The Automatic Millionaire
by David Bach
Lowdown: Really liked it. Although the first chapter is actually an informercial script, Bach’s advice is great.
This book bills itself as the “one-step plan to live and finish rich.” In reality, it is more like five steps. Anything that bills itself as one-step anything approaches the realm of informercial. In fact, the first chapter includes a conversation between the author and a couple that reads so much like a script for an informercial, I grinned and groaned as I read it.
That said, I did find Bach’s advice sound and valuable. The book is very short and designed to be read in a couple hours. But I’ll save you the suspense and time and summarize the main points.
The basic premise (i.e. the “one-step” part) is to set up financial plans automatically. If you have money automatically flowing towards savings and debt payments, you never see that money because it automatically goes to the most important places first (which means it isn’t in your checking account). If that money isn’t available, you can’t spend it, which forces you to cut expenses.
The first thing to do, Bach says, is figure out your “Latte Factor.” Most people don’t think they can afford to increase their savings. But if you spend a week, or even a day, writing down what you buy, you’ll be surprised at the little expenses you have that, when added up, equal a lot. Five dollars each work-day on a latte, for example, is $1,300 a year. Even $30 once a week eating out comes to $1,560 a year.
Begin saving by contributing automatically to a 401(k) account (or other tax-deferred savings plan, like an IRA). Contribute at least enough to get the biggest match from your employer. Contribute as much as is allowable by law1. All 401(k)/IRA contributions are not taxable, so depending on your tax bracket, pre-tax savings is like getting an extra 10-30% for each dollar you earn.
Next, set up automatic contributions for emergencies and long-term savings (cars, furniture, vacations, etc.). Bach recommends saving up three months worth of expenses, but I prefer and recommend six months (but I only have one month in the bank). Try to find a high-interest savings account to stash it in (e.g. Money Market, savings bonds, etc.).
Then, buy a home2. Pay it down early by making half your payment every two weeks (which results in an extra payment every year). If your bank doesn’t allow this, add 1/12 a payment to every monthly payment and make sure it gets applied to the mortgage’s principal. This will save hundreds of thousands of dollars in interest over the life of a loan and cuts five to eight years off the life of the mortgage. (I need to start doing this.)
Next, get out of debt. Save for things and pay only cash. If you have credit card or other consumer debts, setup automatic payments to pay those down. Try to consolidate all your consumer debts into one account and pay it off as fast as possible. If you can’t consolidate, pay down each card in the order that makes sense: highest balance and highest interest rates, lowest balances so it feels like you’re making progress, etc. Bach recommends dividing each balance by its minimum payment to get its DOLP number, and paying off the cards with the lowest DOLP first. Make the payments automatic.
Lastly, give automatically to charity. The act of giving back makes us less selfish, less focused on spending, which helps us manager our money better. Plus, we feel good when we support a good cause.
Even though the book feels like an infomercial in parts, all of Bach’s advice is pretty sound. It is worthwhile to pick up a copy because there are a lot of good details I don’t talk about: resources for finding the best IRA, money market savings account, ways of charitable giving that help at tax time, etc.
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1 If you are setting up a 401(k) contribution, consider using a flat dollar amount instead of a percentage. When bonus time comes around, you’ll take home more of your bonus and put less into your 401(k). (Of course, some people would argue that because bonuses get taxed at a higher rate, you should contribute more of it to a 401(k). You choose.)
Find out the maximum allowed annual contribution you’re allowed to make. In 2009, it’s $16,500 ($20,000 if you’re 50 or older). Divide that amount by the number of paychecks you get in a year, and use that as your contribution amount. If you get paid twice a month, divide by 24: which comes to $687.50 a check ($833.33 for 50+). If you get paid every two weeks, divide by 26: which is $634.62 ($769.23 for 50+).
Don’t want to contribute the maximum amount? That’s fine. Figure out what percentage of your pay you want to save, and divide that by the number of pay checks in the year. For example, a 6% contribution and $50,000 salary is $3,000 a year. Divided by 24 pay checks gives you a per-check contribution of $125; 26 pay checks is $115.38 per check.
2 This is where I disagree. Buying a home is a huge deal. Although homeownership brings a sense of stability and (hopefully) earns equity as house values go up, not everything about owning a home is roses. If you need to move, you usually pay realtors 3-6% of the selling price. If you aren’t careful, this could lose you money. Also, owning a home is expensive: repairs and maintenance can add up.
I counsel people to wait to buy a house until they’ve got 20% down and are in a place they want to live for 10+ years (preferably even longer). More importantly, you shouldn’t buy a house unless you can afford the payments after maximizing your retirement contributions and have an emergency savings reserve. Nobody is going to loan you money to retire, so that should always be your first priority.
