Short of winning the lottery or receiving an inheritance from your wealthy great-aunt, there’s really only one way to build wealth: you gotta work for it. But while stashing your pennies is a great way to save up for the future, you probably aren’t going to wind up wealthy on those earnings alone.
Instead, you need to find ways to put your money to work for you, which will enable it to grow at an even faster rate than if you are just saving a portion of what you make. And for most people, investing is the answer.
How investing builds wealth
So, just how does investing build wealth in a way that simply saving alone cannot? There are three primary ways.
It provides another vehicle for savings
There’s no denying that savings accounts are an important part of any financial strategy. Putting some of those savings in an investment account, however, allows you to spread your assets out a bit, rather than putting all of your chickens in one basket.
By diversifying your assets, you are more likely to see healthy returns regardless of how the market behaves, than if you were to simply choose one place to focus your efforts.
It’s not earned income
Earned income describes money that you actively earned, such as taxable employment income.
For many of us, earned income makes up the bulk of the money that we bring in each year, whether from your primary job or side hustles. However, earned income is very limiting in nature.
Whether you make $10 an hour or $10,000 an hour, the fact is that you only have so many hours with which to earn. Even if you did nothing but work nonstop each day, eventually — between sleeping, eating, commuting, and (hopefully) showering — you would still run out of potential earning hours in the end.
Investing is mostly passive, and doesn’t require you to trade your hours for each dollar earned the way that earned income does. You can earn investment income in your sleep. You can earn investment income while you chaperone your kids’ field trip. And you can even earn investment income while you’re at your 9-to-5 job.
This helps amplify your wealth-building efforts, so you are earning more without trading your precious hours for those earnings.
Returns are amplified
When you invest, you give your money the opportunity to grow at a significantly higher rate than if it were left in a savings account or stashed between the mattresses. And for every invested dollar that grows, you have essentially “earned” extra money without needing to actually work for it.
Want an example? Take the S&P 500.
The S&P 500 — which is a weighted index of the biggest 500 companies in the US — has a long-term average return of 9.64%. Some years earn more, some earn less, but on average over an extended period of time, you can expect to earn somewhere around 9% on your invested funds… which is about 9% more than if you kept your cash in a coffee can or in a non-interest-bearing account.
In 2019, the S&P 550 return was a whopping 31.49%, much higher than the long-term average. According to the FDIC, though, the national average savings account rate was only 0.09% APY. So if you had put your money in a dedicated savings account, you would have earned less than one-tenth of a percent in interest; if you’d invested it in the S&P 500, you could have earned more than 30%.
Every penny of that 30%+ return would get you closer to your idea of wealth, without you needing to work a single extra minute at your job.
Dividends pay you
Many investments pay out dividends to shareholders (investors) on a regular basis. These dividends — which are essentially a distribution of the company’s recognized profits — are often disbursed annually or quarterly, and put even more “free” money in your pocket.
You can withdraw dividends or you can reinvest them back into your portfolio. The latter allows you to buy even more stock, which can then compound (grow exponentially) and earn you additional dividends in the future.
First steps for building wealth
Before you’re really able to successfully start building wealth, there are a few tasks you’ll need to complete.
Get out of debt
Debt can absolutely wreck your finances, in so many different ways. If you’re trying to build wealth — regardless of how you plan to do so — getting out of debt can be a serious impediment.
Debt is costly. Even if you have a reasonable interest rate, such as on a home mortgage or auto loan, your account is still costing you money each month. Eliminating that debt saves you from additional finances charges and also frees up the funds you needed to dedicate to that payment each month.
Start with the most costly debt
Credit cards are some of the biggest offenders. With interest rates well into the teens (or higher, in some cases!), a credit card balance can easily eat up your budget and cost you thousands each year in interest. If you have high-interest credit card debt, this should be your first priority.
In order to build wealth and commit more of your income to investments, you need to eliminate as much of your debt as possible from the get-go.
Reduce monthly expenses
You’ve probably heard the old adage, a penny saved is a penn earned. Well, when it comes to personal finance — and building wealth through investing — this couldn’t be more true.
The value of cutting down monthly expenses and eliminating excess spending is multi-faceted, and simply cannot be overstated.
