Wealthy without luck

Habits that can set you up for financial freedom

May 10, 2023

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Warren Buffett is an anomaly. In a world where the Efficient Market Hypothesis is accepted as fact, and experts crow about how it’s impossible to beat the market consistently over a long period of time, his record has remained untarnished for nearly a third of America’s existence. So most experts do the prudent thing – They write off his success as a freak event, being in the right place at the right time, or even luck. Michael Lewis, the author of The Big Short, called him a “big winner produced by a random game”.

But what if Buffett wasn’t the only anomaly? In a speech made in 1984 at the University of Columbia, professor Michael Jensen argued that if everybody in the United States predicted the result of a coin flip for ten days in a row, there would be about 215 “experts” who would get it right while most would lose their money – and that active investing was a similar scam where the lucky survived. Buffett opened his counter-argument with the same example, except that he added a twist: What if a large number of the winners came from the same place? That would mean that there was probably something interesting going on there, something common to all the people. Buffett went on to show that it was not just him, but a bunch of like-minded value investors who all had superior returns. It wasn’t just luck – It was based on simple but powerful ideas.

Over 23,000 papers in economics were written over the next twenty years, but there were only 20 references to Buffett’s detailed data-backed presentation – and no satisfactory argument. The point of this story isn’t that you can replicate Buffett in a short time. It’s to show that if there’s a pattern of behavior that’s followed by a lot of successful people, then there’s probably something worth looking into there…

Over the last decade, I’ve studied the personal finance and investing habits of a number of high net-worth individuals, millionaires, and investors, and there’s a handful of principles that almost all of them follow as if they studied at the same school. Following these helped me fast-track my own wealth creation reliably, and if you’re focusing on financial independence, here are 9 things you can control that could increase the chances of hitting your financial goals.

1. Live below your means

The foundation for most financial disasters is set in people’s twenties for the simple reason that the change in their earning ability just soars during this period. From being a high-schooler with no means of earning and dipping into debt to get through college, you could probably start earning a hundred thousand or more a year for the first time in your life – but if recent stats are anything to go by, that’s not enough!

Inflation is partially to blame for this, but lifestyle inflation is an even worse problem. “Pay yourself first” is sound advice, but it doesn’t mean splurging and taking on debt to get on the hedonic treadmill. Rather, it’s about paying for your utilities first, then paying your future self first to ensure your financial independence, and then spending on your wants. Have a clear idea of what you can afford and which needs you would be spending on… Otherwise, you’ll probably look back and wonder “What happened there? I was earning so much!”

Once you inflate your lifestyle, you will have to keep running to sustain the pace of spending, playing a game of catch-up that never ends. In my twenties, I obsessively focused on not letting my spending be dictated by the amount of money I made – driving a used Toyota Prius for a decade and living in an 800-square-foot duplex in LA. This paid off in terms of the freedom I gained in my 30s. Most millionaires focus on building a nest egg first and investing in their future growth and delaying gratification in the form of nice things. It works.

2. Tracking your expenses

What gets measured gets managed. The people who don’t track their spending are the ones most likely to spend on non-essential purchases. A 2019 survey discovered that Americans spend a whopping $18,000 a year on things they don’t really need, and more than $300 a month on random impulsive purchases. One of the key reasons is that they don’t have a budget to keep track of their spending.

One common objection to having a budget is saying “I’m going to overshoot it anyway”, but that’s not the point. By setting a number, you are anchoring your mind around a number. If you set your “fun” budget at $2,000 a month, you will be conscious of overspending once you hit $2,500, and start scaling back. You might even do a better job planning for next month. But without that anchor, you would have no idea how much money is being sunk in that hole and what spending you can cut out… So use this psychological trick to your advantage.

Think of this like your personal “Check Engine” light – this activity will flag the problems in your expense sheet so that you can dig deeper. Wealthy people manage their own money like they manage a business, and by tracking your expenses with a free tool like Mint, Personal Capital, or Rocket Money, you’re taking a step in that direction.

3. Don’t max out your credit line

When your lender tries to upsell you on the loan amount you are eligible for, always think twice. What you qualify for and what you can afford are two separate things. The lender would want you to take the maximum loan that you could get citing a lot of perfectly reasonable benefits – but if you think about the lender’s incentive, it’s that they get bigger profits the more you borrow. Instead, think about what you need and can afford. Let’s look at some stats:

The average car is financed at $716 a month.
The average mortgage is $3,048 a month.
The average American has access to more than $30,000 on credit cards.

That’s a recipe for disaster. I’d recommend first coming up with a budget and then sticking with it regardless of what the lenders offer. In my case, I was pre-approved for a $1.5 Million home, but I spent close to $600,000 on a fixer-upper in a modest area. My recent home cost about $1.4 Million though I was approved to buy something worth up to $6 Million. It’s a good idea to always spend less, save the difference, and have that safety buffer to protect you from a sudden change in fortunes.

