PDF Summary:The Automatic Millionaire, by David Bach

The Automatic Millionaire provides a simple but powerful action plan for you to quickly automate your finances, build your wealth, and achieve financial freedom. David Bach argues that, with just a few dollars a day, you can immediately benefit from this book’s advice and grow your finances.

This guide explores Bach’s key ideas about how to automate your personal finances and build wealth. We’ve added commentary throughout to compare and contrast Bach’s process with other popular financial authors like Ramit Sethi (I Will Teach You to Be Rich) and Scott Pape (The Barefoot Investor). We’ve also included psychological research underlying why people fail to prepare for their financial futures, possible caveats to Bach’s recommendations, and updated resources.

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If You’re Self-Employed

Business owners can take advantage of many different types of retirement accounts and benefit from many tax breaks. Bach claims that the simplest options to choose from are: the Simplified Employee Pension (SEP-IRA) and the One-Person 401(k) Profit Sharing Account, otherwise known as the “Solo 401(k)”.

(Shortform note: Bach briefly explains the benefits of both plans, but doesn’t elaborate on some details needed to make an informed decision about which to choose. For example, he doesn’t mention that the SEP IRA has no catch-up contributions—employees aged over 50 cannot make additional contributions. Furthermore, Bach claims that you can qualify for the One-Person 401(k) plan if you only have family members working for you. However, that’s not the case. You can qualify for this plan if you don’t have employees or if your spouse is your only employee.)

Investment Options for Your Retirement Account

Once you’ve chosen your retirement account, you’ll need to select investment options that determine how your money will grow—retirement accounts can only earn interest on and grow your money if that money is invested into stocks and bonds. As we’ll see, these options will cover how long you intend to invest your money, and how aggressively you want to invest.

Diversify Your Investments

Bach explains that to ensure that you get the best return from your retirement plan, you need to diversify your investments—this means that you need to invest your money in a combination of cash, bonds, and stocks. The more diversified your investments, the safer your money—stocks may lose their value, but if your money is diversified, the overall value of your plan will stay consistent. However, the safer your investments, the less likely you are to make money on your plan.

What Does It Mean for an Investment to Be “Safe”?

Bach explains that you need to diversify your investments to ensure that your money is safe, but he doesn’t elaborate on why some investment options are “safer” than others. We’ll therefore explain the difference between “safe” and “aggressive” investments.

• Safer investments (cash and bonds) make less money because they are based on short-term investments with minimal risk. They are less risky because the value of cash and bonds don’t change according to the whims of the stock market—their value remains stable.

• Growth investments (stocks equate to a share of ownership in a company) create more money but are also susceptible to income fluctuations that impact the value of your investment. A company’s value fluctuates according to how well it’s performing and the economy in general. Therefore, stocks are ranked by how safe they are, or in other words, how likely the company is to grow in value.

• The riskier the investment, the more aggressive it is. For example, an investment in an established company such as Netflix is classed as a growth investment because the company is expected to continue to perform well. However, if you invest in an unknown start-up based on the assumption that it will eventually become as valuable as Google, this is classed as an aggressive growth investment: If your prediction is right, your shares in the company will be worth a lot more than what you initially invested. But, if the company fails, your investment will lose value.

Build a Safety Net

Bach recommends that you build a safety net—a savings account with money you can use for emergencies. Bach states that the average American has less than three months’ worth of expenses saved—these people are financially unprepared for the bad, unexpected things that could happen such as isolating at home and quitting work due to a pandemic.

(Shortform note: In addition to a safety net to see you through hard times, many experts argue that you should also invest in health insurance to ensure that you’re covered for unexpected medical costs.)

Bach outlines two steps to create your safety net: assess how prepared you are and grow your savings.

Assess How Prepared You Are

Bach explains that financially secure people aim to save at least 3 to 24 months’ worth of savings. To figure how many months you could survive on your current savings, divide the amount of money you have saved by the sum of your monthly expenses.

(Shortform note: Bach doesn’t explain how to accommodate irregular salaries—income that varies from month to month. Sethi suggests that, in addition to your savings accounts, you also set aside three to six months’ worth of living expenses to cover you during the months when your income doesn’t cover all of your expenses. This way, you can simulate a stable income and you won’t have to dip into your savings accounts to cover your expenses during low-income months.)

Grow Your Savings

Bach recommends that you keep your emergency savings separate from your checking account so that you’re not tempted to spend the money. Further, he advises that you invest the money in high-yield savings accounts so that it can earn interest and grow.

(Shortform note: Bach’s process focuses on creating a single savings account and doesn’t accommodate the large expenses you’ll have outside of unexpected emergencies. In contrast, in The Barefoot Investor, Pape recommends that you allocate a percentage of your money to a “happy” savings account—an account used for large expenses that you want to save up for such as a holiday or a car, and a “grow” savings account—an account for long-term investments and savings goals. This way, you don’t need to dip into your long-term savings accounts to fund your large expenses.)

