Building Personal Wealth

Table of Contents

How Do I Get Started
Wealth Accumulation Steps
Asset Allocation and Diversification
Other Wealth Building Tips
Expense Minimization
Minimizing Taxes
Building Wealth through Job Hopping
Homework and a Test
Required TV for Building Wealth

How Do I Get Started

We have all heard the old cliché, "You gotta have money to make money". In this section, we provide tips and tricks on how to start the process of building up wealth by saving and investing. Later sections under Investment Strategies will discuss other more advanced techniques and tips for increasing your wealth. This section is more geared toward getting started. In addition, this section assumes that beginner investors will initially confine their investments to mutual funds and money markets, as opposed to individual stocks.

The basic technique we will discuss here for building wealth is called "Dollar Cost Averaging". Simply put, this technique assumes that money is allocated for investments on a rigid periodic schedule (i.e. monthly). Assuming we are investing in equities (i.e. mutual funds, stocks), by purchasing investments every month, probability theory  shows us that we get a freebie. In addition to steadily accumulating wealth through saving on a periodic basis, on average, we will  purchase investments more often when they are low in price, thereby, making our investments worth more in the long run (assuming our equities exhibit a long term growth trend).

Wealth Accumulation Steps

Lets now simply describe the steps of how to easily accumulate wealth:

STEP 1)    Minimize your current debt.

****** INCOMPLETE ***********

Step 2)    Maximize your monthly contribution into your companies 401k plan or equivalent.

Since the money you contribute to your companies 401K plan reduces your taxable income, you automatically save money every month on taxes (i.e. you could save maybe 15% to 33% or more on taxes for the money you contribute). Since many companies match a portion of your contribution (i.e. say the company matches 65% of the first 6% you contribute), you also may get some FREE tax free money. In addition, any profit you make on this invested money is tax free also. Assuming that what you are investing in your 401k (i.e. mutual funds, money markets, your companies stock) grows an average 5% annually, its not unreasonable to assume that your effective yield could be 40-50%. WOW !!! Where else are you going to find an investment that good every month ?

In company 401K plans, your investment options are usually limited to money markets, mutual funds, and perhaps, your companies stock. If you have the option, in general, it may be best to confine your 401K investments initially to guaranteed money markets and mutual funds. If you are forced to invest all or a portion of your contributions into your companies stock, then that is what you must do. In general, do not purchase your companies stock unless you are knowledgeable enough to know that the fundamentals of your company indicate that it may be a good investment. You work there, so you have an excellent opportunity to learn if your companies stock is a good investment option. This topic will be covered much later in Individual Stock Investing.

STEP 3)    Put your maximum allowable annual contribution into your Individual Retirement Account (IRA)

This will require that you open an IRA brokerage account (i.e. Charles Schwab, Fidelity, Ameritrade, etc.). Generally, each person is allowed a maximum $2000 contribution into their IRA. Since you have already paid tax on this money, it makes good sense to have a ROTH IRA account (see your local IRA account representative for a determination of the best type of IRA for you). Once in an IRA, any profits you make grow tax free.

In an IRA, your investment options are not limited (as they are in your company 401K plan). You have literally thousands of mutual funds, bonds, and stocks to choose from, as well as a number of money markets. Again, initially confine your IRA contributions to guaranteed money markets until you are knowledgeable enough to know what mutual funds and individual stocks to invest in. Picking your first mutual fund will be covered much later in Mutual Fund Investing.

STEP 4)    Save up $2000-$2500 and a minimum of $200-$250/month to purchase and dollar cost average into a mutual fund.

This will require that you open a standard brokerage account (i.e. Charles Schwab, Fidelity, Ameritrade, etc.). Most mutual funds have a minimum initial purchase limit about of $2000-$2500, and a minimum monthly deposit of about $200-$250. Have the monthly deposit automatically deducted from your checking account, so it makes it hard to cheat yourself.

Note that profits (i.e. profits from the sale of an equity, interest, and dividends) in your standard brokerage account are taxable income.

In a standard brokerage account, your investment options are not limited (as they are in your company 401K plan). You have literally thousands of mutual funds, bonds, and stocks to choose from, as well as a number of money markets. Again, initially confine your standard brokerage account contributions to guaranteed money markets until you are knowledgeable enough to know what mutual funds, bonds and individual stocks to invest in. Picking your first mutual fund will be covered much later in Mutual Fund Investing.

