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Building wealth can take time, dedication and a fair amount of good fortune. Different people, however, may have different definitions of wealth.
For some, it may mean having enough money to cover the monthly bills without stress, or becoming financially independent so they can stop working. Or, you may have a more luxurious image in your head, complete with high-end hotels, designer goods and first-class flights. In every case, there are a few initial steps you'll need to take on your path to building wealth.
Learn to Live Within Your Means
High income doesn't necessarily lead to wealth. Perhaps you've seen news stories about celebrities or athletes who made millions and then declared bankruptcy. Or, conversely, the teacher or janitor who slowly amassed a fortune and gave millions to charity at the end of their life.
No matter your income, spending less than you earn and putting the difference into savings is a tried-and-true way to increase your net worth over time. Otherwise, you could wind up living paycheck to paycheck even if you're making millions.
If saving is your goal, it's important to create and follow a budget. There are many ways to make a budget, and different types of budgets and budgeting software. Aggressive savers may consider the 50-30-20 plan that limits spending in certain categories (50% of your budget goes to required expenses, 30% to buying "wants" and the remaining 20% goes to managing debt or saving).
As with any new skill or practice, it can take time to get into the swing of things. Try out a few systems and tools to figure out which one you like the most.
Find Ways to Save Money
Learning and practicing money-saving habits can make it easier to live within your means. These can come in many forms, from looking for sales and coupons to using cash back credit cards on purchases you were going to make anyway.
You can also look for ways to lower your monthly payments, such as negotiating lower rates on internet and cable services, comparison shopping insurance policies and making lifestyle changes to use less energy at home.
Once you've built up your savings, it's easier to find additional opportunities—such as paying for high-quality goods rather than inexpensive ones that you need to replace frequently. Or, getting a discount on a membership or bill by offering to pay the full amount upfront.
Pay Down Any Existing Debt Quickly
If you're saving and investing, compound interest can help your money grow exponentially. But when you owe others money, the math works against you—the longer you take to pay off debt, the more interest you'll wind up paying overall.
With this in mind, consider some of the tactics you could use to more quickly get out of debt:
- Try the avalanche or snowball debt repayment strategies to either pay as little interest as possible or stay motivated while paying off debts.
- Consider a balance transfer credit card that allows you to transfer other debts and pay off the balance during the promotional period (often 12 to 21 months) without paying any interest.
- A debt consolidation loan could also help lower your costs as you combine high interest debts into the new, lower rate loan.
- Look for ways to increase your income, and put the extra money toward your highest-rate debt.
Even with the best tactics in play, paying off all your debts can take time. Patience and perseverance are often the keys to success.
Use Credit Wisely
Building your credit and using credit wisely can also be important. Having excellent credit can make it easier to access different types of financial products, and help you qualify for the best rates and terms on a new loan or credit card.
An example of using your good credit to build wealth could be when you've saved up money to buy a new car with cash, but you also qualify for an introductory 0% financing offer on an auto loan.
You could take the 0% financing offer and put your savings into a low-risk investment, such as a certificate of deposit. Then, you can collect interest on your investment, knowing that you can pay off the loan before the 0% rate ends.
However, whether your credit is poor, excellent or nonexistent, you still want to be careful when taking on new debt. Avoid taking out loans for wants rather than needs, and always pay your credit card and loan bills in full each and on time month.
Don't Be Afraid to Invest Early
Figuring out whether to pay down debts or save and invest can be an ongoing challenge.
In short, if you're making long-term investments in index funds (such as retirement savings that you don't expect to touch for 20 to 30 years), you might expect an approximate 8% to 10% annual return on your investments. Focus on paying down debts that have a higher interest rate first, then investing and then paying off low rate debts.
Starting to invest early can be especially important, as you have years of potential growth ahead of you. For example, if you invest $100 a month and earn an average of 8% each year, you'll have nearly $55,000 after 20 years—and almost $136,000 after 30 years.
Consider Buying a House
Homeownership isn't right for everyone, but buying a home could be a potential path toward building wealth. If you choose to pursue it, there are first-time homebuyer programs available that can make buying your first home easier.
While you'll need to pay for maintenance, repairs, insurance and property taxes, you may also be able to deduct some of your mortgage interest and property tax payments from your income and save money come tax time. You'll also be building equity (ownership) in your home when you pay monthly mortgage payment, rather than paying a landlord.
The big benefit comes when you sell your home after it increases in value. As long as the home was your primary residence for two out of the past five years, you won't have to pay federal income taxes on your first $250,000 of profit (or $500,000 if you're married and file a joint tax return). The exclusion applies to every home you sell, not just your first one.
Focus on Your Goals for Building Wealth
If you want to build wealth, consider starting by defining what wealth means for you and writing down your personal goals. If you compare yourself to the wealthiest members of society, you might be compelled to spend money to keep up with others but never feel satisfied. Focusing on your personal goals could be the key to building wealth, feeling content and avoiding lifestyle inflation.