The less you spend, the more successful you can be
By spending less each month, you are able to dedicate more of your money toward your financial efforts. This might mean paying off student loans or a home mortgage early, or eliminating credit card debt sooner than expected. If you have extra money to put toward these efforts each month, you’ll reach your goal ahead of time.
The less you spend, the more you’ll save
Paying off debt early can save you years’ worth of interest payments along the way. Every penny you save — that would have gone toward interest — is more money in your pocket and, ideally, in your investment portfolio. Also, the less you need to earmark for monthly expenses or debt repayment, the more you can save and invest.
It’s a fantastic cycle that really only benefits you.
The less you spend, the less you need
Additionally, the lower you can get your monthly spending, the less money you will need to save for your retirement. This means that you may be able to retire early or simply reach your wealth-building goals with a bit less effort.
Make more money
It’s simple: the more money you have, the more you can dedicate to all of your financial goals… including your investments.
Easier said than done in many cases, I know. But if possible, look for any and all ways that you can earn more.
This could involve asking for a raise at work, applying for a promotion, or even changing jobs to snag a more competitive salary. If you’re paid on commission, see what you can do to boost your performance and bring in a higher income.
You can also look into starting a side hustle to earn extra cash each month. That bonus money can be put toward everything from debt-payoff to your kids’ college savings or, of course, your investment portfolio.
How do I build my wealth through investments?
Now, onto the real reason you’re probably reading this article: you want to know how to go about building wealth via investing.
There are a few different strategies out there in terms of wealth-building, each with its own approach and starting point. Almost all of them involve the following nine steps, though, in one order or another.
Step 1: Have a plan
All smart investors take the time to develop a plan of some kind before they jump into their wealth-building strategy.
This doesn’t mean that you need to know every step of your investment journey today, nor does it mean that you should be able to predict your future earnings, market returns, retirement needs, or even the curveballs that life may throw your way. Rather, having a plan means sitting down to determine where you stand today, where you want to wind up, and how you think you can get there.
Depending on your current financial situation and targets, your plan may be very specific or very general in nature.
For instance, retirement planning should be an important part of this step. Get a general idea of what you think you may need in retirement in terms of savings — the closer you are to retirement age, the more specific this target will be. However, even if you’re just starting your career and have many decades to go before you retire, you can still set a general target date and even a rough estimate of savings.
Plan for now, plan for then
Your plan may also involve personal goals and short-term plans. Want to buy a house in the next five years? Sending your high schoolers off to college soon, or intend to turn your home into a real estate investment property? All of these can be factored into your plan for building wealth.
Once you’ve designed your general roadmap, put it somewhere that you can reference it often. Expect that your plans will change as the years go on, too. Whether you get married, have children, declare bankruptcy, win the lottery, fall ill, or even watch your Dogecoin shares hit $10,000.00, you’ll likely need to make adjustments to your plan over time.
Step 2: Make a budget
Next up is your budget.
Building wealth through investments is heavily dependent on how much money you can dedicate to said investments. By designing a healthy budget, and then following it, you’ll ensure that you have the best chance to meet your goals in both the short- and long-term.
A budget can be an excellent financial tool in so many ways. It can keep you from overspending each month, it can help you get out of debt faster (and for less), it can help you pinpoint and eliminate excess spending, and it can help you earmark a specific portion of your earnings for savings.
Budgets should be fluid, too. Revisit your budget monthly to ensure that you’re following your own rules, and see where the plan needs to be tweaked. Utilize certain tools and budgeting platforms if you struggle to track it all, and even automate the process if necessary.
Over time — as your debts are paid off, your needs change, your income shifts, and retirement nears — you can also adjust your budget accordingly.
Step 3: Don’t invest everything
As beneficial as an investment portfolio can be, it still shouldn’t be your only approach.
Don’t forget to keep some cash in liquid savings, whether you put that money in a checking or high-yield savings account, or tuck it away in a certificate of deposit (CD).
Everyone needs a safety net in case of unexpected situations and expenses. If your emergency fund money is locked away in investments, it’s not readily accessible to you. Plus, it may wind up costing you (think lost earnings on a specific stock or penalties from an early withdrawal of a retirement account) to pull that money out if you need it quickly.