“The value of a thing sometimes lies not in what one attains with it, but in what one pays for it - what it costs us.”
– Friedrich Nietzsche

4. A good understanding of taxes

A dollar saved is a dollar earned. By being unaware of the basic steps you could take to save yourself some money on taxes that you pay, you could be under the illusion that you have a lot of money before the IRS takes a third of it away every year. That’s 4 out of every 12 months of your effort! The only way you can combat this is by educating yourself on the stuff they didn’t teach you at school, about how to keep and save more of your money by planning it wisely.

Taxes might seem inevitable – but the pain that comes with them isn’t. Some steps that you can take include:

Checking if your employer offers a 401k which reduces your taxable income by the amount you invest.
Tax loss harvesting – If you know that there are some investments that are surely not bouncing back, selling them to offset your gains reduces the taxes you pay.
Incorporating as an LLC or S-Corporation if you’re a business owner to reduce liabilities for your business expenditures.

These are not illegal or unethical – but the government won’t tell you that about customized ways for you to save money on taxes. It’s up to you to find out.

5. Don’t ignore retirement accounts

Retirement accounts come with a ton of benefits. Continuing the conversation on taxes, there are some ways you can invest through retirement accounts that reduce your tax liability and even offer you added financial incentives:

Invest in a Roth IRA – You can invest up to $6,500 a year and all the profit you make in that account is tax-free at the age of 59.5.
Invest in a traditional 401k – You can invest up to $22,500 a year. You are taxed on this money later, beyond the age of 59.5. What’s the advantage? The initial capital for compounding is far more, and with time, inflation reduces the value of your money. So the tax you defer is equivalent to money saved.
Invest in a HSA – This essentially covers medical expenses. Contributions, withdrawals, and appreciation are tax-free (but check your eligibility first). You could invest up to another $3,850 here.

Between these three options, you would be potentially removing tax liability on $32,850 a year – saved and compounded over 20 to 30 years, which adds up to an enormous sum of money.

6. Have multiple income streams

This could seem like an optional rule at first glance, but it’s taking advantage of one of the most important principles of investing – diversification. Though investors diversify their investing portfolio and savings, they hardly give any thought to the inflow of cash which is usually restricted to one source. But it’s as important, maybe more, to diversify your streams of income so that they are resilient to changes in the outside world.

Are you working on creating multiple streams? How has the effort vs return trade-off been so far? Let me know below.

7. Being cheap vs Being frugal

This is one pitfall that I’ve been guilty of – Being cheap is not the same as being frugal. Frugality is cutting back on things that you don’t need. Cheapness is cutting back on things that can actually improve your productivity, efficiency, and quality of life. Luxury isn’t the only thing that can be used as a status signal – when everyone’s being flashy, being austere and cheap can be a way to show off too. If you take this to the extreme, you’ll forget why you were frugal in the first place.

Let your budgeting and spending habits serve your goals. Don’t gamify yourself to make the amount you spend itself the target, while losing sight of what’s important. Think about every purchase in terms of the cost of the purchase long-term before making the decision to buy or reject it.

This is where the “Boots theory” comes in – A wealthy person buys good boots that can last them a lifetime while another might buy poor quality boots that need constant replacing. In the long run, the wealthy person actually saves money. Of course, you don’t need to make everything a lifetime purchase, but be aware of the trade-off between price and quality, and realize what something costs can dawn over you in the long run. For example, I hired a cheap accountant once and he lost me a lot of money by not guiding me in the right way – Lesson learned.

8. Planning for the worst

One of the oldest businesses in the world that funded the financial rise of the British Empire even is the insurance business – because disasters never go away, and people are aware of that. It’s a bitter pill to swallow, but you could lose your job, or your health, or an earthquake could strike, or you could hit a parked car and not have third-party insurance… Of course, don’t live your life worrying about all the things that could go wrong at every given moment, but always have a backup plan.

Regular tracking and planning mitigate disasters. Apply that to each area:

Have regular health checkups, and have health insurance cover.
Keep a pulse on how indispensable you are at your job, and test out whether you can get a job at another place.
Service your car regularly, and make sure it’s insured.
Have a 3-6 month emergency fund that can let you take a step back if things don’t go your way.

It’s a good idea to automate these by scheduling them into your calendar and forgetting about them. When you receive the alert, take care of things one at a time, instead of getting overwhelmed by the huge mass of things you need to handle.

9. Have a plan

Alright, this is probably what should come first on the list, but it’s what I want you to take away from this piece. Think hard about your financial goals – What do you want, and why do you want them? Are you working toward your goals or somebody else’s?

Here’s a thought experiment: When you see a man in a Ferrari, you probably think “Wow, I wish I had a Ferrari.” But most people don’t pay any attention to the man. They only think about how cool they would look in the man’s place – without realizing that once they get the Ferrari, others would see them in the same place. It’s one more reason to think hard about why you want the things you want.

If you plan it carefully, you might not need tens of millions of dollars to live the life you would enjoy. You just need to identify the things that really matter, understand your money habits, and put systems in place that let you do all this on auto-pilot.

Stay safe, stay invested, and I’ll see you next time – Graham Stephan.

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