Your Brain Makes Building Wealth Hard

One of the first steps to overcoming a challenge is to recognize there is a problem. If you do not know where your stumbling blocks lie it is often impossible to achieve the results you desire. In the wealth building process there are multiple challenges, but one that many people don't recognize is your own brain. Our brains developed to do a great job helping us hunt, gather, and reproduce. Unfortunately our brains are not particularly suited to the challenges of creating wealth.

There is [relatively speaking] a new field of study called Behavioral Finance. The basic idea is that investing decisions are made by people, and people are influenced by psychology in addition to the pure numbers of the markets. In fact, investors (being human) are subject to quarks of neurology, biochemistry, and evolutionary anthropology which in turn influence all of our money decisions.

So, now that we realize that there is more to investing than just the numbers, what does that mean? First off, it means that your brain is not always aligned with your aspiration to build wealth. In many cases your brain can drive you to do the wrong thing with staggering regularity. The best example is the tendency to sell your investments (in panic) during a market downturn.

Everyone knows that to make money a person must "buy low, sell high" but in practice most investors jump on the bandwagon when the market seems to go up, up, up and then sell to stop the pain as the market falls. What is the result? The average investor buys stocks when they have already gone way up and sells after they have dropped. This is a "sell low, buy high" strategy that will loose money every time. Why then do some many people follow this pattern?

The short answer is people "feel" the pain of a loss in the market much more strongly than they "feel" the joy of a gain in the market. Think about this, if you have saved a nest egg of $200,000 which would effect your emotions more, gaining $20,000 or loosing $20,000. The vast majority of people are more emotionally impacted by the loss. In order to stop the pain, they sell the stock. This effect is call Myopic Loss Aversion and has been studied and documented in the majority of people, professionals and amateurs alike.

Behavioral finance relates to several other important ways in which your brain sabotages your finances. It has uncovered important data about why people have such a difficult time saving, budgeting, and investing for the long term. It turns out we are nearly all subject to a Stone Age era inability to evaluate the benefits of long term returns versus instant gratification.

Centuries ago it was much better to have a bird in hand (to eat tonight) than to wait a few weeks or months to be able to eat two birds. If you starved now, doubling your "investment" isn't worth anything (you'd be dead). This is one key reason our instincts fail us when it comes to evaluating market returns. Market bubbles and crashes are another example of psychology creeping into our investing reasoning (and reaping havoc).

In other words, behavioral finance has some impact on nearly all aspects of our financial lives. Now that we know there is a problem, lets do what we can to create wealth for ourselves in spite of our brain.

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10 Simple Steps to be a Millionaire

Believe it or not anyone can become a millionaire. Becoming a member of the millionaire club can even be achieved on a very modest income. The trick is to realize that what determines wealth is not how much you make, but instead how much you save and invest. Here is the proof, a New Jersey man while never earning more than $11 an hour became a multimillionaire. There are literally thousands of examples of people who started with nothing and were able to achieve their millionaire dreams.

When I started Aspire 2 Wealth I quickly decided that I would need a plan if I was going to reach my goals. As a part of that plan I wrote down a list of rules or steps that would guide me on my path to wealth. These are ideas that are embodied by millionaires all around us that built their wealth gradually and deliberately over the years. I want to share with you my Millionaire Rules.

Ten Millionaire Rules:

1. Write Down Your Goals
2. Create a Spending Plan / Track Your Progress
3. Learn to Say "No" to Your Wants (and those of others)
   
4. Set Up Automatic Savings
5. Save an Emergency Fund
6. Payoff Debt (except a mortgage or federal student loan)
7. Fund 401(k) to Get the Full Match
8. Fund a Roth IRA to the Limit
   
9. Buy a House and Cars You Can Afford
10. Generate Multiple Income Streams

While implementing all of these rules in your life may not always be easy I can tell you that they are simple. The rules are simple because they are things that anyone, no matter how much income or level of finance education, can understand and apply to their own life. To follow these rules you do not have to clip coupons or live like a monk. It is about making small, practical adjustments to our relationship with money that will allow us to spend less than we make and invest what's left.

Aspire 2 Wealth is all about a shared journey to become wealthy and taking even some of these rules to heart will have a drastic effect on your lifetime wealth. Take some time to read the full article for each rule and decide to put them into practice in your life. It will take years to "get rich" this way but even after only a few months of following my own steps I have started a drastic change in my finances. I have spent less each month and saved more, while still meeting all of my needs and most of my wants. It is worth it. Start Now!

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Class In America

I stumbled onto a special feature from the New York Times about Class in America. It seemed like a good follow up to my post last week about Wealth Porn. I learned some interesting things by reading the articles and running some numbers in their tools. First, based on the How Class Works calculator I rank in the 74th percentile of Americans. My education and salary both push me high up the scale while my net worth brings me down a good bit. If I put my parents on the same scale, they both have masters degrees and make upper middle class salaries; they are at the 90th percentile. I think with enough time I will catch up to them, but I think it is unlikely for me to surpass the level of my parents. I started near the top and I have followed in my parents foot steps.

