Investing and wealth-building sound sexy and swanky. Saving, paying down debt and balancing your budget sound like the grim and frazzled grind of day-to-day life.
The processes are snugly intertwined, however. It’s nearly impossible to build wealth without investing but it’s impossible to invest without savings. Without the discipline to live below your means you’ll never have adequate savings.
Want to start investing and building wealth? Do this before you start:
Pay down high interest debt
The analogy is well-worn but apt: Investing before paying down debt is like filling a bucket with sand and then drilling a hole in the bottom. You’re never going to have as much sand as you otherwise might have.
Debt, particularly the high-interest revolving type, erodes wealth. Not only because of the obvious high cost of interest payments, but it comes with a high opportunity cost as well. The dollars spent servicing debt could have been used much more productively.
The habit of squirreling away money will be the foundation of your investing success, combined with compound interest over time. The bulk of the average person’s wealth won’t come from a brilliant stock pick or perfect market timing.
The historical annual average return of the stock market, using the S&P 500 as a proxy for the market, has been nearly 10 percent over the past 86 years. A 10 percent average annual return is what you would have gotten if you were lucky. Average investors tend to underperform the average return of the stock market.
Who knows what stocks will return in the future, but investors who take market returns via low-cost index funds in a diversified portfolio will probably find themselves ahead of the curve.
Unless you’re already fairly wealthy, adding savings to your investment mix is going to be the second engine powering your wealth-building efforts. For instance, the chart below illustrates two potential scenarios. One line shows the growth of $1,000 over 35 years at a 7 percent annual rate of return with no additional deposits. The second line shows the same account with an additional $1,200 annual deposit.
Learn to live beneath your means permanently
Spend less than you earn and save what’s left. It is easy to spend money and harder to save. One way to make it easier is by making it automatic. Workplace retirement plans, such as 401(k) or 403(b) plans, work with human nature. Contributions to the retirement account are made before cash goes into your bank account so there’s no chance to spend it and, oops, have no money for saving. Unfortunately, only about half of the population gets a retirement plan at work. So it’s up to many individuals to set up their own automatic savings plan.
Make saving and wealth building a priority and flex your saving muscle regularly by saying no to frivolous purchases.
What do you think?
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Senior investing reporter Sheyna Steiner is a co-author of “Future Millionaires’ Guidebook,” an e-book written by Bankrate editors and reporters. It’s available at all the major e-book retailers.