I’m not an advocate of “get rich quick” ideas. There are tons of guru’s who will promise to teach you “their way” to get rich quick. It may work for some but to me, the best way to build wealth and keep wealth is a slow, boring process that requires discipline through good times and bad.
Take advantage your 401(k)
If you are fortunate enough to have access to an employer-sponsored 401(k) and you either have not enrolled in the program or are not contributing enough to get the full employer match, stop reading this article and go deal with that. You are literally turning down FREE MONEY.
A 401(k) is a kind of defined contribution pension. You deposit money into the account and your employer will match the money you deposit up to a certain limit. Usually 5% of your salary. Another critical thing to understand about your 401(k) is that you must choose how to invest the money in the plan.
If you make $100,000 per year and you contribute $5,000 into your 401(k), your employer will also deposit $5,000 on your behalf. You just doubled your money by literally doing nothing.
This employer match makes an incredible difference over the course of your career. The difference between investing $5,000 per year and $10,000 per year amounts to over $500,000 over a 30 year period. Over a 40 year period, the difference is $1,000,000.
The simple, boring way to become a millionaire
- Find a job making $50,000 per year and access to a 401(k)
- Contribute 5% of your salary to your 401(k) and receive a matching contribution from your employer.
- Diversify your investments inside your 401(k) to provide a 7% rate of return (more on that later)
- Repeat for 36 years and you are a millionaire.
If you take one thing away from this article let it be the importance of ensuring you are getting the full employer match in your 401(k).
If you take a second thing away from this article let it be that how you choose to invest the money in your 401(k) makes a tremendous difference.
When you sign up for a 401(k) you are automatically enrolled into the “default” investment fund. For many 401(k)’s the default investment fund is something with zero risks like a money market fund. While money market funds are not risky, they also pay crappy interest, which is usually below 2%.
I just laid out that someone making $50,000 per year receiving the full 5% employer match into their 401(k) will be a millionaire in 36 years IF they can receive an average return of 7% per year.
How much money would that same person have in their 401(k) after 36 years if they invested all of their money in a “safe” asset earning 2% per year? They would have $365,000. A difference of over $635,000.
Clearly, how you invest your money makes a huge difference in how much wealth you can build over your lifetime.
You Can’t Control Or Predict The Market
The first thing to realize about investing in the stock market is that you cannot control what happens in the stock market. If the global economy goes into recession the stock market will fall. There will be days the stock market takes a nose dive — it is unavoidable. The quicker you can accept and be at peace with that fact, the better off you will be.
Second, you cannot predict when the stock market will nose dive and when it will shoot through the roof. Many people have lost their shirts by trying to “time the market”. You are better off investing what you can afford to invest when you can afford to invest it. Keep it simple.
Investment Factors You Can Control
Time In The Market
The first thing you can control is when you start investing and how long you choose to keep your money in the market. Generally speaking, the longer your money is in the market, the more your money will grow. So the earlier in life you start investing the better off you will be.
The next thing you can control is how you diversify your investments. There are two ways in which you can diversify your portfolio.
By Geographic Market
You can invest domestically within the USA, internationally in places like Europe and in “emerging markets” which are countries like China or Brazil. A well-diversified portfolio will be invested in as many geographic areas as possible.
By Asset Class
You can also diversify your portfolio by investing in different types of assets such as stocks, bonds or real estate.
If you combine the two methods of diversification, you’ll have investments in stocks, bonds and real estate in the USA, internationally and even in emerging markets.
Both mutual funds and index funds have what are called management expense ratios (MER). The MER is a ratio for what you are paying in management fees as a percentage of the total assets you own in the fund.
Many equity mutual funds (mutual funds that invest in stocks) have an MER of around 82 basis points or 0.82%. Meaning if you have $10,000 invested in that mutual fund, it will cost you $82 per year to pay for the services of the manager and other costs associated with the fund.
You have to pay these expenses every year, regardless of whether your investments went up or down that year. Large expenses can cost you hundreds of thousands of dollars over the course of your life so you need to be aware of what fees you are paying and be prepared to change investments if you are overpaying for the services you receive.
When the stock market takes a nose dive, many of us panic. It’s scary to see the value of your hard earned money decline right before your eyes. I can only imagine how it felt for investors during the 2008 financial crisis. Which is what makes it a perfect example to highlight why discipline matters.
Between August 2008 and February 2009 the S&P 500 lost 41% of its value. For all we knew, at the time, the market could have dropped another 41% over the following six months. People were freaking out.
The people who panicked and sold at the bottom of the market were selling for pennies on the dollar. Those who maintained their discipline and kept their money in the market would be rewarded by a 300% increase over the next 10 years.
For more on how fear of the stock market is keeping many Americans on the sidelines checkout this article.
How I Invest My Money
I choose to invest my money in low-cost Index funds because they tick all of the boxes we have discussed.
- Index funds are passive investments, which means that they do not try to beat or time the market. They simply aim to track the market. Recognizing I cannot control or predict the market, I choose index funds.
- Since an Index fund tracks an entire market index, they are well diversified by definition. You can buy index funds that track stock markets all around the world. In addition to that, you can buy index funds that track bond and real estate markets all around the world.
- Index funds are incredibly cheap. For example, you can buy the Vanguard S&P 500 Index Fund for 0.04% per year. That costs you $4 for every $10,000 you have invested each year.
- Given the simplistic nature of Index Funds and the fact that they only seek to track the general stock market, they make it easier for me to remain disciplined. If we see another financial crisis and the S&P 500 drops by another 41% I won’t need to worry. I’ll be much more confident that the stock market, in general, will bounce back. If I were invested in individual stocks, I would be less confident that the individual stocks I picked would bounce back and would be more likely to make a panic sell.
Index funds work for me, but the important thing is you do your research and find investments that work for you and make sure you are getting AT LEAST the full employer match on your 401(k). It’s a boring but efficient way to build wealth that lasts.
Want to keep the discussion going? Check out this video on maximizing your 401k
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Consult a financial professional before making any major financial decisions.