MONEY
Here's a question with an easy answer: Want to get rich?
Even if you're not the type to chase wealth, you'd probably say yes to financial comfort. That feeling of not having to think about money — or the more typical reality, stress over it — is what we're all really after.
More from Nerdwallet:
Simple portfolios to get you to your retirement goals
To retire early, focus on just one thing
No 401(k)? No problem. You can still save for retirement
Simple portfolios to get you to your retirement goals
To retire early, focus on just one thing
No 401(k)? No problem. You can still save for retirement
Whether you ever get to breathe that sigh of relief depends not on the next lottery drawing or get-rich opportunity, but on a combination of your circumstances and your approach to managing your finances. Admittedly, some of those circumstances may be beyond your control. But how you approach the money you have — however limited it may be — is not.
Here are five virtually surefire ways to slowly build wealth.
1. Use your time wisely
Unlike leftovers or an unmowed lawn, unspent money actually gets better with time. Getting an early start on investing for retirement can be almost as valuable as shoveling a ton of money away. (Of course, those who are able to put the two together end up sitting on the real pot of gold.)
Let's consider three people who have $10,000 a year to invest. The first — we'll call her Strong-Start Sammy — begins investing that $10,000 at age 25 and continues for 10 years. The second person, Consistent Cathy, starts saving at age 35 but keeps it up until age 65 without skipping a beat. Finally, Perfect Penny one-ups them both by contributing that $10,000 every year from age 25 to age 65.
It's not hard to figure out that Perfect Penny comes out on top here: She puts away more money over a longer time horizon. The curveball comes from Cathy, who saves $200,000 more than Sammy but ends up with a balance that is only about $35,000 higher.
For that, Sammy can thank — and Cathy can curse — compound interest. The longer your money has to grow, the more you end up with and the less you actually have to save — investment returns start to multiply over time and pick up the slack.
2. Spend less than you earn
You've heard people tell you to live within your means. They're wrong. To really build wealth, you need to live below your means — preferably, about 15 percent below.
That's about how much you should be saving for retirement each year (though it's worth determining a more personalized goal by using a retirement calculator), which leaves us with some simple math: If you want to save that much, you need to spend that much less than you make.
While the math is easy, the commitment to spending less is not. It requires an ongoing value judgement: Is this purchase today more important than retirement tomorrow? If it isn't, try to pass.
It also requires avoiding high-interest-rate debt, which can effectively wipe out any chance you have of saving enough — and almost always indicates you're living too large for your budget.
3. Progressively raise the bar
If you can save early and consistently like Penny, you get lots of head pats.
The rest of us need a more reasonable approach: Start small with whatever you have to save, and then regularly increase that amount. Doing so once a year is great; more frequently is even better.
Getting a raise is a good time to do it, as is after you've paid off a large debt. Direct that extra money toward savings and you won't miss it.
4. Use every advantage
Aside from the obvious benefit of saving for retirement — that eternal hammock at the end — there are ongoing benefits, too: If you use the right accounts, you can lap up free money and lower your taxes.
That free money comes if you're fortunate enough to have an employer plan like a 401(k) that offers matching contributions. Those dollars are an instant return on your investment: If you contribute 6 percent of your salary, for example, your employer might kick in 3 percent … and now you're saving 9 percent of your income.
The money you put into a 401(k) also reduces your taxable income for the year, lowering the taxes you pay. (You're not actually avoiding taxes, just pushing them down the road, when you'll pay taxes on distributions from the account in retirement.)
If you don't have a 401(k), consider an individual retirement account. A traditional IRA has the same tax treatment as a standard 401(k) — tax break now, pay taxes later — while a Roth IRA works in the reverse: You don't get a tax break now, but you also don't pay taxes on retirement distributions. You can compare Roth and traditional IRAs to see which account makes sense for your situation.
5. Don't try too hard
Can you stock-trade your way to retirement? Sure, but you could also sit back, relax and let mutual funds do the work — specifically low-cost index funds or exchange-traded funds, which track a benchmark index such as the Standard & Poor's 500.
These funds are like baskets that hold small pieces of many different individual investments, which means you get instant diversification, lowering your risk but typically not your returns. Here's a how-to guide to investing in index funds.
You can build a solid portfolio out of just four funds, and while you may not beat the market, you should be able to easily keep pace.
Like this story? Like CNBC Make It on Facebook!
No comments:
Post a Comment