I would like to just give a few more helpful tips on how to build your wealth. Yesterday we saw that paying yourself first is an important key to wealth building. What is the best way to pay yourself first? Don’t leave it to chance. Put it on autopilot and watch your nest egg soar!
In my own case, I have set up auto deposits every month from my checking to my brokerage account. Perhaps your employer offers a 401k plan (or something similiar outside the US. A 401k is a retirement account.) Sign up and have your contribution automaticly deducted from your pay. The key point is regardless of your situation, determine how much you can save each month and put it on autopilot. You won’t forget or put it off till later in the month when the money just isn’t there. Think of it as your savings tax. The money available for you to spend comes after it has been paid.
The next big question is where to put the money. The stock market can be a very scary place. Just in the last 30 years we have seen the crash of 87, the asian financial crisis followed by the collapse of Long Term Capital Management, the dot come bubble, the Enron and accounting scandal, 911 and the housing bubble. And yet even with all the volatility, the S&P 500 still delivered over 8% annual returns with dividends reinvested.
What about bonds? The attraction of high quality corporate or US treasury bonds is if held to maturity, you will receive whatever interest the bond pays and all your principal back. However bonds are far from being risk free. Bond prices move inversely to interest rates. When rates go down, bond prices go up. When rates go up, bond prices go down. In the current environment, rates are near historic lows and beginning to move higher. The average rate on the 10 year treasury has been 4.9% since 1900. The current rate is 2.57%. Investing in longer term bonds is just not appealing at the moment. You are getting a meager return while risking a big drop in bond prices if rates increase.
That leaves us with CDS and money market funds. The average money market fund is paying roughly .5% while 1 year CDs are paying .8-1%.
So where should we put our money? If you are just starting, an old fashioned savings account will work until you have the minimum that most investments require. If you have at least $1000 and your horizon is 10 years or more, stocks are the place to be. Most mutual funds are unable to match the returns on the S&P 500 over the long haul. There are Index funds that match the S&P 500 and generally outperform over 50% of mutual funds on a year to year basis. Over a longer period, the gap rises even higher. After 10 years, they beat the return of over 70% of actively managed funds. An Index fund offers you diversification and a historical return of 8% over the past 30 years. And since you will be adding to your savings month to month, it will smooth out your average cost over time. There will be bumps and wild rides along the way but over the long haul index funds give the average investor the best bang for their buck. No homework to do. No poring over earnings reports and balance sheets. You set up an index fund, put your monthly contributions on autopilot and you’ve set up a nest egg that will grow over time. The only thing needed is increasing the amount of your monthly contributions as you are able.
Remember the first key to wealth building is to start as soon as possible, so set up your auto pilot savings program right away. Years from now, you will see it as one of the wisest things you’ve ever done.