Another graphic shows income mobility in America from 1988 to 1998. It clearly demonstrates that a number of people from the very bottom are able to rise to the very top of the scale. It also shows that those in the middle and lower middle ranges have an equal probability to end up in any of the income categories with about half improving their standing. However, this does not mean that everyone has an equal likelihood to end up at the top. Only about half of those in the lowest group are able to move up the scale. Those who had the early advantage of starting in the top bracket continue to populate about half of the of the top bracket 10 years later. Thus, it is equally likely for someone at the top to fall as it it for someone at the bottom to move up. That seems to me like the American Dream is alive and well.

Some of what I read was encouraging. Some of it made me think. I recommend everyone take a minute to read some of the content and explore the tools. Comments about class in America and class mobility are welcomed.

I have been featured in the following carnivals lately that I would like to share with you:

• Carnival of Personal Finance hosted by The Financial Blogger
• Carnival of Homeowners hosted by Homeowners Insurance Lowdown
• Festival of Frugality hosted by Mighty Bargain Hunter

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Wealth Porn!

I am completely guilty. I love to gawk at how the wealthy live. I love the TV channel Fine Living, the Forbes Life section of Forbes.com, and the Real Estate Journal section of The Wall Street Journal. I even recorded some episodes of MTV Cribs on my DVR the other day. To save a little face, I don't read People magazine or follow the tabloids, and what I get most interested are the parts about houses and real estate. But still, why-oh-why do I like this crap?

I think that we are fascinated with both how similar and how different from us these super wealthy people seem. I've rationalized to myself that there is no way that Donald Trump is any smarter or talented than I am. So why are our lives so different? Then I'm honest with myself and say, "Well, he went to Wharton for an MBA and has used debt, leverage, and risk to build wealth in real estate." The stress and difficulty of that path would make my stomach do back flips. You see, we are so similar, but yet so different.

I think we all have a little bit of class and wealth envy in us. I think it is one of the things that drives us to take risks and achieve more. We see the good life and work hard to get there. We innovate, invent, and invest our way to a better life. If we never knew something better existed we may never have aspired to do more. This of course can also lead us to do some very foolish things.

Dante defined envy as "love of one's own good perverted to a desire to deprive other men of theirs." By this definition, we watch wealth porn not to inspire us to achieve more, but instead out of a desire to see others fail. If I were to give into envy I would think about how Donald Trump does not deserve his wealth. On some level I would desire for him to falter, rather than consider constructively how I might learn from him and better my own situation. It is important that we aspire to do better and not to bring others down.

I have chosen to highlight Donald Trump because I can relate to him. When I watch MTV Cribs I see the opulent homes and cars of musicians, athletes, and celebrities with which I have nothing in common. There is very little to learn from watching that type of show other than to see how it is on the 'other side of the tracks' so to speak. It seems more and more that this may lead to frustration rather than to realistic aspiration. I know just how few people achieve that level of financial success, but do the teens who spend hours every day practicing free throws or power chords rather than doing their homework? But again, if I want to bring them down in order to bring myself satisfaction, I am guilty of Dante's envy.

One of my excuses for some of my wealth porn habit is that, "What I really care about is the beauty of the house itself; the architecture, rather than the lifestyle it represents." I nearly went into architecture so this makes some sense. Of course underneath that explanation I am internally figuring how much wealth I would need to responsibly own a house like that. $10, $20, $30 million? I aspire to own these types of luxurious homes. Is that greedy? I hope to own what most would call a McMansion of around 5,000 sq ft one day; is that because of the wealth porn or because of a natural drive to succeed; to be King of my own castle?

Wealth porn (or actually even the guy down the block) has the ability to push us into spending more than we earn or buying things we don't need. I have a feeling that keeping up with the Jones has been a part of our society from the beginning, but has it gotten worse because of TV, magazines, and movies? Certainly the availability of large amounts of credit to the masses has compounded the problem. All I know is that, despite aspiring to increasing my standard of living, since founding this blog I have committed that I will get my debt in check and be cautious about how the greed, envy, and desire for immediate gratification affects my spending. If I do it right, the time may come when I will have earned the luxuries, and I can live a lifestyle that would, to outsiders, qualify as wealth porn.

It seems that with this post I have asked more questions that I have answered. It has been an interesting philosophical journey for me to write this. Please leave some comments and let me know what you think about some of the issues raised.

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Today Was A Great Day

I had a nice pop in my traffic today from being included in the Carnival of Personal Finance. I was very pleasantly surprised. I'd like to thank everyone who came by the site, and I hope you subscribed to my RSS while you were here.