STEP 5)    Repeat Step 4 as many times as your budget will allow.

You probably have a question: "How do I know what to invest in ?". Hopefully, this will become clearer as you progress through the sections under Investment Strategies.

If your financial condition will not allow you to at least make it through steps 1 through 4, then go back to the Retirement Planning section for help on taking control of your financial future.

STEP 6)    Track your investments

You will receive statements (usually monthly or quarterly) for all of your investments. There are two things you must keep track of: 1) The total worth of all of your investments; 2) The total of all of your contributions.

Armed with this information, keep a running total of your percent profit. Compare your percent profit to that of the S&P 500 index. If your percent gain beats the S&P 500 index, you are performing better than roughly 75% of all professional mutual fund managers. More on this topic in the next section, Understanding Equity Markets.

Asset Allocation and Diversification

Asset Allocation is defined as the appropriate mix of various types of assets (i.e. large, mid, and small cap stocks, international stocks, fixed income securities, bonds, municipal bonds, and cash) required to meet your individual investment needs. Determining the asset allocation that is best for you is a crucial part of the wealth building process. Your asset allocation is a function of your age, retirement timeframe, risk tolerance, tax bracket, portfolio size, retirement income requirements, etc.

In general, the majority of asset allocation experts contend:
 

• If you are young, have a high risk tolerance, and all or most of your savings are predominately for retirement, then you may want to assume a higher level of risk via an asset allocation of mostly stocks, with a very small percentage of bonds and cash.
• If you are middle aged, with a moderate risk tolerance, with a retirement timeframe of say 10-20 years, then you may want to have a smaller percentage of stocks and a higher percent of bonds and cash.
• If you are currently in or close to retirement, with a low risk tolerance, then you may be more comfortable with a smaller percentage of stocks, and higher percentages of bonds, fixed income securities, and cash.
• If you require all or part of your savings for a near term expenditure, then that money should be allocated in investments with the least amount of risk such as fixed income securities, money markets, or short term government bonds.

The Quicken Financial Planner from Intuit also provides an asset allocator which adjusts itself based on the projected rate of return (risk) you specify for your investments.

Fidelity Investments provides an asset allocation planner on their web site. SmartMoney.com also provides an interactive asset allocator at their web site, as well as an asset allocator provided by The Glenmede Trust Company.

Diversification is a form of asset allocation within a particular class of investment. For instance, if the asset allocation you select says that you should have 85% of your savings in stocks, does this mean you should have only one stock ? Or three US oil stocks ? Or five small cap stocks ? Or one growth mutual fund ? Or one balanced mutual fund ? Or three sector mutual funds ? Or two global growth mutual funds?

Diversification implies that your investments are spread across many diverse sectors and markets around the globe. Your asset allocation should be detailed enough so that it specifies what your percentage of large to small cap stocks , international stocks, corporate and government bonds you should have.

Mutual funds can provide some degree of diversification, but there are many types of funds comprised of large to small cap stocks, bonds, precious metals, real estate, fixed income securities....you name it and there is probably a fund out there that does it. The investor must be sure that a mutual fund (or better yet, several different funds) meet his or her selected asset allocation. More on this later in Understanding Equity Markets and Mutual Fund Investing.

Likewise with stocks, there are as many different types of stocks as there are publicaly traded companies. If your asset allocation says you should be invested 70% in US large cap stocks, then you should invest in a number of different stocks in different business sectors (i.e. retail, drugs, high tech, manufacturing, oil, etc) (at least 5 different stocks, or more if you can keep track of more companies). More on this later in Understanding Equity Markets and Individual Stock Investing.

In closing, as your portfolio grows, some investments at various times will grow faster than others. Therefore, you must periodically rebalance your portfolio to make sure that your asset allocation among these investments follows your asset allocation plan.
 
 

Other Wealth Building Tips

Expense Minimization

Obviously, keeping your family expenses under tight control can provide you with more income to invest. These topics were addressed in a previous section, Retirement Planning.

