There are many reasons why Munger’s lament is true. One is the federal tax code. It requires a significant chunk of working people’s income—particularly those who are self-employed—to go to the government. Another is the level of debt that many people face. Yet another problem is lack of knowledge when you’re just starting out. Imagine the hours, effort, and heartache you could save yourself if you could go back in time and pass on your wisdom about money—and life in general—to your teenage self. This article offers some tips on how to put aside your first $100,000 in investment capital, free and clear. For further advice, you can always consider consulting a financial planner. Income of $147,000 or less is subject to a 6.2% payroll tax for Social Security in 2022; the threshold increases to $160,200 in 2023. Income of all levels is subject to a 1.45% payroll tax for Medicare. For each worker on the payroll, employers pay another 6.2% for Social Security and 1.45% for Medicare. And those who are self-employed must cover the 15.3% ([6.2% x 2] + [1.45% x 2]) total tax on their own. The good news is that half of your payroll taxes are deductible from your income taxes. However, the net effect is that many Americans still pay far more than their stated income tax bracket would have them believe. In other words, if you make $800,000 and pay $350,000 in taxes, you will feel a big bite, but your standard of living will still be high. If you make $20,000 and pay $2,800 in taxes, your standard of living and ability to save will be greatly affected. The Internal Revenue Code allows you to invest pre-tax or tax-deductible money into a traditional IRA or 401(k) plan every year to save for your retirement. For example, if you contribute $5,000 to a 401(k) and are in the 24% bracket, you won’t have to pay $1,200 in federal income taxes on that money because, for now at least, the government acts as though it never existed. If you were to use that same amount of money—only after taxes this time—to pay bills, you would have, at most, only 76 cents on the dollar. In the example, you got $1,500 from your employer, invested $5,000, and saved $1,250 in taxes on that investment. So by putting $5,000 in your 401(k), you have a total of $6,500 of capital working for you. That’s $2,750 more than you would have had if you had taken $5,000 from your paycheck, paid taxes on it, and put the money in a brokerage account. By bringing in more money, rather than just reducing expenses, you fund your investments without greatly affecting your day-to-day life. That’s important, because you’ll likely be more willing to stay the course it you don’t feel deprived. On the other hand, if your interest rate on a student loan or mortgage is very low, it would probably be a mistake to focus on paying off that debt first. After factoring in inflation, missed tax savings, and the opportunity cost of not investing in better assets, paying off that debt at the expense of investing could result in hundreds of thousands of dollars of lost wealth over a long period of time. This advice applies to firms with a long track record of paying dividends and, even better, increasing them regularly. If a company has recently cut its dividend, you might consider selling the stock altogether and investing the proceeds in a company with a better dividend-paying history. Index funds track the performance of a benchmark such as the Standard & Poor’s 500 Index. Because it costs less for the fund manager to simply mimic an index rather than actively pick stocks, index funds have very low costs: They should be less than 0.15% of your assets and may be as low as .015% per year. On a fund company’s website, you can sign up for a plan that automatically and periodically invests money from your bank account into the fund. You also won’t have to be concerned that big annual fees will eat away at your gains.