A couple days ago I came across a neat article about Aspirational Finance on the blog Don't Mess with Taxes. I thought it was particularly on topic for my blog by cause of my emphasis on aspiration. The article describes the Living Large Index which was developed by Citigroup to track the spending of the affluent. It includes stocks of high end retailers, luxury goods makers, and travel and entertainment companies such Nordstrom, Callaway golf, and Wynn Resorts. The problem I have with this theory is that I think the true wealthy aren't the ones that spend their money on these things. It seems to me the true wealthy put their money into assets that appreciate or follow the philosophy of the Millionaire Next Door. IMO, the real people the Living Large Index tracks is the wanna-bes and the debt laden "Jones" that will cut back drastically when the economic tide changes. These seem to be exactly the goods that would be first to go from my life (if they ever show up at all). What do you think?

Today I also found out that an old college roommate and one of my best friends was offered a job in my city. When we finished our undergrad he went off to grad school at a very good institution and I took a job and entered grad school 200+ miles from my alma mater. As luck would have it we both finished grad school and the job market has landed us both jobs as cubical monkeys within a few miles of each other. It is also great news for him because he was starting to stress out about finding a job that pays enough for him to set up a homestead and make the student loan payments. He's even going to have a 401(k) and full benefits which will be a first for him. I might have to get him hooked on financial blogs like I am so we can be old rich guys together too.

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Acquiring Wealth - An Introduction

How does a person become wealthy? The goal of this blog is to help me and those around me achieve this goal, so this post will start a multi-part discussion to address acquiring wealth. First, what is wealth? For now I am only going to consider economic wealth, which is something which has monetary value. To be wealthy a person simply must accumulate things which have value and get rid of those things which take away value. Examples of things which have value, called an asset, would be stock, bonds, real estate, or business venture. Examples of things which take away value, called liabilities, would be debt, spending, and gambling. Once you recognize the difference between an asset and a liability you can begin to acquire assets and eliminate liabilities to create wealth.

In order to establish a common set of terms that are used to describe the process of acquiring wealth we must define some of the most common financial concepts. First, the outflow of money (spending) is called a debit and the inflow of money (income) is called a credit. Over a specified period of time (a month for example), the credits during that period minus the debits during that period is called the cash flow. When income is greater than spending it is called having positive cash flow and when the opposite is true it is called having negative cash flow. When positive cash flow is carried over to be spent in the future it is called saving. In the most basic sense, it is impossible to accumulate wealth over any period of time if there is no savings.

The model presented in the previous paragraph neglects additional concept that is essential. Appreciation is the increase in value of an asset, and depreciation is the decrease in value of an asset. Appreciation and depreciation can be clearly seen in the fluctuating value of a share of stock. Stock is bought and sold at a price which changes over time based on the perceived value of the stock. When the stock is purchased and the selling price for the stock goes up it has appreciated and wealth has been created. The same process can occur in reverse whereby the selling price for the stock goes down and wealth has been lost. Appreciation and depreciation of assets are the most important process for acquiring wealth because it allows an individual to create wealth many times greater than the positive cash flow that was used to buy the asset.

The final basic concept which must be defined is compound interest. It is the simple concept that the appreciation of an asset is subject to further appreciation. In other words, with compound interest if the value of an asset goes up 25% and then later goes up 25% again the effective appreciation is actually 56.25% rather than the 50% appreciation which would result from simple interest. Over long time periods during which regular savings are invested, the assets which accumulate due to compound interest can greatly outweigh those which result from savings.

An example of all of these terms should help clarify how the wealth acquiring process of assets functions. At age 25, Joe Worker starts saving some of his income each month. At the end of each month his income exceeds his spending by $200. He puts half of his savings into a tax free retirement account at his local bank which pays him interest at 4.75% compounded yearly. He puts the other half into a retirement savings plan which invests commission and tax free in the S&P 500 stock index (historical annualized return 11.9%). Joe continues making both of his contributions each month until he retires at age 65 and is surprised to find that his bank savings account has a balance of $143,011.35 and his S&P 500 account has a balance of $1,139,903.70. The in each account Joe saved $48,000 and compound interest accounts for the remainder of the balance.

This example includes a number of simplifications and assumptions which may not hold true in the real world. It is also important to note that past performance of investments in not a predictor of future success; however, Joe’s example does illustrate the power of building wealth by investing in appreciating assets. Investing only $100 per month can create over one million dollars of wealth if invested.

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Let's Go!

I am Adfecto. Ha. My new nickname seems a bit goofy and maybe even pretentious when I say it. What it means is "aspire to." I want to go out into the world and get myself a big piece of the proverbial pie.

Welcome to my new blog. Aspiration (and one day achievement) is what this new blog is all about. I want to create wealth for myself and those around me. I am going to chronicle my thoughts (and the thoughts of others who share my aspirations) on saving, investing, taxes, jobs, and other wealth related topics. I also plan to detail the real world successes and failures I encounter.

Today I am launching Aspire2Wealth and a new chapter in my life. I am ready. Let's go!

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