My #1 Most Effective, Yet Simple, Wealth-Building Strategy

It’s simple and easy, but the devil is in the details

Just over 31 years ago, I came to the US with my then-wife and two toddlers.

We owed more than we owned — a.k.a. had a negative net worth, my salary was just $31k, and my wife wasn’t allowed to work due to our visas.

Things were not so easy.

It took many years to claw our way out of that place and reach our current, vastly different financial situation.

Along the way, as do we all, I made many choices.

• Some were straightforward mistakes, like buying an $8k used car with a $6k loan at 10.4 percent interest.
• Some were career decisions that greatly delayed any financial progress. I don’t regret these because they built up the basis for what I do now.
• Some were pure gold.

The following is the single most effective strategy I used to supercharge our wealth-building since I started working for myself, bringing a comfortable retirement close at hand.

Importantly, it’s something almost anyone can use to get ahead financially.

My Best Wealth-Building Strategy

It’s not simple “live below your means” or “pay yourself first,” though both are good ideas, and if you don’t already follow them, that’s not a bad place to start.

It’s not to invest in low-cost index funds, though that’s a legitimate strategy if you can’t or don’t want to learn how to pick market-beating funds (some would say picking market-beating stocks is the way to go, but personal experience and logic dictate that’s a red herring to be avoided by almost everyone).

I prefer to invest in active mutual funds and have been beating the market by ~1 percent/year doing that for a couple of decades now.

It isn’t to build a healthy emergency fund, though having one is a crucial step in protecting yourself from financial breakdowns, like extended loss of income or major medical issues.

Nope.

My single best strategy has to do with how you behave when your income increases, be it a one-time occurrence, like a large cash gift or bequest, or a periodic but uncertain event , like annual bonuses, or a permanent one, like a large raise).

Many (most?) people respond to such good news by celebrating (Great! You deserve it!), splurging on a fancy vacation or some such, and proceeding to increase their annual spending by as much or more than the new income.

That’s so common that there’s a term for it.

Lifestyle inflation.

But if each time your income increases you increase your spending by as much or more, you join the large group of high-income Americans who still live paycheck-to-paycheck and resort to credit cards to keep the party going.

On the other hand, the FIRE crowd and their like advise you to sock every penny of the new income into your portfolio of stocks, rental properties, or both.

Mathematically speaking, that’s the ideal way to build wealth as quickly as possible.

If you’re a robot.

If you’re human, you have to consider emotions. There’s an entire field of study dedicated to it — behavioral finance.

And if you consider emotions, you realize that delayed gratification isn’t unlimited. Very few people will stick with a draconian budget for the years or decades needed to build enough wealth for a truly great retirement.

So, if you’re to avoid spending as fast as money comes in (or faster), and I’m telling you that you shouldn’t just invest it all, then what’s my recommendation?

As you probably guessed by now, it’s taking the path of moderation between those extremes.

When new money comes in, invest somewhere between one-half and two-thirds of it for your future self’s needs, and spend the remainder on having fun now!

The exact percentage is up to you, but I highly recommend you make it at least 50 percent to investments. And the larger the new income, the higher the fraction I suggest you invest because it’ll still leave you with lots of dollars to spend.

This is the way to build wealth as quickly as humanly possible, sustainably, with no penny-pinching.

The Critical Twist to the Strategy

However, there’s just one additional twist to the strategy.

When you spend the portion of new income that you’re allocating to current enjoyment, match the type of income to the type of spending.

• If it’s a one-time windfall, use your “spend” portion of it on one-time expenses, e.g., taking a once-in-a-lifetime vacation, replacing your clunker with a new car, making a large donation to a favored cause, etc.
• If it’s a periodic but uncertain income, use it for splurges that don’t create long-term commitments, e.g. increasing your travel budget, taking up a hobby you’ve been interested in but didn’t want to spend on the needed gear, eating out more often, etc.
• If the increase is permanent, like a raise, you can take on longer-term financial commitments, e.g., moving to your dream home, buying a cabin in the mountains, etc.

Here’s why.

Say you got a $250k bequest and spent $100k of that on upgrading to a more expensive home. By doing this, you’ve likely increased your monthly mortgage payment for the next 30 years. You’ve also increased your costs on homeowners’ insurance, property tax, maintenance, utilities, etc.

And since the new money was a one-time deal, you’ll be hard-pressed to maintain your newly increased monthly spending.

Even increasing your travel budget is risky.

Sure, you could keep traveling until the new “spend” money is gone, but if your mindset was that more travel was your “new normal,” it’ll be psychologically challenging to reset to the old travel spending level. Thus, this sort of new spending isn’t as risky as upgrading your home, but it’s riskier than knowingly splurging on a one-time great vacation.

Even if you get annual bonuses, upgrading your home is risky.

Employers give you bonuses because they want to compensate you well, but don’t want the legal and moral responsibility of having to keep paying you more. If the following year, business slows down, your bonus will most likely shrink or disappear.

If that happens after you’ve made difficult-to-reverse increases in your spending, you’ll have some unpleasant decisions to make.

One last thing. Keep in mind that all of the above examples are just that — examples.

When you choose what you’ll spend on, pick things that align with your priorities and are within your means (and especially within the reliability and stability of your new income).

The Bottom Line

There are many great ideas out there for building wealth, and I’ve used a fair number of them.

Of them all, the above is my favorite because it’s so powerful but also so easy to implement because it accounts for our human desire to enjoy things now, rather than putting off all gratification to some nebulous future that may or may not arrive.

After all, none of us is promised tomorrow, let alone next year or several decades.

Disclaimer

This article is intended for informational purposes only, and should not be considered financial, investment, business, tax, or legal advice. You should consult a relevant professional before making any major decisions.

About the author

Opher Ganel has set up several successful small businesses, including a consulting practice supporting NASA and government contractors.