3 Simple Steps to Building Wealth – Investopedia
Pamela Rodriguez is a Certified Financial Planner®, Series 7 and 66 license holder, with 10 years of experience in Financial Planning and Retirement Planning. She is the founder and CEO of Fulfilled Finances LLC, the Social Security Presenter for AARP, and the Treasurer for the Financial Planning Association of NorCal.
Building wealth is a topic that can spark heated debate, promote quirky get-rich-quick schemes, or drive people to pursue transactions that they might otherwise never consider. But is “three simple steps to building wealth” a misleading concept? The simple answer is no.
Basically, to accumulate wealth over time, you need to do just three things: (1) Make money, (2) save money, and (3) invest money. This article looks at each step in turn.
This step may seem elementary but is the most fundamental one for those who are just starting out. You’ve probably seen charts showing that a small amount of money regularly saved and allowed to compound over time eventually can grow into a substantial sum. But those charts never answer this basic question: How do you get money to save in the first place?
There are two basic ways of making money: through earned income or passive income. Earned income comes from what you do for a living, while passive income is derived from investments. You may not have any passive income until you’ve earned enough money to begin investing.
If you are either about to start a career or contemplating a career change, these questions may help you decide on what you want to do—and where your earned income is going to come from:
Taking these considerations into account can help put you on the right path if you don’t already know exactly what you want to do. Once you’ve landed a job, you should also evaluate your income situation periodically—say, at least once a year. Ask yourself: Is your current income adequate for your needs, including saving? Do you believe that if you stay with your present company or in your current line of work, your income will increase at a reasonable pace in the future?
Simply making money won’t help you build wealth if you end up spending it all. To set more money aside for building wealth, consider these four moves:
Keep this in mind, too: You can only cut so much in costs. If your costs are already down to the bone, then you should look into ways to increase your income.
Once you’ve managed to set aside some money, the next step is investing it so that it will grow.
(Before you start investing, however, make sure you have some money set aside to handle any unexpected financial emergencies. A common recommendation is to build up enough to cover at least three to six months’ worth of expenses in a liquid account, such as a bank savings account or a money market fund.)
Investments vary in terms of risk and potential return. As a general rule, the safer they are, the lower their potential return, and vice versa.
If you aren’t already familiar with the various types of investments, it’s worth spending a little time reading up on them. While there are all kinds of exotic investments, most people will want to start with the basics: stocks, bonds, and mutual funds.
Perhaps the most important investing concept for beginners (or any investor, for that matter) is diversification. Simply put, your goal should be to spread your money among different types of investments. That’s because investments perform differently at different times. For example, if the stock market is on a losing streak, bonds may be providing good returns. Or if Stock A is in a slump, Stock B may be on a tear.
Mutual funds provide some built-in diversification because they invest in many different securities. And you’ll achieve greater diversification if you invest in both a stock fund and a bond fund (or several stock funds and several bond funds), for example, rather than in just one or the other.
A concept closely related to diversification is asset allocation. It involves deciding what percentage of your portfolio you want to invest in each particular asset category, or type of security, based on risk and other factors. As another general rule, the younger you are, the more risk you can afford to take because you’ll have more years to make up for any losses.
If you have high-interest debt, such as many credit card charges, it usually makes sense to pay it off before you invest. Few investments ever pay as much as credit cards charge. Once you’ve paid off your debt, redirect that extra money to savings and investments. And try to pay your credit card balance in full each month, whenever possible, to avoid owing interest in the future.
Mutual fund companies have different minimum initial investment requirements to get started, often beginning at about $500. After that, you can usually invest less. Some mutual funds will waive their initial minimums if you commit to investing a regular sum each month. You can also buy mutual fund and exchange-traded fund (ETF) shares through a brokerage firm, some of which charge nothing for opening an account.
Exchange-traded funds (ETFs) are investment pools much like mutual funds. A key difference is that their shares are traded on stock exchanges (rather than bought and sold through a particular fund company). They sometimes charge lower fees as well. You can also buy them, along with stocks and bonds, through a brokerage firm.
While get-rich-quick schemes sometimes may be enticing, the tried-and-true way to build wealth is through regular saving and investing—and patiently allowing that money to grow over time. It’s fine to start small. The important thing is to start.
Harvard Business Review. “9 Out of 10 People Are Willing to Earn Less Money to Do More-Meaningful Work.”
U.S. Bureau of Labor Statistics. “Occupational Outlook Handbook.”
Budgeting & Savings
Budgeting & Savings
Budgeting & Savings
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