The abundance of online articles promising tips on how to become wealthy leads the public to believe there’s some secret to the process.
I’m talking about investing. It won’t make you rich overnight, but if you do it right, it can get you there eventually.
Here’s a look at how much you could potentially earn and some tips to get you started.
How investing grows your wealth
When you invest, you’re purchasing an asset — a stock, bond, or mutual fund, for example — at whatever its share price is at the time. This price will vary over the years, but if you’ve made a smart investment, it should rise over the long run. When you sell the asset, you’ll get whatever the new share price is.
It’s difficult to predict how much your investments will grow, particularly for stocks, because their prices can fluctuate or even drop temporarily before rising again. Over the long term, the stock market has averaged about 10% annually, though the return for a given year could be higher or lower. In any case, it’s much higher than the average savings account interest rate, which currently sits at 0.09%.
To illustrate the effect that investing can have on your savings, consider $1,000 invested in a savings account with a 0.09% annual percentage yield (APY) compounded monthly and $1,000 invested in the stock market that earned a 10% annual rate of return. Here’s how much you would have after different amounts of time:
Source: U.S. Securities and Exchange Commission Compound Interest Calculator. All figures are rounded to the nearest dollar.
This example isn’t perfect. It assumes that you’ll earn a perfect 10% annual rate of return every year and that savings account interest rates will never rise over 0.09%. But it illustrates how much more quickly investing can grow your wealth compared to saving.
How to start investing
You’re already investing if you’ve ever put money into a retirement account. This is one of the best places to begin, because money you put into these accounts gives you tax breaks, either in retirement or in the year you make the contribution, depending on the type of account. But you’re limited in how much you can put into retirement accounts each year. You may only contribute up to $19,000 to a 401(k) in 2019 or $25,000 if you’re 50 or older. These limits will rise to $19,500 and $26,000 in 2020. You can also stash up to $6,000 in an IRA or $7,000 if you’re 50 or older. These limits are the same for 2019 and 2020.
Those looking to invest more than this and those who’d like to be able to access their money before 59 1/2 without penalty should consider opening a taxable brokerage account.
Contributions to these accounts don’t give you the same tax breaks as contributions to retirement accounts, but if you hold your investments for longer than one year, they become subject to capital gains tax, not income tax. Long-term capital gains tax brackets are lower than income tax brackets for the same level of income, so this can save you money.
As for what to invest in, that’s up to you. You’re better off sticking to companies and industries that you know because you’ll have an easier time picking out the good investments. Whatever you choose, make sure you stay diversified among many different investments so that your portfolio doesn’t take too much of a hit if one of your assets performs poorly.
Index funds are a great place for beginners to start because they offer instant diversification, low fees, and historically good returns. These are mutual funds — bundles of stocks and bonds — that passively track a market index, like the S&P 500. When the assets within the index do well, you do too.
You might need to make some changes to your budget in order to free up cash for investing. Try cutting back on discretionary purchases and removing any unused subscriptions or other unnecessary expenses from your budget. If you already have savings, you can use some of this to get started, but don’t invest all of your money. Leave some for your emergency fund and any planned major expenses within the next three to five years in your savings account.
You don’t need to make a lot of money to become wealthy. You just need to know how to most effectively use what you already have. Investing is one of your best options for growing your wealth, no matter your age or background, so give it a try if you’re not doing it already.
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Source: The Motley Fool