Tuesday, May 27, 2008

The Automatic Millionaire

The Automatic Millionaire by David Bach

The basic premise of Bach's book is to automate as many financial aspects of your life as possible. With today's technology, this is much easier and more accessible than in the past.

A main focal point of the automation is having automatic deductions from one's paycheck go into a retirement account. The benefit being that one learns to live on the lower net income and does not even notice the automatic deduction. At the same time the investor is saving tax if investing in tax deferred accounts such as a 401(K), 403(b), SEP, or traditional IRA retirement account.

So for example if you take a $1,000 paycheck and deduct 15% to go directly into a retirement account, that would be $150. In contrast if you did not put anything into the retirement account first, you would bring home $800 assuming a 20% tax rate. By "paying yourself first" you avoid tax today on the $150 and rather than only bringing home $650 based on the $200 tax on a $1000 paycheck, you would actually bring home $680 due to not paying tax on the $150. This may not seem like much but can make an enormous difference over time.

The millionaire part comes into play by following this system of setting it up one time to automatically deposit the money and letting the power of compound interest work over the course of a number of years.

He also recommends automating things such as a house payment by having payments drafted from your account once every 2 weeks rather than once per month. This results in an additional full payment each year with the advantage of paying off a 30 year mortgage (if using one that long) in only 22 years. This cuts out a huge amount of interest paid and gets you out of debt that much quicker. Rather than relying on discipline and remembering to send in a payment every 2 weeks you've automated it and don't ever have to worry about it.

An additional idea Bach presents is that most people have a "Latte Factor." This essentially is little things through out the day which you may not think about spending money on such as picking up a $3.50 latte and $1.50 muffin at Starbucks in the morning. While this is ok from time to time, the point is that if done on a regular basis without thinking about the total cost, it can really add up to substantial amounts of money in time. Say for example you did this on the way to work each morning (5x50=250x5=1250) $1,250 per year in coffee and muffins. In my book that's a decent chunk of change.

An idea Bach does not mention but which is effective is to give oneself a monthly budget for random purchases. Dave Ramsey calls this the blow category in a budget. Money which can be spent as you please without having to fall in a specific category. If your blow category is $50 for the month, at the beginning of the month you put $50 in an envelope and can spend it any way you choose. But when the money runs out and the envelope is empty, you don't spend any more. It really helps in making you pause to consider a purchase before whipping out the plastic and swiping away that $1,250 in muffins and coffee.

Other elements which Bach promotes are paying off debt and giving money away. Debt will really hamper one's ability to become wealthy so by attacking it, you free yourself to run unfettered towards wealth. The giving aspect helps put things in perspective and give you a sense of wealth and generosity even before becoming "wealthy."

One aspect that I would give caution to the reader about is Bach's chapter on real estate. If not read in a proper context, the reader could get the impression that taking on large amounts of debt or "leverage" great ideas with limited risk. One should always incorporate a big risk factor whenever introducing large amounts of debt. Regardless of how leverage is couched, real estate prices do not always go up as seen recently, and renters do not always make payments. So if taking on a mortgage to purchase real estate, it would behoove the person to make a large down payment and pay off the mortgage as quickly as possible.

Overall, The Automatic Millionaire offers some good ideas on helping to reduce the discipline needed to attain financial independence and comfortable retirement. Automation of investments is a great way to consistently build wealth over a long period of time.

You can also read this review at Helium.com.

If you found this review helpful, please let Amazon know here.

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