How To Be Rich

As April 15 quickly approaches, many people are finishing up their income tax returns. This year, I will owe the government money when I file, and that is okay with me.

In fact, my preference is to owe the government a little bit come tax time each year. If that doesn’t happen, my second preference is to get back a tiny bit back as a refund.

I know lot of people that look forward to getting a tax refund each year. In my opinion, that is poor money management.

Understand what it means to get a refund. The Free Dictionary defines refund as “to give back, especially money.” In order to “give back,” it must have started out as yours. And in fact, it did.

When you have taxes withheld from your paycheck each pay period, those monies are your money that is being pre-paid in anticipation of taxes that will be due at the end of the year. Rather than trying to come up with several thousand dollars all at once at the end of the year, the government has your employer take a little bit each time. But it starts out as your money.

If you paid too much during the year, then the government will give it back, true, but could you have have used it during the year? By giving it to the government early, you have essentially given them a loan. When they send you your refund, they send you back exactly what you over-sent them. Usually when we lend people money (or people lend us money), the expectation is to pay it back with some interest. Except the government didn’t pay you any interest for the use of your money over the last year.

Last year (2011), the average refund was $2913. On a PER DAY basis, this represents almost $8. Compound that to $56 per week ($112 per pay if paid bi-weekly) or $242.75 per month.

The sad thing is, the White House asked people what $40 meant to them in regards to reinstating the Social Security tax that had been cut. The website got a whole lot of feedback saying people need that $40.

So here we are saying, “Please don’t take back the mandatory 2% to put towards Social Security (which is quickly running out of money). Instead, I want to voluntarily give up $112 dollars so I can have a tax refund.”

What?

Through better planning (and a new W-4 form), the average person could get back $112 dollars on each paycheck. That would more than cover the $40 (or 2%) that the FICA tax was reduced by. And I’m sure these same people needing the $40 now will also be wanting their full social security check when they retire as well.

Not only that, we tend to treat money received as a refund differently than money received as part of our paycheck. Many people use their refund to splurge on themselves, when those same people often should not do so. Remember, the goal of this blog is to help you get rich. Poor money management is not the way to get there. Plan your spending. If you want to take a vacation, then you save a little each pay so at the end of the year, you have almost $3000 for your vacation. Don’t let Uncle Sam do the saving for you.

Have you filed your taxes yet? Are you getting a refund? What will you do with it? I look forward to hearing what you have to say in the comments.

So on the first Monday of the month, I talk about Financial Riches. More specifically, how to get rich from a cash perspective.

So it may seem odd that I want to encourage you to buy food for breaks and bring it with you instead of buying on location from a vending machine.

I mean, shouldn’t “buying” be on the “Material Riches” Monday? Perhaps directly, but I want to focus on the indirect benefit (and we may look at the direct benefit on a different Monday).

By bringing your own break food (or snacks), you can control not only the health quality of the snack, but also the portion size.

This will help increase energy, making your more productive at work (with the potential to earn more money for doing more work).

This will help decrease health issues, causing less spent at doctor’s offices and hospitals (and less time away from work, causing a loss in wages).

What do you snack on? Are you addicted to vending machines? I’m eager to hear your thoughts in the comments.

Based on previously covered information, we estimated that a family that makes $5000 each month could probably get by on $3150 each month taking into account taxes that won’t have to be paid and expenses that could be cut in a crisis situation.

But how many months of savings should you have? 1 month? 3 months? 6 months? 8 months? 12 months? All of these are current suggestion by financial gurus today. So who is right?

It depends.

I think, at a minimum, everyone should have 3 months of expenses saved just in case. Fortunately, we are not all clones of the next guy. Unfortunately, these differences also cause different needs for safely. I think the cause for extra funds required can be narrowed down to three different reasons.

1. Pay consistency. Some people work for salary, so they earn a consistent paycheck from week-to-week and month-to-month. However, many people work positions where their income is variable. Obviously, a person working on commission has a lot of variability in their income. However, people who work for an hourly-wage could also have their hours reduced and/or overtime limited which would also cause a drop in pay. Rate yourself for this reason either a 1, 2, or 3, with 1 being very consistent and 3 being very inconsistent.
2. Job security. Back in the day, a person could get a job right out of high school, work for the same company their entire life, and retire hold only one job in their life. Today, the average person holds their job for about 3 to 4 years. Sometimes, they choose to leave; other times, they are asked to leave. When companies are down-sizing, it is often the middle-management who are let go. Rate yourself for this reason either a 1, 2, or 3, with 1 being very secure and 3 being very insecure.
3. Expense consistency. There are two parts to the spending equation. The emergency money needs to protect us in case of reduced income, but also in case of increased expenses.  Rate yourself for this reason either a 1, 2, or 3, with 1 being very consistent and 3 being very inconsistent. (Note that anyone with children at home should probably score this a 3.)

Add your three ratings together and that number indicates the number of months I feel you should have reserved for a potential emergency. The best you can so is 1 + 1 + 1 = 3, so 3 months minimum.

Do you agree with my reasons? Can you think of any more? Would you change any of the reasons? I’d love to hear your thoughts.

So we talked about getting a starter Emergency Fund. $1000 as quickly as you can saved up.

But is that enough? How much is?

Different people have different definitions of that “how much” question. Many don’t put a hard dollar on it, but rather base it on your income, then a certain amount from there.