Clear Your Debts

Bach argues that, if you’re in debt, you should prioritize clearing the amount before you build your savings account. This is because the interest you earn in your savings account is far less than the interest you pay towards your debts. To clarify, if you owe $2,000 in credit card debt and just make the minimum monthly payments, it will take you more than 18 years, and a total of $4,600 to pay off your balance. The same $2,000 held in a savings account earning 1% will only total $2,392.29 after 18 years. Therefore, you’ll save far more money if you clear your debts first.

(Shortform note: It’s true that clearing debts before you build your safety net will save you more money in the long term. However, if your job situation is insecure, some financial experts advise that you should prioritize your savings before you clear your debts. This way, you’ll avoid getting into further debt if you do lose your job—you won’t have to rely on your credit cards to survive because you’ll have savings to fall back on.)

Your Debt-Clearing Plan

We’ve broken the process down into four distinct steps: total up your balances and interest, make commitments, reduce your payments, and prioritize your debts. (Shortform note: Sethi’s debt-clearance plan differs from Bach’s method and provides some contradictory advice—we’ll compare Sethi’s process to Bach’s throughout each of the four steps.)

Step 1: Total up your balances and interest: If you’re currently in debt, you’ll need to total up the balances you owe and the amount of interest you’re paying on top of this balance.

(Shortform note: Sethi advises that you should call up your credit companies to find out how much debt you owe, how much interest you’re paying, and the minimum monthly payment. He claims that many people are unaware of exactly how much debt they’re in so need to speak to their debtors before they can come up with a plan to clear their debts.)

Step 2: Make commitments: Don’t buy things you can’t afford (property is the only exception as it tends to appreciate in value), and refuse to use credit cards—cancel them and remove the temptation to use them.

(Shortform note: Both Bach and Sethi advise that you don’t buy things you can’t afford, but they differ on what methods you should use to pay for what you buy. In contrast to Bach, Sethi suggests that you keep your credit cards as they’ll improve your credit history—make use of them but always pay your balance off in full. This way, you show lenders you can be trusted to pay back the money you borrow.)

Step 3: Reduce your payments: Contact your credit card company and ask if they can lower the rate of interest you’re paying, or consolidate all of your payments—move multiple debts to a single low-interest account. In addition, automate your payments to avoid paying late fees.

(Shortform note: In addition to consolidating and automating your payments, Sethi argues that you should negotiate lower interest rates regardless of whether you’re in debt or not. This will reduce your chances of getting in debt if you ever fail to pay off your balance.)

Step 4: Prioritize your debts: If you choose not to consolidate your payments, pay off your debts one by one. Bach suggests you divide the balance of each debt by the minimum payment required—this will show you the number of payments you need to make to pay off the debt. Next, rank your debts so that the lowest number of payments is on top. Prioritize paying off the debt at the top of your list while you continue to pay the minimum balance for your remaining debts.

(Shortform note: Sethi also suggests that you commit to paying off one card at a time while using automated payments to pay the minimum balance for the rest of the debts. However, he believes you have two options for doing this: prioritize the cards with the highest interest, or use Dave Ramsey’s “snowball method” to prioritize paying off cards with the lowest balance (regardless of the interest they charge). He advises that you should plan to make more aggressive payments until you clear your debts.)

Own Your Home Outright

According to Bach, the average American homeowner is more than 35 times richer than the average renter. This is because homeowners end up spending less money than renters in the long run. Let’s say you rent an apartment at $1,500 a month over 30 years—at the end of this period you’ll have spent $540,000 and have to continue to pay rent. On the other hand, if you buy a house and you pay $1,500 on your mortgage for 30 years, at the end of this period you’ll own your own home (no more payments) and be free of debt.

In addition, buying a home will also provide financial security in the form of equity—over the long term, the value of real estate investments always increases (the average annual return since 1968 is 5.3%).

The Disadvantages of Owning a Home

In contrast to Bach, Sethi argues that you shouldn’t think of your home as an investment as the expenses involved will make it difficult for you to make any money from it. He claims that:

• Your costs will be higher than they are when you rent because you’ll be responsible for insurance, property taxes, and maintenance.

• You’ll only gain an average of 0.6% a year on this asset compared to an average annual return of 8% on the stock market.

• You’ll end up paying additional taxes and fees when you sell your home.

• You’ll miss out on the amenities and perks offered by rentals in the same price range as it works out far more expensive to buy properties in convenient areas (close to public transport, local schools and shops, and so on) than it does to rent them.

So, while Sethi doesn’t discourage you from buying a home, he does insist that it’s not for everyone—consider whether you’re happy with the costs (not just financial) involved in owning your own home before you take the leap.

Bach suggests you follow three steps to buy a house: pay your down payment, choose the right mortgage payment plan, and accelerate your mortgage payments.

