Learning how to build wealth is essential for financial security and independence. If you have financial goals, such as buying a house, paying for your kids’ college or securing a comfortable retirement, building wealth is the key to achieving those objectives.
The basics of wealth building
If you want to build wealth, it’s best to have a long-term mindset.
Patience is crucial: Seeing the fruits of your wealth-building efforts may take years. That’s especially true if you begin to save and the market goes into a downturn or an especially volatile period.
It’s really common sense, but budgeting, maintaining a consistent savings habit, avoiding or paying off debt, stashing money away in an emergency fund and spending less than you make are all pillars of building wealth. Investing is the more glamorous side, and that’s also necessary, of course. But day-to-day money management habits are equally important, if not more so.
When it comes to your investments, you can diversify your holdings by owning stocks, bonds, real estate and alternatives like commodities. That’s a proven way to smooth your return and help mitigate losses.
It’s easy to have “expense creep” as your salary increases over time and you feel that you can spend more money. That’s why it’s important to monitor your expenses. Consider doing a review once a year to see if you can trim any excess fat from your budget, such as unnecessary memberships or subscriptions you no longer use.
Setting financial goals
Identify your objectives, like saving for a home, paying for your kids’ education, funding your retirement or other goals that are important to you. For example, some people salt away a year’s worth of living expenses so they can start their own business.
Quantify these goals with clear, measurable targets. Establish a realistic timeline, given your income and expenses. Prioritize goals based on importance and urgency. For example, it’s a good practice to get out of debt, including your mortgage, before you retire.
Review your goals and progress regularly, as life happens and priorities can change.
Saving to build wealth
If you’re wondering how to build wealth from nothing, begin by cultivating a savings habit.
Allocate a percentage of your income to savings and investing. Invest wisely, consider low-cost index funds and take advantage of an employer-sponsored 401(k) retirement plan if available.
Embrace frugality, distinguishing between needs and wants. That’s not necessarily fun in the short term, but your future self will thank you.
In your working years, acquire new skills to enhance your employability and income potential.
If you keep saving and investing, you’ll be able to take advantage of compounding over time, which is the process of earning interest and returns on the interest and returns you’ve already earned. Doing so can transform a modest starting balance into a substantial foundation for lasting wealth.
Investing to increase wealth
For many investors, a key consideration is how to build wealth that can be passed down to heirs for generations to come. By strategically allocating funds to appreciating assets like stocks or real estate, you can harness the power of compounding over time.
When investing to build wealth, including generational wealth, start by evaluating your time horizon and risk tolerance.
When considering your time horizon, don’t just stop with the date you hope to retire. You’ll need to account for your life expectancy, as well as your spouse’s or partner’s. Here’s a hint when looking at life expectancy: Don’t use your parents’ lifespans as your guideline, particularly if they died relatively young. That’s a trap that many people fall into, and it can result in underfunding your retirement.
Finally, avoid “timing the market,” at least in your accounts earmarked for retirement. Plenty of research shows that attempting to buy ahead of market rallies and sell before market crashes generally has the opposite effect of what people want, as it’s extremely difficult to consistently beat the market. If you have a small, designated account meant for trading rather than investing, that’s the place to scratch your trading itch with “fun” money.
Diversification in wealth creation
Diversification simply means spreading your money across various asset classes, sectors and global regions. That helps mitigate risks associated with individual holdings.
For example, say you own Apple stock in your portfolio because you like the company and its products. That’s fine as long as you limit your holding to a reasonable percentage of your portfolio and balance it with other stocks and bonds.
Instead of overloading your portfolio with Apple or other single stocks, consider diversifying through pooled investments like mutual funds and exchange-traded funds that track baskets of stocks. That decreases the probability that a problem with any individual stock will drag down your portfolio value.
In addition, diversification can smooth your return, as not all asset classes move in the same way at the same time.
Real estate investment
Investing in real estate can be a sound strategy for building wealth.
Real estate offers potential appreciation, rental income and tax advantages. In addition, it can offer diversification from a stock-and-bond portfolio.
You have several choices for investing in real estate. One option is renting out residential or commercial properties. Using debt to purchase these properties can amplify your return, but it comes with risks. If you want to invest in real estate rentals, educate yourself by staying updated on property values, and consider the long-term growth potential of the area.
