5 steps to building wealth

Building wealth is a process. It’s one that will span your entire life. 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 finances can help you and your planner ensure everything is working in harmony toward your 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 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.

1

Hanging onto credit card balances can have a cumulatively negative effect. 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.

On the flip side, auto, college and mortgage loans typically have much lower interest rates, 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

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. 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. 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.

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 overconcentrated 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

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 expenses?
• How stable is your income? For example, are layoffs possible? Are you a business owner with fluctuating 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:

• Savings account
• Checking account
• Money Market fund
• S. Treasury bill (T-bill)
• Short-term bank CD
• Series I savings bond (I bonds)
  • Note: you should consider I bonds only if you have already saved at least 12 months of liquid cash reserves. I bonds must be purchased through Treasury Direct and are illiquid for 12 months. Any I bonds that are redeemed before five years have passed will forfeit the previous three months’ worth of interest. The maximum purchase is $10,000 per calendar year plus $5,000 in paper I bonds via your federal income tax refund.

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

• ​​​​​​​U.S. Treasury notes

Notes mature in two to ten 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 in more than 10 years.

• S. EE savings bonds

These don’t qualify as reserves until one year after you buy them because you cannot cash them in before then.

• Bank CDs and commercial paper

Most of these have longer terms, making them an unsuitable choice, but the only acceptable exception would be any that mature within one year.

• 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)

These mature in 5, 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.

• Stable value funds

These funds invest in commercial paper and other securities that are designed not to fluctuate in value, but that doesn’t mean they can’t, making them a less than reliable option for reserves.

4

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

5

​​​​​​​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.