Try to set aside at least $1,000 in an easy-to-reach emergency fund. This money can tide you over whether you need a new windshield, the water heater bursts, or your kiddo breaks a tooth.
You may also want to save a few months’ worth of expenses in a liquid (but still interest-bearing) account. How much you save is up to you (though many experts recommend three to six months’ worth), but this money can support you in case you were to fall ill, get injured, or lose your job unexpectedly.
The rest, you can invest.
Step 4: Learn and strategize
I don’t care if you’ve been managing your own finances for decades or are a seasoned investor; there’s always something more that you can learn and apply to your own wealth-building strategy.
Always aim to educate yourself about investing, whether it’s by watching the market, analyzing your own investment performance, joining online forums, reading personal finance blogs (like this one!), or talking to a friend who is more knowledgeable. Then put those lessons into practice and watch how they affect your portfolio and overall net worth.
Pros can be worth their weight in gold
Speak with an advisor or financial planner to get advice about your specific situation, and how you can best strategize with what you have and where you want to go.
These professionals will likely have ideas for you and your savings that you hadn’t yet considered. They will also help ensure that you are remembering key aspects of your financial planning, such as taxes, potential penalties, and even specific costs in retirement.
Ideally, you’ll want to find a fiduciary, or a financial professional who is legally and ethically obligated to put your financial interests first. This is an important one, as some individuals could direct you into certain investments not because they’re the best option for you, but because they make money off of the referral.
Step 5: Determine your risk tolerance
Thanks to Reddit forums and investment apps, there are many new investors out there with dreams of quick (and aggressive) return. For most of us, though, investing is a longer-term strategy.
Before you ever begin investing, you’ll want to first determine your risk tolerance. This is a gauge of how much variability you’re willing to accept (and withstand) as an investor, and how it relates to your financial planning.
For instance, if you are in your early 20s, you can probably stand to ride out some serious market volatility before you ever need to touch your investment savings. With a higher risk tolerance, you can afford to invest in more volatile stocks, which have higher potential earnings; even if the market bottoms out, there’s a high likelihood that you will earn your investment back (and then some) long before you ever need to use that money.
If you’re in your late 50s and plan to retire at 62, though, your risk tolerance is much lower. Rather than invest in volatile stocks, which could potentially lose value and not recover in time for you to retire, you may prefer to invest mostly in “safer” options, like bonds.
Technology to the rescue
Not sure where to even start when it comes to determining your risk tolerance? Let the many investment platforms and roboadvisors help.
These platforms offer a variety of risk tolerance and rebalancing tools. Depending on your financial targets, they can help you decide how aggressively you want to invest, and when to pull back in order to safely retire.
As you creep closer to retirement age, you’ll want to adjust your risk tolerance accordingly.
Step 6: Create streams
You may have heard that millionaires have an average of seven different income streams. While this may not be exactly true for every successful investor, it is true that spreading out your wealth-building efforts can be an excellent way to hedge losses and capitalize on market growth.
For most people, the income from their everyday job is their primary income stream. If you have a spouse’s income and/or side hustle income, this will probably make up the bulk of your incoming funds.
One additional income stream could involve compound interest, such as the money that your emergency fund’s savings account earns. This money probably won’t be enough to get rich on, but every penny of compound interest is a penny you didn’t have to actively earn.
Then there is investment income, such as the dividends earned on certain stocks. Whether you withdraw this money when it’s distributed or put it to work by reinvesting it, this is an added form of income that you don’t have to do much to actually earn.
Another stream may include your retirement accounts, such as a 401(k) and/or traditional or Roth IRA. The returns on these accounts won’t necessarily make you a millionaire on their own, but the tax advantages and workplace benefits (such as an employer match on your 401(k)) can be invaluable to keeping more of your money in your own pocket each year.
Then, consider the other income streams you can create. Real estate investing is a popular one among everyday investors and millionaires alike. You can turn your home into a rental property, purchase seasonal homes that you then rent out, invest in commercial real estate, or even add a REIT (real estate investment trust) to your portfolio.
By diversifying your investments, you improve your chances for success.
