The secrets to building wealth aren't hidden behind locked doors in the realm of the rich. Plenty of wealthy people make disastrous financial mistakes. But those who succeed understand how to make their money work for them as well as how to take calculated risks.
The current low-rate environment from the Federal Reserve's easy money policies means that playing it safe with investments is not an option for those who want to increase their net worth. Taking on some risk with investments has proven to produce a higher return.
At the same time, the speed with which investments evaporated during the recent financial crisis fostered an air of caution among the wealthy, says Brent Fykes, a wealth adviser to ultra-high-net-worth clients in Jupiter, Florida. They've taken less risk with savings by not leveraging them, and they've pulled back on spending.
"The recession did a great job at showing people what's essential and what's nonessential," he says.
Bankrate polled wealth advisers around the country to gain insights on the wealth-building habits of the rich. It really amounts to looking at their spending, investing and saving habits.
Spending habits of the rich
If they are still working, the wealthy are living strictly off wages, allowing their investment portfolios to grow, says Fykes. It's a smart strategy because as you spend money from investment returns, you reduce the overall amount of your portfolio; consequently the amount of income that can be safely withdrawn in the future may be lower.
"As your wealth grows, it's easy to become accustomed to spending more at the age of 40 than you did at the age of 30," says Fykes. "But by living within a set income level and not drawing from investments, your portfolio can recover from the dips."
Ignore the Joneses
Not getting caught up in the competition to keep up with the Joneses is critical to building wealth, says Jason Flurry, Certified Financial Planner with Legacy Partners Financial Group in Woodstock, Georgia. It's about establishing a standard of living that brings happiness but doesn't make you feel that you have to go bigger the next year, he adds.
A long-range view helps quell spending urges that derail financial plans, says Lisa Leonard, vice president wealth manager at True North Advisors in Dallas. The wealthy "generally have an idea of where they'd like to be in two years, five years, even 10 to 20 years, and they make sure they don't outlive their assets," she says. "If they have $2 million, they don't think they can go out and buy a Lexus."
Investing habits of the rich
The wealthy share three major traits when it comes to investing success, says Eric Ross, CFP, financial planning specialist at Truepoint Wealth Counsel in Cincinnati:
- They have a diversified portfolio.
- They keep investing fees low.
- They are disciplined about rebalancing.
Rebalancing works, says Ross, because it keeps the portfolio on track with your goals. At Truepoint, portfolios are monitored daily against targeted asset classes and if any one of them strays outside an acceptable range, assets are bought or sold to bring them back in line. While most people don't have the time or expertise to monitor their portfolios daily, Ross advises setting rebalancing parameters based on asset prices rather than a preset time period.
It's also easy to rein in investing fees, he says, through the use of index funds and exchange-traded funds, which provide a low-cost way to get exposure to a variety of asset classes.
Bucket list different than most
The wealthy are generally smart about the sequence of various "buckets" they fill with investments, gaining all the tax advantages they can, says Ross. For example, first they would invest the maximum amount allowed into a company-sponsored 401(k) to get the match from the employer. "That's free money and you don't want to leave it on the table," he adds.
Depending on your tax situation, for the second bucket you could invest in a Roth IRA, or if you're over the income limit for the Roth, convert a nondeductible traditional IRA into a Roth. Health savings accounts are another tax-advantaged possibility.