What exactly is wealth? Where does it come from?
I prefer to define wealth as the value of all assets free and clear on any debt. This means wealth includes the equity in your home, your stocks, bonds, mutual funds, ETF’s, 401k, and IRA’s. It even includes your cars, rental homes, and equity you have in your business. As long as the assets you own continue to accumulate and rise in value, your wealth increases accordingly.
Wealth is also the ability to live off your investments. In other words, you don’t have to work (or work as much) in order to sustain your lifestyle. When your investments can produce enough income to pay your bills, that’s wealth.
If you ask the experts, most Americans wealth is tied up in their homes. This is because the home value rises and the debt owed, the mortgage, is reduced over time. The difference between what the home is worth and what is owed on it is the equity.
And equity increases your net worth, which in term builds wealth.
Some might say that a home is not a great source of building wealth because you don’t have access to the cash in your home without paying interest on your own money via a home equity loan or outright selling your home, incurring how fees charged by the banks (not to mention you still need a place to live).
But equity is equity and owning a home is the surest way to increase your wealth. It’s relatively stable, the interest can be deductible, and the principle portion of the payment you make every month is effectively forced savings. The best benefit is that, if you choose to sell your home, the profit you make from it is tax free up to $250,000 ($500,000 if you’re married)!
Unlike owning a home that automatically builds wealth every time you make your monthly payment, using retirement accounts to build wealth requires you to actively engage in investing. This means you need to actually contribute to it consistently and select appropriate investments, and monitor its performance.
Furthermore, unlike a mortgage in which you make a payment to one company, you may have to use multiple retirement accounts. The 401k is the king of retirements accounts, following by the IRA. You may use both to invest over the long term. If you also have a side gig, you can add a SEP IRA to your mix, making three different retirement accounts you can contribute to.
Retirement accounts build wealth because of two reasons: 1) tax advantages 2) the focus on long term investments.
Retirement accounts are designed to be long term solutions. The money you put in these accounts aren’t meant to be pulled out in the short term. We are talking decades from now. If you’re in your 20’s, you’re looking at least 40 years of accumulating funds. IF you’re just getting started in your 40’s, you’re looking at 25 years or so (so get started early!).
The majority of retirement accounts have tax advantages associated with them. You get to deduct what you put in on your taxes and you don’t have to pay taxes on your account until you start pulling money out.
If you make your contributions automatic, building wealth can work the same as building wealth through your home. Over time, your contributions accumulate, grow and compounded upon itself. The key is to start now.
The Side Gig
Day job pays the regular bills. Perhaps you’re able to put a little aside into savings and investments. According to various sources, most American’s aren’t saving much.
This is why the side gig is key. Even if it’s sporadic and a constantly flow of income, the cash you bring in from doing things on the side can go straight to building wealth. Whether that is reduce the debt side of the equation or the side of the equation, it’s a way to build wealth.
Having a business is a great way to keep your wealth heading north. It’s the reason why so many wealthy people tend to own their own businesses. Sure, if you work for someone who gives you stock options and lucrative pay packages, but for most people, owning a business is cited as the best way to build long term wealth.
Start small, think big.