Steps to Building Personal Wealth
Is it surprising that self-made millionaires see saving as a stepping stone to wealth? According to nerdwallet.com, the “average” millionaire saves 20 percent of their income. But it’s more than just saving. Millionaires tend to view money differently than most Americans, and they stay fiercely rooted in their goals. This impacts how they choose to increase their wealth and spend money.
Bottom line: reaching your goals requires a game plan.
Step 1: See where you are
It’s important to know where you stand today. Be honest. And take heart, no matter your age or income, you can always take steps to get to a better place financially. First, calculate your net worth:
Net worth = assets - liabilities
You can also create a personal balance sheet showing your assets and liabilities. Simply calculate the total market value of your assets (house, furniture, car, savings, CDs, investments, 401(k), etc.) and then deduct your liabilities (mortgage, home equity loan, car loans, credit card debt, etc.) Assets you still owe money on can be counted, as will its corresponding loan balance. The final figure will reflect your net worth, and what you set your goals from.
Step 2: Determine where you want to be
Set incremental goals – first monthly, then annually, and finally, for when you retire. As you accomplish your initial goals, you build confidence. Use that confidence as a motivator and to stay focused.
Goals can include:
- Saving a targeted amount each month
- Setting up an emergency fund
- Paying down debt (most expensive first)
- Contributing to a 401(k)
- Investing in the stock market
- Deciding when you want to retire and a desired lifestyle
- Determining how much money you need to retire
Step 3: Create a budget
Remember to remove the emotion from your financial life. View budgeting as a tool to support your goals rather than a necessary evil. Use a budget to set goals and spending limits for necessities and extras, so you stay organized and committed.
Start by writing down what you spend in a month. List it all – from rent or mortgage payments down to your daily coffee stop. Do you see patterns you wish to keep or change? Next, separate your budget into categories, such as housing, utilities, food, transportation, insurance, and entertainment. Earmark savings as a category as well. Then, try setting aside ten percent of your take home pay working up to 20. This step will help ensure you pay yourself each month. Click here for a sample budget worksheet.
Step 4: Cut back on spending
For this step, try eliminating a few everyday items each week. For example, do you purchase a coffee on the way to work? Perk your own instead for just 38 cents per 16-ounce cup. ($5 vs. $0.38 = $23.10 saved.) Do you go out to lunch? Try brown-bagging it during the work week. ($8 vs. $3 = $25 saved.) Do you pay a club membership? Switch to at-home workouts or outside activities like walking or biking. Cancel cable and subscribe to Netflix. Get rid of unread magazine subscriptions. Carpool whenever you can. Visualize not spending as saving.
Step 5: Pay down debt
Getting completely out of debt may not be realistic, especially if you’re in your 20s, 30s or even 40s. What you can do, at any age, is be choosy about the type of debt you incur. Avoid using credit to live beyond your means. The more debt you have, the more you’ll pay in interest and the less you can save. Visualize excessive debt as limiting your opportunities.
You have some extra cash.
Should you pay down debt or invest? A good rule of thumb is to look at your after-tax return on investments. If it is more than your after-tax cost of debt, it is probably better to invest any surplus. If it costs you more to keep the debt than any potential return on an investment, pay the debt off.
Your goal in debt reduction (excluding mortgage payments) is for payments not to exceed 15 to 20 percent of your take-home pay. Some loans are better to pay down, including higher-interest rate debt, credit cards or student loans. If you have several loans but are having trouble reducing debt, you may need something more structured, such as Dave Ramsey’s Debt Snowball Method.
Step 6: Build your net worth
PracticalMoneySkills.com has great resources to help you build your net worth based on certain life events. Consider other ways to build your worth. Does your employer offer a 401(k)? If yes, take advantage of its maximum potential. Many employers will match a portion of what you save.
Contribute at least what your employer will match. Your tax burden will also be less – contributions are before-tax and will reduce your taxable income. Also, review your budget frequently. If you’ve recently paid off a car loan, for example, use those funds towards saving more or investing.
The power of compounding.
Saving is a way to generate wealth. But it’s even more powerful when you’re young since you have the gift of time. You can save longer and factor in the compounding of interest. This enables you, like the wealthy, to focus on earnings rather than how much you can save.
Say you contributed $5,000 a year to a 401(k) for ten years – assume that investment earned eight percent annually, and the earnings reinvested in your account. Compare how much more you can earn the longer your investment has to compound interest:
- You start saving at age 25 and stop at age 35; when you retire at 65 your account would be worth about $787,000.
- You start saving at age 35 and stop at age 45; it would be worth about $364,000.
- You start saving at age 45 and stop at age 55; its value would be only about $170,000.
- You wait until age 55 and contribute to age 65; you'd only amass about $78,000.
These examples assume you invest $5,000 each year for ten years and then stop. If you were to contribute that amount annually from ages 25 to 65, you would amass more than $1.35 million during those 40 years. These examples do not include consideration of the time value of money, inflation, fluctuation in principal, or taxes.
Step 7: View your choices
Risk tolerance affects much in life including how you save and invest. Some people, no matter their age or income are risk-adverse; others like to take chances. If you’re in your 20s or 30s, you have a longer timeline to recoup any loss, giving you potentially more freedom to choose a higher-risk mix. As you approach middle age or beyond, you may need to be more conservative. Your 401(k) or other investment plans usually offer choices based on your risk tolerance, ranging from extremely conservative to aggressive.
A balanced portfolio is sensible for most. Liken it to not having all your eggs in one basket. So, if one area is not performing well, you can relax knowing your investment is diversified. Stocks are considered riskier, mutual funds less so, and fixed-interest treasury bonds the most conservative. You may even prefer federally-insured investments, such as CDs at banks or Share Certificates at credit unions, including United.
Being frugal is okay.
The wealthy aren’t afraid to be frugal. And contrary to perception, many don’t put stock in keeping up with the Joneses. Billionaire Warren Buffett, for example, lives in a house he bought in 1957 for $31,500. Being frugal is really about making thoughtful spending decisions. It can also become a lifelong habit to increase your net worth.
Step 8: Reevaluate
The best financial plan is fluid and flexible. Review your budget monthly until you’ve established a routine. Make tweaks so the plan is realistic and working for you. Over time, you can review it less frequently, perhaps quarterly or every six months. But always reevaluate when you’ve experienced a life change. Have you gotten a raise or paid down debt? Have you taken on new debt? Have you married or had a child? Adjust your plan accordingly.
Like the wealthy, keep your emotions at bay when making financial decisions. Stay committed to your plan, and feel confident in your steps to building personal wealth
Interested in setting your plan? We have tools to help you start building that future.