The Basic Building Blocks of Wealth
How to build wealth and how to keep it.
What does it take to build wealth? Everyone can theoretically build wealth, but for many reasons, not everyone does. Building wealth is hard. It requires resources, knowledge, time and other elements that all need to align properly. It’s quite easy to start building wealth and see it all evaporate because of a poor decision or factors outside your control.
But the basic building blocks aren’t that complicated. This list isn’t meant to be comprehensive, but I hope it’s close. Here are a few things you need if you want to build and preserve wealth:
1. Income
You need startup capital at a minimum, if not an ongoing stream of income to build wealth. The most common way the average person does this is by earning money and investing some of their income, usually through a 401(k), Roth IRA or other tax-advantaged account. Some people build wealth by starting a business. Developing the business generates profits and equity in the company that can be sold to investors. But if you’re looking to build wealth through the stock market or real estate, you need a continuous stream of income.
2. Achievable Goals
Before you start building wealth, you need to know what you’re building wealth for and ideally, what enough looks like to you. Let’s say you want to build enough wealth to live off your portfolio and retire. That’s the most common reason the average person in the middle class builds wealth. You can figure out how much income you need a year and using some kind of rule like the 4% rule, decide what amount you need to accumulate.
3. Knowledge
You need to know how to invest. The most reliable way to build wealth is through index funds or some sort of systematic approach. The basic points are:
Diversify — this means home country and international markets
Keep your fees low — index funds already accomplish this
Don’t tinker with your investments — stick to your plan for the long term
Don’t try to time the market — invest when you have money to invest
Building wealth requires a mostly stock portfolio. Ideally, if you’re young enough, you avoid bonds entirely until you get closer to the time you’re ready to begin withdrawals. Risk is not optional. Avoid risk by keeping your money in cash and you won’t beat inflation. Hold too much in bonds and you might not make your goal on the timeline you’ve set.
4. Time
Building wealth takes time. I don’t care if you heard that someone earned a fortune because they bought Bitcoin a decade ago. This approach is not replicable, so don’t try. Accumulating $1 million in a portfolio can take decades unless you earn a high salary and save most of your income. But the thing about compounding is that each subsequent million takes less and less time. If you expect a 7% return, your money is doubling every decade. Once you hit a million, it will only take 10 years to hit $2 million, and then 5 years to hit $3 million.
Starting early gives you a serious advantage. If you start late it’s still possible to reach your goal but you’ll have to invest way more money than you would have otherwise. If you’re still young, take every opportunity you can to put money into your 401(k), Roth IRA or brokerage account. It’s hard to make up for lost time.
5. Discipline
All that waiting, working in a job you may or may not like and slowly putting money into your portfolio can feel like a slog. But taking shortcuts isn’t going to do you any favors. Discipline and patience will pay off, but that doesn’t mean it’s easy. Here are some things to keep in mind:
Stick to your asset allocation: Again, don’t tinker with your investments. Create a reasonable portfolio for your goals and risk tolerance and then stick with it.
Don’t panic sell: When the market turmoil hits and the future looks uncertain, remember that this isn’t the first time. Ride out market volatility, consider it a buying opportunity and remember you’re doing this for the long term.
6. Insurance
Wealth can be easily wiped out by an accident, a job loss, a medical event or anything unexpected that costs a lot of money. To protect against these events, you need the right insurance protection to keep you from tapping into your wealth prematurely. An emergency fund to cover your basic needs also helps.
7. Reduce Taxes
Taxes can be a significant drag on your investment returns. The good news is there are so many ways to reduce or eliminate the taxes you pay.
For high earners, pre-tax accounts will be most advantageous. If you’re in a lower tax bracket, Roth accounts are best. Taxable brokerage accounts are often overlooked, but they too come with tax benefits if you hold your investments for at least a year, choose the right funds that have minimal tax consequences and know how your overall income affects what you pay.
8. Avoid Debt
Debt is a wealth killer. You’re either making debt payments that reduce your ability to invest or you’re earning a 7% return while getting hit with a 30% interest rate on a credit card. It’s important to start investing early, but if you have serious debt with high interest rates, you might consider putting all your disposable income toward debt payments before investing.
Why Building Wealth is Hard
Building wealth is simple, but it’s still hard. First, you need enough income after basic living costs to put into investments. But you also need basic knowledge about how to invest and the fortitude to stick with your investments for decades, riding out all the inevitable periods of market uncertainty, personal financial shocks and temptations to take shortcuts.
It’s still worth it to put in the effort. And it will get easier as the years go by and your money is growing faster and faster. At a certain point, your money will be growing by more each year than you’re able to invest.
Wealth can protect you from financial ruin, allow you to live the life you want in retirement and much more. Setting your sights on a realistic goal and knowing how to pursue it is one of the more critical aspects of financial planning. It’s well within your ability if you have all the right elements together.