Building wealth is simple but not easy. However, the modern financial system is rigged against the middle class. It is almost impossible for the average middle class American to build any significant wealth without paying attention to these 3 principles.
Generally speaking, in order to build wealth, we need time for our investments to grow. Hence the power of compound interest is in time. With all the competing interests for our income which includes taxes, housing, transportation, food, lifestyle, insurance etc., it is very tough for the average family to save enough money to accumulate wealth without finding a way to trick your money into working for you. These 3 principles are critical to wealth building.
3 Bedrock Principles of Building Wealth
- Retirement Account Contribution: As mentioned earlier, time is a critical ingredient in wealth building. Contributing to a retirement account, be it you company sponsored 401(K) or personal Individual Retirement Account (IRA) or any other plans is essential. You should strive to contribute the maximum allowable limit every year. We recently conducted an analysis that a typical 40 year old American that started working at the age of 23, would have approximately $650,000 to $850,000 in their retirement account at the age of 40 if they consistently contributed the maximum allowable limit to their retirement account.
- Home Ownership: Home ownership is an undeniable bedrock principle of building wealth. No matter what, most of us will have to pay for housing in one form or the other. Buy a modest home that is in line with your income and let the compounding appreciation work for you. In addition to the appreciation, there is also equity paydown, i.e. part of your mortgage goes to reduce the debt. Just like the retirement account, homeownership gives time to compound which can greatly increase wealth. There are other numerous advantages of homeownership that leads to wealth building.
- Debt elimination: Compound interest is either working for you or against you and the longer it compounds the greater its effect on your finances. Debt is compound interest working in reverse (against you). The longer you are in debt, the more severe compound interest is working against you. Paying off your debts aggressively in every situation is a bedrock to wealth building. Using debt to finance assets and investments and paying them off aggressively is crucial in wealth building. As much as possible, we should avoid using debt to finance liabilities and lifestyle needs, just use it for assets and investments. A good rule of thumb is to limit your personal debts to just two accounts (assets and investments only) at a time and continuously strive to aggressively pay them off.
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