Just for an example (so the numbers work well), suppose you make $60,000 a year (which is $5,000 a month), and you subscribe to the belief that you should hold 6-months worth of savings.

It should seem obvious that if one month is $5,000, then 6 months should be $30,000. (Alternatively, if $60,000 is a full year, then $30,000 is a half year.)

But more than likely, that is wrong. Suppose you lose your job. If you are no longer receiving a paycheck, you no longer have to pay payroll taxes (like FICA of Medicare) or income taxes (federal, state, local). If you are regularly saving for the future (401(k) contributions, vacations) those can be put on hold temporarily. Other expenses can be temporarily eliminated as not being essential (entertainment, restaurants).

Sound Mind Investing suggests that for a median married family household income ($72,751 as of March 2011, the most current information today), payroll, state and federal taxes will account for about 16% of your income. In some states, you have a local tax which could be added to that. Families who make more should probably use a higher number than 16%, families who make less should use a smaller number.

Now that you have your after tax income number, SMI suggests that about 25% of that number can be eliminated from the budget, leaving 75% of the 84% as essential income. This works out to be roughly 63% of our gross income. So in our case of $5,000 earned per month, We are estimating that the essential amount is $3,150 per month. For six months, that number would grow to $18,900. Fortunately, this number is easier to attain than the originally predicted $30,000.

For some, a six month “cushion” is enough. Others may need more (eight or nine months). Some less (three months). We will tackle the time frame to save next month.

In the meantime, how much money (percentage wise) are you bringing home after taxes? If 16% for taxes too high or low for your? Or just right? How much of your net income (percentage wise) do you think you could live on? Could you eliminate 25%? Have you already curbed your spending so it is mostly essentials now? Or are you spending lavishly and can easily cut more? I look forward to reading your comments below.

It is important to have some cash set aside for emergencies, but how much is enough?

I don’t think there is a one size fits all answer for this question. Much of it will depend on current income and current expenses—both fixed expenses, like mortgage and loan payments, and variable expenses, like food.

Many people suggest three months of living expenses. Others would like you to have six months in savings. Suze Orman’s latest recommendation is eight months.

I like Dave Ramsey’s plan to start the Emergency Fund. He recommends initially saving $1000 (or $500 if you make less than $20,000 a year).

He even goes on to give suggestions on how to raise that cash as quickly as you can. Some, you may only want to do for a little bit, like getting a second job. Some you can do only for a little bit, like selling all unnecessary stuff on eBay (eventually you will run out of stuff to sell).

Other suggestions you may want to commit to long term, like carpooling, buying used, or breaking habits. But remember the goal is that emergency fund; If you carpool and save $20 that week by not driving, take that $20 and put it into savings—don’t think that you have $20 extra bucks to spend.

Or if a new shirt would cost you $15, and you bought a used one for $6, don’t spend the $9 you saved on something else.

But that $1000 isn’t a full emergency fund; it’s just a starter. We’ll give you about a month to try to get that together, and come back next month to talk about the ultimate goal.

In the meantime, what have you done to get your starter emergency fund?

If you want to be rich, you need to act like rich people. (If you want to be poor, act like poor people.)

Poor people spend everything that they earn. Some even spend more than they earn, going into debt with credit cards or loans. Living paycheck to paycheck is not fun (ask anyone who has done it).

Rich people spend less than what they earn. Sarah Damon reports that, “80 percent of America’s millionaires are first-generation rich, and they got that way by living below their means and saving the difference.” She then goes on to say, “To live below their means, the majority of millionaires (62.4 percent) track their spending. They know how much their family spends each year on groceries, dining out, gifts, clothing, child care, charity, financial advice, bills, tuition and vacations.

Fortunately for you, you can find a FREE Spending Plan on this blog for your use. Part of that spending plan is a section for savings. Some saving will be for short term use like vacations, furniture, or real estate taxes. Some savings will be for long term like appliance replacement, children’s college, or retirement.

But don’t exclude a special savings accounts for those unexpected expenses. My family use to call it a Rainy Day fund. Mary Hunt calls it a Contingency Fund. Suze Orman calles it Save Yourself Account. Many others call it an Emergency Fund. But whatever you call it, you need to do it.

What is preventing you from starting today?

I think when most people think of “rich,” money is the definition that they think of automatically. While this definition is not the only one I wish to promote, I do believe it is an important idea to pursue.

Some have said that money is the root of all evil. Well, they are trying to restate a Biblical quote—and doing a terrible job at it!

The actual verse states “For the love of money is the root of all kinds of evil.” But we need to look at the context as well at the words of this verse.  The Bible also states, “Curse God and die.” Out of context, it has the wrong meaning.

Fortunately or unfortunately, money is what makes the world run.  We need money to pay for some sort of shelter, like a house. We need money to buy food. We need money to pay for utilities, clothing, transportation… To say that the desire for money is evil denies life itself, for without money, we could not live. 

Money also allows us to help others in need, especially if they are somewhat of a distance away.  Locally, we had some massive flooding last week.  I was fortunately to be able to go and help physically clean up some of the damage. However, for catastrophes that are not close by (Hurricane Katrina and the Japanese earthquake come to mind), my money could help with the cleanup and rebuilding efforts.

The more we make, the more we can give.

If you were to get a raise today, could you give most of it away to help others? Some of it? All of it?