This is something I consider important, at least when I define my financial goals. This post isn't about how to get rich quick, but how to build wealth slowly via savings and investing. In my opinion, over 20 – 30 years everyone should be able to at least achieve some level of financial independence, but most don't. A recent survey showed 64% of Americans don't have $1,000 in savings. This means many are living paycheck to paycheck.
Define Your Goals
Of course, how each person achieves their wealth goal is unique. Most should become wealthy from savings alone. At least for the purpose of this article, I don't discuss owning a business or via other means. You should start saving when you are young and save often. If you are still in your twenties, start saving now!
I break down savings into three discrete steps. I consider setting up three goals to meet – emergency savings, when are you financially free, and when would you be wealthy. Since everyone defines these terms slightly differently, I'll state what I mean:
- Emergency Savings – You have enough to last at least one year without income.
- Financially Free – Enough yearly income from investments to match your yearly expenses
- Wealthy – If you took out 4% of your net worth annually, your net worth would outlast your life expectancy.
It's common for people to save for retirement, but not think about how much they will need when they retire. This is akin to driving without knowing where to go.
First Step – Emergency Savings
If you are starting from no or negative net worth (You can check it with these net worth trackers), you need a savings cushion. Most financial experts recommend 3 – 6 months. I recommend one year of emergency savings. Yes, I understand this could mean $60-70k in emergency savings. Having this amount gives you much more financial flexibility. For many having this much in savings takes off quite a bit of financial stress.
This money should be invested in very safe and liquid investments, should you lose your job or have a financial emergency. I understand this is somewhat hard in the current economic environment, but diversify, and pick your investments wisely.
Unlike most, I recommend setting up at least 2-3 months of savings before pre-payment of other debt. In my opinion, the ironic thing is when you have enough net worth, you no longer need a specific fund for emergency savings. Your emergency savings can be rolled into your other fixed-income investments. What matters with emergency savings is how often you use it, and how long it take to unwind your investments. Based upon this, with your fixed-income investments, you'll need a portion set aside that is very liquid.
As I've stated from one of my first posts, what's more, important is cash flow, than net worth. In the race between the tortoise and hare, the tortoise won because of longevity. Here are our favorite services to manage your emergency fund:
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Third Step – Financially Free
How much income do you need from your investments yearly before you are financially free? It's a lot less than you think. For most people $60,000 – $70,000 is all that is needed to meet your typical yearly expenses. This is where creating your budget comes in handy. Create your budget, and figure out how much you need on an annual basis. This is your starting point for how much you need per year from your investments.
This of course does not take into account inflation and taxes. I'm not suggesting you shouldn't invest past this amount either. Quite the opposite. The goal of this exercise is when can you say you have at least enough saved where if you couldn't work another day in your life, you would at least have a decent-sized safety net. This is the point when you tip the scale, so to speak. After this point, you will generate more income with your savings, then what you will need on a yearly basis to live. You can use personal finance software, such as Personal Capital, to gather all of your financial data you may need. Or you can hire a financial advisor like Farther to get insight into exactly what you need to invest in to gain wealth.
Choose a Strategy to Increase your Wealth
There are so many ways to build wealth. From smart stock market strategies to learning a specialized trade, the methods for making your money work for you seem endless. So which one to choose? Here are the top five:
1. Start Your Own Business
Who actually wants a boss? Creating your own job is one of the most satisfying ways to build wealth. Plus, people don’t realize all of the additional advantages that come along with being a business owner. The absolute best is the money you save in taxes since everyday expenses like your car become a “business expense” to write off.
But really, with more and more traditional jobs being taken over by computers, systems, and technology, becoming a business owner is an excellent way to pave your own path. And — of course — to build wealth.
Want to try it out first? Feel like stretching your entrepreneurial muscles? Either brainstorm your own side hustle or drive for Uber! Help someone move using TaskRabbit! Rent your apartment on Airbnb!
2. Invest in Real Estate
If you’ve thought about how to snowball your money but haven’t considered real estate investing, then I’m not sure where you’ve been looking. This is NOT about owning the house you live in; this is about buying a home and having someone ELSE pay the mortgage. Who gets the tax benefits? You. Who gets the passive income? You. Who gets the equity? You. The list goes on…
There are many different ways to invest in real estate, and here at Investor Junkie we actually walk you through how to get started. But as the saying goes, “In real estate, the money is made on the purchase, not on the sale.” So overpaying for just one property can severely affect how well you build wealth through real estate investing.
Want to just dabble? Thanks to technology, there are lots of ways to invest in real estate that don’t have you fixing faucets or needing $50k in cash.
These are our favorites:
- Fundrise — You need only $1k to start
- Roofstock — With this one you actually do own the home yourself, but Roofstock makes things seriously easy
- Realty Mogul — This platform offers two REITs for non-accredited investors
3. Pay Yourself First
Have you ever heard the saying pay yourself first? If you truly want to build wealth, this is the way to do it. But what does it mean to pay yourself first?
Each month we all have bills to pay: credit cards, mortgages, rent, student loans, etc. But what if instead of prioritizing BILLS, we prioritized OURSELVES?
The easiest way to do this is by setting up automatic deposits from your employer to go into retirement accounts. This way the money never hits your bank account, where it can be redirected to landlords and credit card companies. Instead, the money goes directly to your future self so that compound interest can work its magic. There are employees who followed this strategy and woke up one day to realize they had enough in retirement accounts to quit their jobs forever.
This isn’t to say that you can ignore your financial responsibilities, but it does mean that you should rearrange your priorities so you’re building wealth for yourself and your family, instead of padding someone else’s pockets.
Need more info? Start with learning the maximum amount you can contribute.
4. Take Calculated Risks
Wealthy people, in general, do not sit in a cubicle day in and day out. Sure, sitting in a cubicle earns you a secure paycheck, and… yeah, that’s about it. To really build wealth you’ll need to get out of your “comfort zone” and explore risk. Calculated risks are the key to personal growth, and the same applies to money.
So whether it’s studying the financials of a company you love and buying its stock… or putting a down payment on a home you’ll never live in… or creating an LLC for the company you’ll one day run… You’ll never know wealth until you take these first calculated risks.
Final Step – Wealthy
Once you've passed the first goal, the wealthy goal is the fun part. Unfortunately, many people in the United States don't get past the first goal, let alone the second.
This goal is where you have enough savings you can take out less than 4% of your total saved. Using the numbers above: this is around $3.5 million. So you need at least $3.5 million, and your money should outlast you, instead of you outlasting your money.
Once you have enough investment income, you should be locking in capital gains. Your sole investment objective is to make sure you keep up with the hidden tax – inflation. This isn't to say you should be investing for growth, but your primary objective is to keep risk to a minimum.
Of course, these numbers vary from person to person, but the basics still apply. Having these target goals is important because you know what you are shooting for. If you don't, you are wandering aimlessly.
Readers: How much do you need to be considered wealthy?