Step 1: Pay Your Down Payment

The main reason that people don’t buy a home is that they think they need to pay thousands of dollars upfront to get a mortgage. Bach argues that these people are wrong—there are many programs designed to enable first-time homebuyers to finance up to 100% of the down payment for the home they want to purchase. Bach suggests that you research housing finance agencies if you need help putting together a down payment.

(Shortform note: Bach doesn’t provide information regarding why companies would offer to provide you with a loan for a deposit, and it’s unclear whether these loans would incur additional costs or have strings attached—such as whether you’ll be restricted to buy specific types of houses or limited by location.)

Choose the Right Mortgage Payment Plan

Bach claims that you should be able to spend between 29-41% of your gross income on housing expenses—which include your mortgage, taxes, and insurance. Aim for the minimum if you still have debts to clear and more if you don’t have any debts to pay off.

(Shortform note: In addition to Bach’s suggestions, Pape claims that it’s crucial to also factor lifestyle changes into your housing expenses before you decide to buy a house. For example, if you have children, your expenses will increase significantly—you’ll either have to pay for childcare or reduce your working hours to care for the children, and this will impact your ability to keep up with mortgage payments.)

Accelerate Your Mortgage Payments and Build Your Equity Fast

Overall, Bach recommends fixed-rate mortgages, as he believes these have the most benefits. However, he notes that a drawback of these plans is that you’ll end up paying a huge amount of interest over the full mortgage term (and at the beginning of the term, you’ll pay mostly interest, accruing minimal equity in your home).

However, he insists that you can avoid the disadvantages of fixed plans if you accelerate your mortgage payments: in other words, pay more towards your mortgage each month or year than you need to. This enables you to cut years off your payment plan, thus reducing the amount of interest you pay in total (since interest accrues exponentially over time—cut the time spent paying your mortgage, and you cut the amount of interest you pay).

The Disadvantages of Paying Off Your Mortgage

Bach strongly believes that paying off your mortgage will lead to more wealth so he doesn’t cover the disadvantages of taking this route. While accelerating your mortgage payments will save you thousands of dollars in interest, there are a few possible drawbacks you need to consider before you decide to proceed with this plan:

• Access to cash: Even with accelerated payments, it will take years to pay off your mortgage. During this time, you won’t be able to access the additional money without refinancing or selling your home—make sure you have enough money in savings accounts to cover emergencies.

• Tax breaks: The interest you pay on your mortgage is tax-deductible (you receive a tax rebate for these payments). Once you pay off your mortgage, you won’t be able to receive this tax benefit. If you’re a landlord, this could have a massive impact on your tax payments.

• Credit score: Your credit score hinges on proof of your ability to reliably make regular payments to pay off your loans. Once you pay off your mortgage, this loan will no longer be factored into the equation used to determine your credit score and could lead to a slight drop (this impacts your ability to get a new loan).

• Pay-off: The money you invest into your home would earn substantially more if you invested it into stocks (4.5% for a home and 10% for stocks based on the average rate of return for the last 90 years).

Pay It Forward

Bach insists that the point of building wealth is not just to have more money, but to use the money to do things that make you feel good. He suggests donating a portion of your income to a cause you care about—not only will you feel good about yourself, but you’ll also actually feel wealthier and your pursuit of money will feel more meaningful.

(Shortform note: In addition to making your pursuit of wealth more meaningful, philanthropy helps define your legacy. Pape (Barefoot Investor) claims that, after you’re gone, people are only going to remember you for the contribution you made to the world, not for the amount of money and material things you possessed. Along with donating money, Pape suggests that you could use your money to create your own charitable organization, or to fund a product or service to help your community.)

Choose Your Recipient and Automate Your Donations

Bach suggests that you research and identify charities that are meaningful to you. Once you’ve chosen your cause, your recipient should be able to contact your bank to set up an automatic payment plan on your behalf (with your permission) so that you can make regular monthly contributions.

Bach urges you to keep track of your donations—many charitable donations are tax-deductible so you may save taxes on your contributions (if you donate $100, you can claim back the tax you’ve paid for that $100 on your tax return). You can check with the IRS and request #526 (Charitable Contributions) to confirm whether your chosen charity is tax-exempt.

Should Charitable Donations Benefit From Tax Deductions?

Some politicians are calling for an end to tax deductions on charitable contributions. They argue that these deductions:

• Only benefit wealthy donors (they can already afford to give without the tax break)

• Generally don’t increase donor contributions (compassion, not financial incentive, leads to giving)

• Definitely harms the economy (the government subsidizes charities every time they offer a rebate)

In addition, unless you itemize your tax return and provide proof of your charitable donations, you won’t get the rebate. This additional paperwork means that millions of Americans already contribute without applying for a rebate, and strengthens the argument that these tax deductions should come to an end.