Financial habits of the wealthy

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returns, you reduce the overall amount of your portfolio; consequently the amount of income that can be safely withdrawn in the future may be lower.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.

The third bucket is taxable accounts. The more you can fill up all three, the brighter your financial future and the more options for income you’ll have when you stop working.

Develop a financial plan

Leonard says a financial plan is a must for investors in order to prevent them from getting caught up in a market frenzy and subsequently buying high and selling low. Pay attention to the big picture and ignore the day-to-day noise about specific asset-class returns.

Although the wealthy typically underweight or overweight certain asset classes, depending on the economic situation, it’s rare for them to abandon an asset class, adds Leonard. Maintaining a large position in fixed income, for example, is risky now because the low interest rates are not making up for the bite taken by inflation. But that doesn’t mean you should go all in on equities and abandon bonds altogether.

Those who focused on preservation in 2007 might have allocated 60 percent of their portfolio to fixed income and were more comfortable than others in 2008 and the first part of 2009, she says. But on the flip side, if they maintained that allocation, they were not poised for growth when the market took off. The rich pay attention to opportunities to shift into equities when they’re on sale.

Savings habits of the rich

While investing may appear at times to be complicated and opaque, saving is pretty straightforward. Wealthy folks take a two-pronged approach to saving, says Katherine Dean, senior vice president and managing director of wealth planning at Wells Fargo in San Francisco:

  • They generate more cash inflow.
  • They reduce cash outflow.

Spending and saving often go hand in hand because whatever you don’t spend is potential savings. That’s why the wealthy focus on buying things that will hold value or appreciate in value instead of allowing expenses to eat into savings through continuous consumption, Dean adds. “A lot of wealthy people, when they’re on their way up, manage expenses so tightly. Instead of living within their means, they live below their means.”

One way to reduce unnecessary outflow is to maximize tax savings through retirement plans such as the 401(k), she says. Another is to pay off debt and prioritize by paying the debts with the highest interest rate first.

Keep the end goal in mind

Following these precepts is easier with an end goal in mind, Dean says. Those who gain wealth believe that everything they do is ultimately done to fulfill these goals. For example, people should set a “retirement number,” she says. That number is the goal for how much cash and investments they need for a comfortable retirement. Every time you put money toward saving, you’re a step closer to the prize.

“Sometimes people have to be consistently reminded that you have to be in the habit of saving,” says Lauren Prince, Certified Financial Planner at Prince Financial Advisory in New York City. The more you do it, the easier it will become. Set automatic savings triggers, if necessary, so a portion of your earnings goes from your paycheck into a separate savings account, for example.

Take calculated risks

Savers, like investors, also need to understand risk if they want their money to work for them, says Prince. Savers often think they can’t afford to lose any money by investing in the market. But they don’t realize that when they don’t make their money work for them, they are losing. Inflation, for example, creeps up over the years and steals from your savings if you’re not earning enough to make up for it.

The disciplined, steady approach to saving, investing and spending wins out in the end, she adds.

So the wealth-building habits of the rich don’t involve a get-rich-quick scheme — and the wealthy know it. “It’s a slow, gradual process to accumulate wealth,” says Prince. “The rich are persistent and consistent.”