There are many people who don’t understand how to build their net worth. They can’t seem to figure out a way to invest for their future. In this article, I plan to give you six steps that I personally used in order to increase my net worth.
Pay Off High Interest Debt
The first step to building wealth is to pay off high interest debt. Anything that has an interest rate over 5% is what I would consider high interest debt. The primary example of high interest debt is credit cards. The interest rate on credit cards is so high that if you only make minimum payments every month, the debt will quickly consume you. Some credit cards have interest rates over 20%. This means that if you only make minimum payments, your credit card debt could double in as little as 4 years.
Paying off a high interest credit card at 20% is the same as investing that money and making 20% returns. This should always be step #1 of building your net worth.
Company 401k matching
The next step to increasing your net worth is to participate in your company based retirement plan (usually 401k) up to the amount matched by your company. Many companies will match a percentage of you contribution. For example, in my last job, if I contributed 6% to my 401k, my company would match those donations. This means I instantly double any money I contribute to my retirement account.
This is free money and should be step #2 of building your net worth.
Roth IRA
Once you have paid off of your high interest debt and contributed to your work retirement account (up to your companies match), the next set of contributions should be to a Roth IRA account.
The Roth IRA is an excellent way to increase your net worth. The primary advantage of this account type is that since it is funded with after tax dollars, there is no tax liability when the money is withdrawn. This can be a huge advantage for those in retirement since you won’t have to pay any taxes on the distributions.
In 2021, you can contribute a maximum of $6,000 into a Roth IRA.
Max 401k
After maxing your Roth IRA, if you still have available money to contribute, consider maxing out your company retirement plan (typically 401k). In 2021, the maximum contribution by you (the employee) is $19,500. The benefit of the 401k is that it will lower your AGI (adjusted gross income) for the current year. Unlike the ROTH account, you will pay taxes when the money is withdrawn, but the benefit is that you will pay less taxes now (in the year of the contribution).
Tax free compounding is a wonderful thing.
Real Estate
Real Estate, whether to live in, or for investment purposes should definitely be lower on the priority list. Buying real estate is an excellent way to grow your net worth but is not very liquid. If you need quick access to the cash to invest in something else, it’s just not feasible or cost effective to sell a property quickly.
The benefits though are that you can control a lot of house for about 20% of the capital. For example, a $400,000 house may require you to put 20% down or $80,000. As the house appreciates, your gains are leveraged. Let’s say the value of the house goes up 25% to $500,000. Your $80,000 investment is now worth $180,000. Note that this is a really simple example as I didn’t take into consideration your monthly mortgage payments, insurance, property tax etc. My point was to show you that using leverage in real estate can be a great way to increase your net worth quickly.
Stocks and Crypto
Stock, Index Funds, Mutual Funds and other financial assets are a great way to increase your net worth. I do recommend that this come after you pay off your debt and invest in retirement accounts. Some prefer to start this before real estate and the choice is ultimately up to you.
As a young person with many years before retirement, I typically would recommend placing a large percentage of your investment here into index funds or ETFs that track the S&P 500. I personally invest in IVV as it has the lowest expense fees at .03%. That’s right, that’s 1/33rd of 1%.
As you get older, you may want to diversify and start looking at index funds or ETFs that give you exposure to bonds. Some potential candidates are BND or TLT.
Some advisers recommend that as you reach retirement age, a large portion of your portfolio should be made up of bonds or bond funds. I personally tend to disagree with that statement. My personal feelings about bonds are that the return is too small and even in retirement, I think I will try to remain at least 70% stock, 20% bonds and 10% international in order to diversify.
The steps above are what I followed to increase my net worth over a period of about 20 years. I am still many years from retirement but already have a very comfortable 401k, multiple real estate properties and a decent sized stock and crypto portfolio. I hope the steps above can help you to be as successful as I have been. Good luck!