding debt or paying off debt is doable. It seems impossible, but it isn’t. It is simple, but not easy. To start “from nothing” you have to first get up to “nothing.” If your net worth is negative, you must get to zero before you can build wealth.
I Needed Help to Get Out of Debt
It is alright to get a little help and to learn from others. You may need a lot of help. You may even need a total money makeover. Once you climb out of the hole of debt, you will not miss owing money. Trust me.
I enjoy interest payments now. They all flow to me, not away from me. As Dave Ramsey points out, if you don’t like being debt-free it will be easy to go out and get yourself some loans. I will not be doing that! I’m guessing you won’t either.
You now have a simple three-step plan to build wealth from nothing (or less than nothing). The rest is up to you.
Save. Eliminate debt. Invest. Mostly or exclusively in stocks. Choose low-cost broad index funds. Automate the process. Don’t panic in down markets.
Keep it simple. Let the disarmingly-simple wisdom of JL Collins guide you. There is indeed a Simple Path to Wealth.