What if instead of being some unattainable goal, being wealthy was actually a very simple process? Wealthy people look at their money and investments and put them in three separate buckets.
Short Term Investing
Short term investing is not day trading. In this case, it is money that you need to keep somewhat accessible. A savings account is a perfect example. It is 100% liquid and you are able to get at it if necessary without paying any fees or taxes. It is important to establish a savings account so that you have a bucket for the what-ifs. Now the wealthy may have a much larger “what-if” bucket, but we all need one and it needs to have at least 3 months of expenses in it, but ideally 6 months.
Another short term investing tool is a monthly investing program. A mutual fund is a nice example here as you are able to establish one of these for as little as $25 per month. Each month the mutual fund company withdraws the money from your bank account and invests it in the investment you chose. This is a little more difficult to get at then a savings account, but still easy enough as you can have the money back within 24 hours in case of an emergency. However, if you are properly planning, you will have the savings account established so the emergency funds you need will be covered. Also, there are no penalties for withdrawing, but there may be taxes on any gains you received.
Long Term Investing
Long term investing is just as the name says, for the long term. This includes retirement accounts and your home. Retirement accounts are great ways to save and create wealth because they come with special tax treatment. Regular retirement accounts like a 401(k), 403b, and an IRA are all tax deferred so you only pay taxes when you finally need to access the money. A Roth retirement account is the opposite. You pay taxes before you put the money in and never have to pay again. These added benefits come with penalties if you access the money early, thus, that is why they are in the long-term bucket. Although the benefit of tax deferral and paying tax once greatly outweighs the penalties by a long way. The wealthy love the idea of not paying taxes because they are usually in the highest tax bracket; so they take full advantage of any or all legal tax loopholes.
Another long-term investment is your home. In the mid-2000’s, the U.S. forgot this was a long-term investment and people starting using their homes like an ATM, thus the mortgage meltdown of 2008-2009. Since you are paying your mortgage each month, you are getting a couple of benefits over renting. One benefit is that each month you are paying down the balance you owe the bank and creating more equity that is like a forced savings account. Eventually, when you sell the home, that money comes back to you. The other benefit is that the interest you are paying is tax deductible. This tax deduction can be very helpful in limiting your tax liability each year, which is putting more money back in your pocket. Many people think wealthy people do not have mortgages. Well they do and now with interest rates so low, they are more likely to have them than ever before. The reason wealthy people have mortgages is the same reason we should want them – for their tax deductions.
Passive investing is the last and final piece of investing. Passive investing means making money without effort on your end. This is when your money is making money for you. This type of investing is third for a reason. You need to have short-term and long-term investing in place before you can reach this level.
So what is a Passive Investment? Owning a rental property is probably the best example because after you have purchased the property, ideally the rent checks just keep showing up on the first of the month. In reality, there is more work, but you get the picture.
Another passive investment, which actually starts out as a short- term investment, are the dividend paying stocks. The average stock in the S&P 500 currently pays about 1.9%, which is not very much. But if you started an investing program 20 years ago in a mutual fund that mirrors the S&P 500 and reinvested all the dividends, which on average grow over 5% per year, your dividend payout today would be over 9.5%. Imagine making 9.5% just from dividends.
Passive investing is the goal of all wealthy people and should be the goal of everyone. Passive investments is how the wealthy pass wealth on from generation to generation. A little planning today and taking the time to copy the 3-bucket system of the wealthy will get you on the right track to being wealthy yourself.