“A penny saved is a penny earned.” – Benjamin Franklin
In his book The Automatic Millionaire, David Bach says there are six ways to get enough money to be rich:
1. Win it.
Although playing the lottery is the “No. 1 way working people try to get rich,” it’s the least likely to pay off. The odds of winning most state lotteries — the workingman’s most commonly used get-rich scheme — are 13 million to one. And slot machines, the next worst way to become wealthy, take in about $20 billion a year from would-be wealthy people in the U.S. alone.
2. Marry it.
If you are very good-looking and don’t care to be distracted by love, this may be a good route to take. Shoot for someone who is already rich. Target potential spouses who are older, fatter, and uglier.
3. Inherit it.
If you are in a position to inherit money, you already know it and are probably counting on it. You also don’t need our (or David Bach’s) advice on how to get rich.
4. Sue for it.
“This one is really big these days,” Bach says. “More than 75% of the world’s lawyers practice in the USA and upward of 94% of the world’s lawsuits are filed there. It seems some people feel that rather than earn, save, and invest, a better strategy is to ‘find ’em, sue ’em, and sock it to ’em.'” However, this is not a real system that can be counted on to build wealth.
5. Budget for it.
This is the scrimp-and-save method. It rarely works, because who wants to put off having fun for 30 years “in the hopeful expectation that someday you’ll be able to retire and start enjoying your life?” Most people aspire to become financially independent, but the vast majority of them retire at age 65 with next to no assets. They never win the lottery, never get an inheritance, and never even get around to saving some of their hard-earned money. And that brings Bach to the approach that he recommends:
6. Pay yourself first.
The idea that you should pay yourself first, Bach admits, is not original. But most people who’ve heard this advice don’t really understand what it means . . . or how powerful it is. Instead of paying themselves first, they pay all their normal expenses and then decide to save whatever is left over. But there’s never anything left over.
The main reason for this tragedy is a variation of Parkinson’s Law: “Expenses rise to meet income.” In other words, if you increase your income by, say, 25% this year, chances are your expenses will also increase by 25%, leaving you right back where you started.
“Paying yourself first” means that you do the same thing the government does with your salary — you take your share off the top. Before 1943, income taxes were not automatically withheld — and the government was having a hard time collecting all the money it was owed. Then some genius figured out that it could solve the problem by getting paid first. And so it did.
“Not only did the government arrange to get paid first,” says Bach, “it automated the process so there wouldn’t be any slip-ups. It figured out a darn near foolproof way to make sure it would always get its money. No ifs, ands, or buts.”
To become wealthy, you must do the same. “You need to set up a system that guarantees you’ll get paid — a system in which you pay yourself first automatically.”
How do you do that? The best way is with a pretax retirement account. The best-known are 401(k)s, IRAs, SEPs, and 403(b)s. Money invested in these accounts is deducted from your gross income. That means you get it before it’s taxed (i.e., before the government gets to it).
The impact of saving pretax income may not seem like much — but if you add it up over 15 or 30 years, it can be enormous. It can mean the difference between ending up with a net worth of (to use an example from Bach’s book) $661,437 (which, at 10% interest, will provide you with an income of $66,000 a year) or a net worth of $1.7 million (which will allow you to live very comfortably on a yearly interest income of $171,000).