Step 7: Automate what you can
If you’re feeling overwhelmed by the idea of building wealth through investments, don’t worry: much of this can (and should!) be automated once you have a general road map in place.
You can automate your investment accounts in a few ways. These include:
- Setting up automated contributions to retirement accounts, either through an investment platform or your employer
- Automating purchase orders for specific mutual fund or stock shares through an investment app or advisor platform
- Scheduling automatic savings account transfers each month
- Opting in for automatic portfolio rebalancing through your roboadvisor
There is only so much time that you have to dedicate to your wealth-building efforts, in addition to earning income and, well, enjoying your life. By automating as much of this as possible, you not only ensure that it gets done each month, but you free yourself up in the process.
Step 8: Spread out your efforts
While it can be fun to invest a large lump sum of cash, it’s usually a smarter move to spread your efforts out in smaller increments. In other words, don’t save up all year long with plans to invest everything all at once.
Rather, add to your investment portfolio on a regular basis as soon as the funds are available, such as making small weekly contributions or boosting your account once a month when you get paid. At the end of the year, you’ll still be investing the same amount whether you contribute $1,200 in December or $100 a month throughout the year.
This serves three purposes.
One, it’s easier to budget for your investment contributions if they are made steadily and in smaller increments. You can also keep yourself on track, versus needing to stash savings away until the time is right (and potentially tempting yourself to spend the money).
The second reason is timing.
If you had a crystal ball, you would be able to see what the market will do in the days, weeks, and months to come. You could then time your investments accordingly, buying when they’re at their lowest prices and ensuring that you get rich quick.
Without that crystal ball, though, each investment you make is at the mercy of market volatility. By spreading your contributions out over smaller, regular intervals, you also spread out your risk. This practice, also called dollar-cost averaging, reduces the chance that you’ll be buying investments at their height price, and lowers the average cost paid.
The third reason is that your money can simply start working for you sooner if you invest it earlier. If you’re putting savings in an interest-bearing account, for instance, each dollar will start earning the moment it’s deposited.
Step 9: Keep revisiting your investments
What’s your definition of wealth? Is it being a millionaire? Is it being financially independent or being able to retire early? Maybe you simply want to enjoy your retirement without running out of money.
Whatever your definition, the process to build wealth is an active one that, honestly, takes some time.
You should plan for the long game when it comes to investment-based wealth-building. Sure, you could get lucky by picking the right stock or coming into a financial windfall. For the majority of people, though, wealth is grown over many, many years of patience and dedication.
It’s important that you continue to watch your progress throughout those years. Building wealth is not a “set it and forget it” experience — as convenient as that would be — but rather one that requires your attention, your frequent updating, and your general oversight.
In some cases, you may find that you need to change your approach as the years go on.
As dividends are paid out and investments perform, for instance, you’ll often find that you need to rebalance your portfolio so that your asset allocation is not skewed. A roboadvisor platform can be valuable in this respect, but you may still need (or want) to keep an eye on the changes.
If your retirement plan shifts, your income goes up or down, or if your budget changes, you should revisit your investment strategy. You might need to invest more or increase your risk tolerance in order to meet your goals, or perhaps you may find that you will reach that target sooner than expected. (Can you say early retirement?!)
Your strategy may also change if and when you have other expenses and sayings to consider. For example, if you have children, you’ll probably want to devote a portion of your income to college savings accounts and even a life insurance policy. If your spouse or parent develops a long-term disability, that can affect both your short-term finances and your long-term targets, as well.
Let’s be honest: most people would love to build wealth over the course of their lifetime. Not only could this benefit their retirement planning, but also make life a bit more comfortable, open the door to fun experiences, and even leave a little behind for the kids one day.
The reality is, though, that building said wealth is a process that takes many years and a dedicated effort. (It might even involve a little luck.)
Luckily, there are a few great ways that you can build wealth for yourself and your family, regardless of what your definition of wealth may be. These include saving and investing as much as possible, diversifying your portfolio with the use of things like real estate, and revisiting your investments’ performance regularly.
No, you probably won’t build wealth with investments overnight, or even over the course of a couple years. If you stick to a clear strategy, though, you’re likely to find that wealth-building is in your reach, no matter how much you earn today or how much you have saved.