5 steps to building wealth

Building wealth is a lifelong process. And no matter how much you have already achieved, there are always ways to help take your wealth to the next level. For example, the more you save, the more you can invest, which puts your money to work for you. And of course, a high-level view of your personal finances can help you and your planner ensure everything is working in harmony toward your financial goals.

No matter the market conditions, every year inflation erodes your purchasing power by making things more expensive. And that can work against your ability to create wealth. One way you can combat the effects of inflation is to have a diversified investment portfolio utilizing various investment options that keeps up with – and hopefully outpaces – the rate of inflation over time.

But with all that in mind, you may be wondering exactly what you can do to put your wealth building plan on the right track. We believe there are five key steps to helping build wealth and achieve financial freedom.

1. ELIMINATE CREDIT CARD DEBT

Hanging onto credit card balances can have a cumulatively negative effect on your cash flow and hinder wealth accumulation. Focus on eliminating credit card debt first, as it typically has a higher interest rate and takes longer to pay off. If you have multiple cards, pay more on the one with the highest rate first, then the next highest and so on. Always pay at least the minimum on your lower interest cards.

By reducing bad debt, you can free up more of your earned income to save and invest toward your financial goals.

On the flip side, auto, college and mortgage loans typically have much lower interest rates and in the case of mortgages can contribute to building home equity, so you should pay those according to schedule. Unless you already have your other debts covered and you have substantial cash reserves, don’t be tempted to pay off these types of debts early.

2. PARTICIPATE IN YOUR RETIREMENT PLAN AT WORK

If you are in a moderate to high tax bracket (say, greater than 12%), it’s best to participate in your employer’s retirement plan to the greatest extent possible. After addressing your credit card debt in step one, the next step would be to max out your retirement plan contribution, which is a critical part of your retirement planning. If you feel that you can’t afford it, start with a smaller amount and increase it every year until you reach the maximum. Make sure to operate within your comfort zone and make only pretax contributions.

If you’re married and one spouse does not have a retirement plan at work, consider investing in a spousal IRA as part of your financial planning. The self-employed have options too, so don’t forgo this valuable savings vehicle. The more money you save, the more money you can accumulate, which can bring you closer to financial freedom.

Choose an allocation appropriate for your goals and risk tolerance. Consider one composed of both U.S. stocks and international stocks and also have some exposure to bonds to help cushion against stock market declines. This may be achieved by investing in ETFs and institutional mutual funds. Generally, you don’t want to have more than 5% in any one stock – including your own employer’s – because more than that could prevent you from achieving adequate diversification. In addition, being over concentrated in one security can cause unnecessary volatility and risk with your retirement savings.

Once you pick your diversified portfolio, stick with it, investing your paycheck deductions in the same investment mix over the long term so you can benefit from any compound growth. Of course, if your time frame, risk tolerance, needs or goals change at any point, you may need to revisit this approach. And don’t forget, your account will need to be periodically rebalanced to maintain the appropriate allocation.

3. INVEST IN A DEDUCTIBLE IRA AND/OR DEDUCTIBLE SPOUSAL IRA (IF ELIGIBLE)

The amount you should keep in cash reserves depends on two factors – your monthly expenses and the stability of your income. So consider:

• What are your mandatory monthly living expenses?
• How stable is your income? For example, are layoffs possible? Are you a business owner with fluctuating income or rental income? The more stable your income, the lower your reserves can be.
• Do you have any large, one-time expenses coming up?

Generally, your reserves should be somewhere between three and 24 months’ worth of spending, depending on how stable your income is.

Of course, you’ll want to be sure your reserves are readily accessible if and when you need them. So consider storing reserves in one of the following relatively liquid assets:

• Savings account (including high-yield savings accounts)
• Checking account
• Money Market fund
• U.S. Treasury bill (T-bill)
• Bank CD (preferably that matures within one year)
• Brokerage CD
• U.S. savings bond
  • Note: Depending on when you choose to cash out savings bonds, they may have not yet matured to their face value or have limitations with their liquidity.

For the same asset accessibility reasons, you should not store your reserves in any of the following investment options:

• Cash positions in a managed portfolio: These would trigger rebalancing if withdrawals were taken from this cash position.
• U.S. Treasury notes: Notes mature in two to 10 years, which is too long to have to wait to get your money back for an immediate need.
• U.S. Treasury bonds: Even worse, these mature typically in 20 or 30 years.
• Commercial paper:  As an unsecured debt issued by companies, this carries default risk for investors as compared to U.S. Treasurys. Changes affecting commercial paper as well as the overall market conditions can happen so quickly that investors may not have the opportunity to sell, making it generally less liquid than other options.
• Life insurance cash values: While they can be considered a cash equivalent, they’re not suitable for use as reserves because of the potentially large surrender penalties, tax risks and other restrictions you could face.
• Fixed annuities: These are the insurance industry’s version of bank CDs, which typically offer a slightly higher rate, but they’re not acceptable as reserves because of potential tax penalties and surrender charges.
• Treasury Inflation-Protected Securities: TIPS mature in five, 10 or 30 years, which is far too long for cash reserves. Plus, if you sell prior to maturity or if deflation occurs, you could lose money.

4. Invest in a deductible IRA and/or deductible spousal IRA (if eligible)

Depending on your adjusted gross income, you and/or your spouse may still be eligible to contribute to a deductible IRA even after contributing the maximum to your company retirement plan. Deductible IRAs offer two major benefits: you get a tax deduction for the money you contribute; and any interest, dividends or capital gains that accumulate in the plan are also tax-deferred until withdrawal.

If you’re not eligible to invest in a deductible IRA or you’re in a low tax bracket (12% or less), you should consider a Roth IRA instead. In any case, look to avoid non-deductible IRAs, which do not entitle you to a tax deduction and require complex tax documentation.

Your planner can provide financial advice to help you determine your eligibility, compare options and decide which IRA may be best for you.

5. CREATE AND FUND A TAXABLE INVESTMENT ACCOUNT AND CONTINUE TO ADD TO THE ACCOUNT MONTHLY

Once your tax-advantaged retirement plan contributions have been exhausted, build assets in an investment account and contribute to it monthly. Additionally, if your 401k plan allows you to contribute after-tax dollars and it will not affect your current lifestyle, consider adding additional after-tax dollars to your 401k plan and converting those dollars to a Roth when permitted.

Investing in taxable accounts allows you to diversify your investment account types and work toward your investment goals beyond retirement savings.

KEEP YOUR FINANCES MOVING FORWARD

Taking these five steps can help you build wealth, achieve financial security and keep your plan on the right track. There are many nuances to each step, however, so consulting a financial planner may be the best thing to do first.

Above all, get started and keep at it. The number one thing that stands between you and the future is procrastination – waiting until tomorrow to do what you can do today. The sooner you put your money to work, the sooner you can take advantage of one of the most powerful forces for wealth creation: compound interest. Your financial planner can help guide you through each step, reducing the temptation to procrastinate and helping you stay on track. Keep that in mind as you look for new ways you can build wealth that can help carry your financial goals forward.