If your get-rich strategy hinges on annual pay bumps, you’re going about it all wrong—and not just because raises have been slowly disappearing. True wealth-building has way more to do with the way you manage your cash than how much of it you make.
“I’ve had clients with large incomes who have a lower net worth than those with smaller incomes—[all] because those with lower incomes invested well,” says Bill Van Sant, CFP, senior vice president and managing director of Univest Investments in Souderton, Penn.
Need some proof? According to figures from the Congressional Budget Office, the top 1 percent of earners in the U.S. receive more than a third of their income from investments—something you can work toward, too, whether you someday achieve 1-percenter status yourself or not.
Notice the emphasis on investing, rather than simply saving. Though the latter is an important habit to master, it isn’t as powerful as investing in the capital markets.
“Savings are often deposited in the safest place that allows you to access money any time—like a savings account—but there’s a trade-off for that security and accessibility; banks offer a very low interest rate that may or may not rise with inflation,” says Kimberly Foss, CFP, author of “Wealthy by Design” and founder of Empyrion Wealth Management in Roseville, Calif.
Investing, on the other hand, provides an opportunity to earn significantly more than the amount you deposit, thanks to higher average rates of return over time and compound interest (though be prepared for dips along the way).
In 2015, for example, the Dow Jones Industrial Average, a benchmark index of 30 major stocks, ended the year down slightly at 17,480. But that was still up 75 percent from where it stood seven years earlier.
Every investment carries some risk, and there’s a chance you may lose money on the way toward your goal. If you’re not investing in the stock market at all, this might be the reason why. But the truth is, there are risks inherent in pursuing any reward, whether it’s boarding an airplane for your dream vacation or opening your heart to a new romance. And, historically, over time the stock market has gone up significantly.
You can lower your risk by having a range of investments, including domestic and foreign stocks and highly-rated corporate and government bonds. Having a portfolio that’s well-diversified helps ensure you’ll be in the black (or positive) on some investments, even if others are in the red.
“Nobody wants to lose money, but you have to keep your eyes on the goal, which is long-term financial security. Investing your assets is often the best way to reach that goal,” Van Sant says.
Another is education. Rather than panicking over market dips, for instance, research how similar events have affected people in the past. What you’ll learn is that the market has traditionally rewarded long-term, passive investors. (If you left your money in the market throughout the Great Recession, it’s likely you’d have earned back your losses and then some.)
“Look at how events [would] affect you personally,” Van Sant says. “If your goals are still the same, a market slowdown can just be an opportunity for you to buy stocks cheap.”
When you’re ready, the array of investment choices can seem overwhelming. Foss recommends ETFs (or exchange-traded funds), which typically offer low fees, making smaller, incremental investmentments more affordable.
Though Van Sant recommends investing 10 percent of your income, don’t be discouraged if you can’t start at that rate. Aim for less—say, 4 percent—and inch up your contributions gradually.
The most important thing is to simply start. “If you’re living within your means and adapting your budget to accommodate ongoing investing, that’s how you build wealth,” Van Sant says.