Yahoo Finance 4 Things Middle-Class People Should Know About How the Wealthy Make Their Money
How did the wealthy get that way? How do they stay that way? To the average person, the strategies that wealthy people employ may seem shrouded in mystery. The countless books and articles penned on the subject are all too often full of platitudes and vague explanations that amount to hand-waving. That’s not to say that there is nothing to be learned from them, however.
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If you follow in their footsteps, can you become wealthy too? There are no guarantees, but observing the habits and strategies of the wealthy could give you a leg up on your own financial journey. Here are four things experts say those in the middle class should know and learn from about how wealthy people make their money.
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Tax Planning
One of the most efficient ways to build wealth is simply to keep more of the money you make. Obviously, spending less of what you take home is a good way to do that – but increasing the amount you take home without doing more work is even better. Taxes take a big bite out of your paycheck, so reducing your tax burden is effectively giving yourself a raise.
Everyone knows that the wealthy take full advantage of tax planning to make sure they pay as little as possible, but you don’t have to be rich to be smart about your taxes. “Tax planning can have an outsized impact. Some common considerations include HSA planning, FSA (Flexible Spending Account) and dependent care FSA participation, Roth IRA utilization if and when it makes sense, 529 account education saving, and asset location optimization,” said Eric Johns, CFP and co-founder of Equilibrium Financial Planning.
You don’t need to be rich or be a tax expert yourself, either. While this level of tax planning may not be something you can manage through tax software or a basic tax prep service, a professional financial planner or CPA can help you, and it probably won’t cost nearly as much as you think.
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Don’t Go Into (High-Interest) Debt
It’s important to know that not all debt is necessarily bad. A mortgage, for example, generally has a low-interest rate – at least compared to credit cards – and allows you to purchase an asset, in the form of a home, that will appreciate in value over time. Student debt can be a burden, but if your degree enhances your earning potential, it will pay off in the long term. For the majority of other purchases, however, using debt is just going to end up costing you more – potentially a lot more.
“Absolutely do not rely on high-interest loans to fund any purchases. This is something wealthy clients never do. Save before you need the new car, until you have the capital in your liquid accounts. Essentially, your checking account balance should always exceed your outstanding credit card balances. Never charge more than you have available to pay immediately,” said Johns.
While it must be said that consistently delaying gratification this way can sometimes make your life much more difficult, it’s worth it to make sure that money goes toward building your net worth, instead of going towards paying the 20% or more in interest on your credit card.
Make Money While You Sleep
Hard work is no guarantee of wealth. You can take on a second job or side hustle to earn more income, but there are only so many hours in the day. If you want to build real wealth, you have to make your money work for you – this concept is often called passive income and it’s one of the most important things to know about how the wealthy turn their money into more money.
Robert Johnson, CFA and Professor of Finance at Creighton University’s Heider College of Business, has studied investing for decades and has co-authored numerous books, including The Tools and Techniques of Investment Planning and Strategic Value Investing. “The biggest difference between the truly wealthy and the middle class is that the wealthy make money while they are sleeping. In other words, they focus on accumulating capital and making that capital work for them. The truly wealthy have a high proportion of their income come from invested capital as opposed to current labor,” Johnson said.
Johnson also noted that starting early is key to successfully building wealth because of the power of compound interest. As interest compounds over time, you are getting a return on your return – and that makes time an investor’s greatest ally. “The surest way to build true long-term wealth and higher net worth is to invest in the stock market,” Johnson said.
Know What You’re Investing In
Todd Shaffer, senior manager of research at VectorVest, a company specializing in quantitative stock analysis software, echoes the importance of investing in the stock market. Wealthy investors may not be particularly sophisticated or knowledgeable, but they do have access to expert knowledge and advanced tools through investment advisors and other professionals. However, there is plenty of knowledge out there to be found for little or no cost if you’re willing to do the legwork.
“Investing in companies to share in their profits and rising share price is a wonderful way to build wealth for everyone. The barriers to entry are few and it can be done from anywhere at any time. However, success requires us to learn some new skills. The good news is that there are resources available to help you master the learning curve and provide the usable information you need to make good investing decisions. When you combine experience with good information, you’ll have what it takes to join that elite class of ‘Knowledgeable Investors’,” Shaffer said.
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