Becoming a millionaire is easier than you might think.
It all has to do with how you manage your incoming cash flow. Investing your money rather than spending it on nonessential wants is the most straightforward way to grow your wealth.
The Simple Way To Become A Millionaire
If you’re in your 20s and looking for the simplest way to become a millionaire, it’s as easy as investing consistently into a tax-free savings account (TFSA) until retirement.
Let’s say you’re 25 today and want to retire at 65 with the equivalent of $1 million in today’s dollars. If you invested $12.50/day into an index fund tracking the S&P 500 until you were 65, then based on historical returns averaging around 7% (adjusted for inflation), you would have around $1 million saved up at retirement, tax-free.
Almost everybody can afford to do that!
But if you’re reading this blog, I’m guessing you want to reach this goal sooner rather than later. The more you contribute towards saving instead of spending, the faster you’ll be able to enjoy your life of financial freedom. It really depends on how much you can afford to save.
Saving Is More Important Than Income
The most important factor in gaining wealth is how much you save relative to your income. The simple truth is that the more you can set aside to invest, the more you can take advantage of compounding returns. And compounding returns makes a huge difference in your portfolio in the long run. It’s what people mean by making your money work for you.
The next important factor is the income that you are generating. All else equal, the higher your income, the greater opportunity you have to save more money and grow your net worth.
The takeaway point is that how much you save matters more than how much you make when it comes to growing wealth.
Many people who make lots of money end up inflating their lifestyle. Instead of saving toward financial independence, they may go and buy a brand new car or go on a lavish vacation because it feels well deserved after the hard work they spent to make that money. As a result, they blow most of their paycheck on short-term wants.
Take this as an example. Person A makes $100,000/year and spends 90% of their paycheck while saving the rest. He or she is left with $10,000/year to invest. Person B makes only $60,000/year, but saves 40% of their income because they only buy what they need. Person B would be saving $24,000/year, compared to Person A who makes more money but saves less! Over longer periods of time, Person B will accumulate a much higher net worth than Person A simply because they saved more of their income.
As you can see, someone who saves more but makes less can grow their wealth faster than somebody who makes more but saves less. This is why the amount you save matters more than the income you make. It’s only once you know how important saving is before a higher income can truly accelerate your path to financial freedom.
If you’re still tempted to spend your disposable income instead of saving it, think about it this way – if you spend now to buy something you don’t really need, you’re foregoing the potential opportunity to buy something much more valuable for yourself later down the road.
The 5 Step Process Of Gaining Wealth
Now hold on a minute. It seems extraordinarily difficult to just save and save and never treat yourself. How am I supposed to maintain the motivation and discipline to do that?
This is where the 5 step process of gaining wealth comes in. By adhering to the following steps, you can form a clear plan to reaching the million dollar milestone.
Step 1 — Identify Your Purpose
I can’t stress how important it is to have a clear purpose to save. Do you have ambitions to become a millionaire? How about never having to work a 9-5 job again? Are you trying to prove every single one of your doubters wrong? Do you want more time to pursue your hobbies, passion, and life goals?
Without a clear purpose or goal in mind, it’s extremely easy to get demotivated and deviate from your saving strategy. If you’re saving just for the sake of saving without knowing why, chances are you won’t succeed. Whenever you feel like not following your plan, the best way to refocus is to think about the high-level purpose or goal you are trying to achieve. Identifying your purpose time and time again will allow you to keep disciplined when it comes to saving money consistently.
For example, my purpose for saving up is to retire early off of the passive income I have generated by investing my savings. Not only will I be able to provide a financially secure life for myself and my loved ones, I’ll also free up valuable time to travel the world and spend much more time with friends and family.
Step 2 — Set Your Target
It is important to set a target for yourself to help you stay motivated and look forward to a meaningful accomplishment.
Your target should be set at a point where you could live comfortably for the rest of your life simply living off the cash flow from your investments (i.e. from dividends, rental income, etc). This is the point where you have truly achieved financial freedom.
Not everybody will have the same target, as it is up to you to determine how much you need to live a happy and comfortable life. Personally, I have set my target at $5 million. An investment portfolio of this size could generate an equivalent of around $150,000/year in passive income after taxes by investing in dividend stocks and bonds. Your target could be much higher or lower depending on your desires and goals.
Setting a target also lets you see the finish line. If you plan on living below your means in order to save at a quicker rate, then setting a target will help you determine exactly when you can switch to living comfortably for the rest of your life with all your savings and passive income.
If you’re uncertain exactly what number you want to target, that’s okay. Think at least of a range and refine your target over time. A word of advice however – if you doubt that you can reach your target, don’t lower it. Take massive action to reach the goal that you set. Your mindset of what’s considered obtainable really changes when your goals are elevated, and you’ll be surprised with where your true potential really lies!
Step 3 — Choose Between 3 Different Saving Strategies
When it comes to allocating your income to save, there are three different perspectives that you can take. Each approach has its advantages and disadvantages. Depending on your financial situation, you can change how you save over time to accommodate what suits you the best. Here are your three options, from easiest to hardest to achieve.