Real estate, in its brick-and-mortar form, can be part of a diversified portfolio.
Alternatively, real estate investment trusts (REITs) offer access to income-generating real estate without direct ownership. There are some privately listed, illiquid REITs, but it’s a better idea to invest in publicly traded REITs, which you can buy and sell on public markets just like stocks.
Retirement planning
Retirement planning is a key component of building wealth, as it ensures financial security in your later years.
By contributing to retirement accounts like a 401(k) or individual retirement account (IRA), you can take advantage of compounding and tax advantages.
A well-thought-out plan considers factors such as lifestyle goals, risk tolerance and anticipated expenses. The further away from retirement you are, the harder it is to envision the lifestyle you want. However, that also gives you more time to stack up money so it’s available to you in later years.
Early and consistent contributions allow your investments to grow over time, providing a nest egg for a comfortable retirement.
Debt management
If you’re paying out a chunk of your income to banks for credit cards or car payments, that’s less that you can put away for retirement.
Effective debt management, including minimizing financial burdens and freeing up resources for investing, is crucial for building wealth.
Credit cards often have high interest rates, which means those payments impede your ability to save and invest.
Also, investors are often curious about how to use home equity to build wealth.
Using home equity to build wealth can be a risky business. It might sound appealing, especially if you live in an area where home values are appreciating quickly.
However, home equity can be a form of debt, so beware of stretching your finances too thin by overborrowing.
How taxes impact wealth
When saving money and planning for retirement, don’t overlook the impact of taxes.
Having a tax strategy gives you an advantage when accumulating wealth and also when spending your money in retirement. It pays to develop an understanding of tax-efficient investment strategies, deductions and credits.
Minimize taxable events, such as selling stocks with short-term capital gains, which are taxed at a higher rate.
Another strategy is tax-loss harvesting. That’s a fancy term for offsetting investment gains by selling some investments at a loss. This is a strategy you can use in a taxable account, but it doesn’t apply to a qualified retirement vehicle, such as an IRA.
Insurance and wealth protection
Insurance protects you against catastrophic events that could wipe out your hard-earned savings in a heartbeat.
Health insurance guards against unexpected medical expenses, preventing health care costs from draining your savings. That’s a big problem behind many bankruptcies in the U.S.
Life insurance provides a safety net for beneficiaries in the event of the policyholder’s death.
The amount of insurance coverage you need depends upon your situation and what your plan indicates. For example, if you have no dependents, you may no longer need life insurance.
However, in some situations, life insurance remains a viable estate planning tool to leave assets to a surviving spouse. That’s why it’s best to discuss insurance questions with a financial planner who can give you an objective view instead of relying on an insurance salesperson.
The role of financial advisors
Financial advisors play a pivotal role in helping their clients develop wealth-building strategies.
No two situations are the same. Advisors provide personalized guidance, helping clients navigate investment options, risk management, tax planning and many more details relevant to building wealth for retirement.
Advisors’ and planners’ expertise aids in long-term wealth preservation. By staying current on not just the market, but also changes to tax laws affecting retirement, advisors help their clients avoid mistakes that could potentially cost tens of thousands of dollars.
Frequently asked questions (FAQs)
The amount you should save for wealth building varies according to your individual goals, lifestyle and time horizon. Remember: It’s ridiculously common for people in their working years to underestimate the amount they’ll need in retirement.
Don’t believe the old adage that you will spend less in retirement. That frequently happens, but it’s not because retirees’ lifestyles cost less. Sadly, it happens because many American retirees simply don’t have enough money saved to spend at the same rate they once did.
Real estate can be a solid option for building wealth due to potential appreciation and rental income.
Investors should weigh factors like location, property type and market trends to make informed decisions.
Diversifying an investment portfolio with real estate can result in long-term returns, but it requires careful research, management and market understanding. Don’t underestimate the hands-on work it can require.
Consumer debt and student loans can significantly impact your wealth-building process because the monthly payments you make on them go to banks and other lenders rather than toward your own wealth.
Paying off debt is crucial for building wealth, as it eliminates both principal and interest payments, freeing up funds for savings and investments. It reduces financial stress and accelerates progress toward achieving your long-term financial goals.