Minimizing Taxes

If you buy a stock or mutual fund, and its price drops, and you don't sell it, you have simply incurred a "paper loss". If you buy a stock or fund in a taxable account, it goes up, and you sell it, then you will be required to pay Capital Gains tax on your profit (e.g. 28% or your federal income tax rate). Money that you pay out in Capital Gains taxes is truly gone from your portfolio (as opposed to just being a paper loss). Therefore, the decision to sell an asset should always incorporate an analysis of the Capital Gains tax consequences of the sale. (Note that this does not apply to 401K plans and IRAs). Likewise, selling a stock or mutual fund at a loss in a taxable account could actually reduce your capital gain taxes. Be sure to review the current regulations on Capital Gain taxes.

If you withdraw money out of your IRA before you reach the appropriate eligible age (i.e. 59 1/2), you will incur a significant tax penalty. So don't put money in these plans that you will need in the short term.
(Note, there are still ways to get money out of an IRA before the eligible age called Equal Distributions. Be sure to investigate the current regulations on IRA distributions that are applicable to you).

In an effort to build your wealth, you obviously want to minimize ALL of your taxes. Regarding another type of tax, state income tax rates vary from state to state. Some states have NO state income tax (e.g. Florida, Wyoming, etc.). Choosing to live in a state that has lower or no state income tax can have a significant impact on your wealth building. For example, if you live in a state with a 5% tax, and you relocate to a state with no tax, you will be saving an additional 5% for the rest of your life. This adds up over time !

Building Wealth through Job Hopping

This trick requires a bit of soul searching, because it obviously comes with inherent risks. You are required to evaluate your own risks in changing jobs.

Many people get a job and remain in it until they retire. Generally, there is a comfort zone effect at play here in some cases. If your job related experience is highly sought after in the marketplace, then you should assess how you are paid in your current job relative to what the job market may be paying other individuals with comparable experience. In addition, compare your benefits (like 401K benefits) between your current company and other appropriate companies that may want to hire you. Also, you must evaluate if that company you have been working at for years may one day reward you with something called a pension, as well as free medical benefits for life. Note that there is a new trend in Corporate America away from these benefits in the not to distant future. If you think you may be one of the lucky few to recieve these gifts, then simply project and incorporate them into your financial planning software and play the appropriate "what if" games (this topic was described previously in the Retirement Planning section).

As mentioned previously, investment options in your 401K plan are limited. If you were to quit your current job, then you would have the option to do a rollover of your 401K into your own IRA account where your investment options are no longer limited. As you become a savvy investor, this could prove to greatly enhance your profit and your wealth. So theoretically, you could hop to a higher paying job (which would obviously increase your wealth building potential), and have all of your previous 401K money in a self managed IRA, (where your investment options are greatly expanded), and possibly have a better 401K plan in your new job. It is most likely more beneficial to do this after you are vested in your old job, so that you have all of your company match in your old 401K. Then, make sure you maximize your contributions in your new companies 401K plan. Evaluate this as an option for yourself.

As stated in the beginning, this is tricky and involves lots of analysis, but for many, it could greatly enhance your wealth building potential. Good luck !

OK Class, Its Time For Homework and a Test

Many of you may have heard of one of the all time great investment managers Peter Lynch. Peter Lynch ran Fidelity's Magellan mutual fund several years ago.

At a Fidelity web site, Peter Lynch provides an introductory class on investing called "Peter Lynch on Investing: Key Things Every Investor Should Know". There is also a class called "Investing in Volatile Markets". This is followed by a test designed to help you get started learning about investing. Your assignment is to thoroughly review all of this material, and then take "The Invest Test".

When you have completed this assignment, review the next section below, then proceed to Understanding Equity Markets. Enjoy !

Required TV for Building Wealth

So now, its friday night. By this time, you are so entrenched into building wealth, that you could not possibly go "out on the town" and waste your hard earned dollars on mere entertainment of the flesh. You long for a true financial entertainment. Well, we have that all figured out for you. Its time for:

Don't miss it, every friday night on PBS. Louis will cut through the hype and give you the true story of what happenned during the week on Wall $treet.  If you are really serious about building wealth, this will be your friday night entertainment. "You Betcha !".

For your morning and afternoon entertainment, be sure to tune into CNBC. 
It airs weekdays on your local cable channel.
For your evening entertainment, don't miss The Nightly Business Report. 
It airs weeknights on PBS.