Option 1: Save The Same Dollar Amount
Anybody can do this, as long as they have some form of consistent income. Simply set a target amount to save periodically. You could set an amount to save weekly, monthly, annually, or whenever you get your paycheck.
For example, you could invest $100/week into your TFSA. This means you would contribute $5,200/year to your TFSA, which is under the annual contribution limit. Any profit you make (such as from capital gains or dividends) is tax-free since withdrawals are not taxed. If you did this for 30 years and gained an average annual return of 7%, your $100/week investment would end up amounting to $531,487!
- Short-term gratification – If your income increases or you come across extra money, you can use that money to buy what you please.
- Set it and forget it – If you set the same amount to invest every year, it is easier to become a habit and to remember the exact amount you need to save, making it easier to keep track of your progress.
- Lifestyle creep – If you keep with this method, you will naturally start spending more on luxury goods once your income starts to increase. These goods end up being perceived as necessities to maintain your current lifestyle. This makes it increasingly difficult to allocate discretionary income to saving rather than consumption.
- Opportunity cost increases as income increases – By spending instead of saving any excess income, you are foregoing the effects of compound interest and your potential savings may be much lower.
Option 2: Save A Percentage Of Your Gross Income
If you’re more serious about saving and willing to put more into investing, you should consider allocating your savings, taxes, and disposable income as a percentage of your gross (pretax) income. That is, you should set aside a percentage of your paycheck to savings and portion the rest to paying your taxes, paying your expenses, and treating yourself. Here are some potential choices you could take, depending on your preferences.
Modest Saving (20% of Gross Income)
This is a conventional approach to saving, in line with the 50 30 20 rule of budgeting. This allocates 50% of your gross income to paying down all the necessary bills, living expenses, and taxes. 30% goes to whatever you’d like, such as entertainment or luxury goods. The remaining 20% is saved towards retirement.
This option is best suited to those who want to retire with a comfortable amount of savings, but are not concerned about racing towards financial independence and living frugally. They just want to get there eventually, not necessarily as fast as possible.
Aggressive Saving (40%+ of Gross Income)
This option is for people who are willing to sacrifice more of their excess income now to achieve financial independence quicker. If you are committed to saving a substantial amount of your earnings, this is an excellent savings strategy to follow. You can even save more than 40% of your gross income if you can afford to. It really depends on your own income and expenses, as long as you can sustain yourself!
By saving aggressively, you will accumulate wealth at a rapid pace relative to your income. I would recommend most people that are serious about financial independence to follow this saving strategy. With this approach, you’re essentially transferring as much of your spending to savings instead.
Regardless of the proportion of your income that you save, saving by percentage has its own set of benefits and drawbacks.
- Balance saving with spending – How much you save and spend will depend on how much you make, which is a great solution for those who want to both spend and save more when they get a pay raise.
- Know exactly where your incoming cash flow goes – By dividing up your paycheck systematically and allocating money for your different accounts, such as investments, expenses, taxes, and emergency funds, you will know exactly how your income is being used, which will allow you to easily handle your personal finances.
- Can be a hassle to implement – Since your savings is dependent on how much you make, the amount you save changes every time your income changes. For some, this may take extra time and effort to monitor than if they spent or saved a fixed amount of money every period.
- Could be impractical if your income is too low – If you’re barely scraping by and being paid minimum wage, most of your income will likely be going towards your living expenses. You may have to really minimize your saving and spending percentages. It may be simpler to start off with a fixed dollar amount to save every period (option 1) and switch to percentage saving when you find better job opportunities.
Option 3: Keep The Same Budget And Save The Rest
This is the ultimate method for those who are willing to do whatever it takes now to reap the rewards later down the road.
To achieve financial freedom sooner rather than later, you need to maximize your wealth in the long term. This requires living below your means. If saving is your primary objective and you’re willing to live a frugal lifestyle to grow your net worth, this option is for you.
Essentially, this method requires budgeting the amount you need to pay off your expenses, not buying anything you don’t need, and then saving all that you possibly can to maximize the effects of compounding returns.
- Fast-track your way to financial independence – If you’re focused on saving like mad, this is the way to do it. You’ll be growing your net worth at the fastest rate you can.
- Live with a minimalist mindset – By only spending on what is absolutely essential, you learn to appreciate what you have and be happier with less.
- Not suited for everybody – If you don’t have the discipline to stick to saving, you may end up making impulsive decisions (like if you’re easily tempted by discounts of products you weren’t going to buy). This strategy is best for people who are obsessed with saving and are happy just seeing the money in their account go up and up.
- You have to live below your means – Your friends may be buying new cars and going on nice vacations while you have nothing to show for but a used car and a small apartment. Only you will really know how hard you’re working and that’s okay. You know that you could buy these things too if you wanted, but you choose not to. Enjoyment comes from the freedom of choice – not the choice itself.
It is also ideal to have 6-12 months of living expenses in a safe and liquid location, such as a savings account to maintain peace of mind for potential emergencies.
Personally, I would highly recommend going with the second or third option. For the second option, aim to save at least 40% of your gross income. If you can’t do that, look for ways to increase your annual income. If you want to go all out frugal and save as much money as you can, go with option 3 and keep your living expenses as low as possible.
Step 4 – Don’t Just Save Your Money, Invest It!
When I say to save the money that you earn, I don’t mean to just put it all in a savings account. Savings accounts are really meant for if you’re planning to use the money soon, or you need a liquid source of money such as an emergency fund. These accounts are not a way to grow your wealth since you will be earning next to no interest income. Typically, banks offer only 1-2% in interest per year. In fact, you won’t even be able to keep up with inflation, and the real value of your money will actually decrease!
Those who are young or have a long savings horizon should take advantage of the higher expected return that the stock market has to offer.
The key advantage of long-term investing is that you can generally take on more risk since you have more time to recoup any short-term losses. Over time, your average rate of return is much more likely to approach historical averages, such as when investing in index funds.
Don’t let your money sit in a bank losing value while the bank uses your money to make a profit!
What you should do is find the right discount brokerage for you. Opening a self-directed investment account will allow you to invest in the stock market.
On this blog my philosophy is that when there’s too many choices, it’s easy to get confused and not end up not taking any action. Therefore when I recommend something, I recommend one choice that I believe is the best option for my audience.
If you’re just getting started investing and don’t want commissions to cut into your returns, I strongly recommend going with Questrade.
I personally have been using Questrade since August 2017 when I first started investing and I have never looked back.
With Questrade, you can open a TFSA account (do this if you haven’t maxed out your contribution room) where you don’t need to pay tax on any capital gains and dividends from your stocks.
- One of the lowest commissions out there – Questrade charges a mere 1 cent per share, with a minimum of $4.95 per trade and capped at $9.95 per trade. This is basically as low as it gets! They also charge Electronic Communication Network (ECN) fees for certain orders and a Securities and Exchange Commission (SEC) fee if you are selling US securities. These fees are fractions of a cent per share and only apply in certain trades.
If you’d like to know the exact cost of a trade including these fees, they make it relatively easy to check on their platform. On the main trading panel, go to the Executions tab and click on the icon near the top-right that lets you edit columns. Then scroll down and add ECN fees and SEC fee to the list.
- Buying ETFs are free of charge – One of the best things about Questrade in my opinion is the ability to buy an ETF without paying any commissions. This makes dollar-cost averaging or buying shares of ETFs regularly an excellent long-term investing strategy, since you can buy as many shares you like over and over again as you receive money without repeatedly incurring commissions. Do note that regular commissions apply when selling ETFs though, but this shouldn’t be a big issue for people who are investing for the long-term.
- Buy US Equities with ease – Questrade accounts have a CAD and USD balance, so you can trade on both Canadian and American exchanges. Furthermore, you can convert CAD to USD within the account by using a process known as Norbert’s Gambit. I’ve done this multiple times over the years whenever I wanted to convert CAD to USD to buy US listed stocks. The best part about this method is that you don’t have to pay any conversion fees – you simply lock in the conversion rate when you purchase.
What To Watch For
- Make sure you understand potential fees – The great thing is that Questrade is transparent when it comes to their fees, and there’s not many to watch out for. Opening up a self-directed Questrade account is completely free. Furthermore, if you’re just doing the basic buying and selling of securities, the main fee you should consider would be the inactivity fee. However, it’s extremely easy to avoid as long as you are mindful of it. According to their website, you just need to satisfy one of the following requirements every quarter:
There are many other different ways to invest your money, depending on factors specific to each individual, such as how much you have already saved. For example, those with more money can consider investing in real estate. Generally speaking, the more money you have, the more options there are to grow your wealth even faster. The key is that you shouldn’t just keep most of your savings sitting there doing nothing – money is a tool that can work for you to make even more money
Step 5 — Build Passive Income To Equal Your Active Income
This step will really help you reach your target that you set. Having passive income will allow you to have multiple streams of income coming in, including your active income. Eventually, you want to build your passive income to a point where it equals or surpasses your active income. There are many different ways to make passive income. They generally require either up front work (such as starting a business or a decent amount of money (such as investing in dividend stocks).
When you finally reach this benchmark, you can choose whether to keep working your normal job, focus all your efforts on growing your passive income, or let your passive income substitute your job pay, without the need to actually go to work! I would recommend only doing this once you are satisfied with how much you are making in passive income per year. It all depends on when you are satisfied with your level of incoming cash flow.
Once you reach this milestone, you are securing a financial future without being dependent on actively working for money, which is when you really begin to become financially independent.
Start Saving For Your Future Today
As you can see, becoming wealthy isn’t all about having a high income. Your money mindset is just as, if not more important, for long-term growth.
Let’s recap the 5 steps to grow your wealth.
- Identify your purpose
- Set your target savings goal
- Choose the right savings allocation for you
- Invest your savings (start with Questrade)
- Create passive income streams to equal your active work income
The moral of the story here is really to get you rethinking about how you view each dollar that you earn. It really comes down to how you think about your money.
By following these steps, you’ll be on your way to reaching financial freedom sooner rather than later.