Building Net Worth

However you define “being rich,” it almost never happens overnight. For most of us, it’s the gradual accumulation of assets and control of liabilities. It’s building your net worth one step at a time. You don’t have to be a financial genius, but it does take some personal qualities that high net worth accumulators typically acquire.

HABITS THAT LEAD TO HIGH NET WORTHS

You know that fellow who lives down the street -- the one who wears khakis to work and drives a seven-year-old pickup truck? He owns a small tool-and-dye shop. His wife teaches school.

They’ve owned the same house for the past 15 years. The house is comfortable, but not elaborate. And so is the rest of their lifestyle.

When they buy a car, it’s at least three years old. They take two-week vacations at a nearby lake. They live well below their means (some might call them cheapskates). That’s okay with them because they don’t believe in living lavishly.

Would it surprise you to know that they are HNWIs? Though still in their forties, their assets exceed their debts by 10 to one. They are what authors Thomas Stanley and William Danko call The Millionaire Next Door. What are the qualities that make them successful with money?

Discipline. They follow a spending plan based on moderation and frugality -- and they stick to it. If you want to build a comfortable net worth, you’ll live within a budget. You’ll buy things according to need and value, not status. You won’t look, dress, or act like a millionaire so that someday you may be one.

Patience. Fortunes take time to build. If you want to build one, you’ll be a methodical investor who understands the time value of money. Wealth accumulates over time by compounding. The earlier you start, the more time works in your favor.

Ambition. About two-thirds of typical high net worth individuals are self-employed, often owning businesses that are considered “blue collar” or dull. You may welcome the opportunity to start a business that provides mundane services others rely on. And you won’t mind putting in the long hours and hard work it takes to be successful.

Vision. Net worth builders think long-term. They see opportunities where others don’t. You will be willing to take reasonable risks to achieve rewards in the future. You are an optimist who believes you can do it.

THE GET-RICH-SLOW PLAN

Daydreamers think in terms of “striking it rich.” They dream of winning the lottery or “getting lucky” with investments. They wonder if Aunt Harriet put them in her will. They don’t understand the most probable method of building wealth: the Get-Rich-Slow Plan. Here’s how it works.

Savings. Start by living on a strict budget today. Even if your income is high and your prospects for the future seem bright, learn to live below your means. Why? Because you want to put as much of your income as possible into savings to establish a foundation for future wealth.

Don’t think about how little your savings will add up to in the near future. Think about what the process of saving will accomplish over the long haul. Albert Einstein said it best: “The most powerful force in the universe is compound interest.” Given enough time, any sum of money that generates steady earnings will grow substantially.

Here’s just one example: Suppose you save just $25 per week in an investment account that earns 5% interest. At the end of 17 years you will have saved $22,100, but your account will have grown to $34,840, which includes $12,740 in interest. Now suppose you stop making new contributions to the account and just let the principal continue to earn interest at the same 5% rate for another 20 years. Your savings will grow to $94,282 – almost $60,000 more in interest. (For more future value of interest calculations, visit www.moneychimp.com.)

Your first investment. For most net worth builders, your first (and maybe best) investment should be in a home. Not only do you build up equity over the years compared to renting, but you enjoy a substantial tax deduction on your mortgage interest and property taxes. The considerable equity you build in your home over the years can be a low-cost (and tax-advantaged) source of borrowing for other investments such as starting a business or buying other real estate for income.

Owning your own business. That may be something you have always wanted to do – or never wanted to do. Not everyone thrives on being the boss and shouldering the responsibility of business ownership. Nevertheless, owning a successful business is a time-honored path to financial success.

If you are an “idea person,” but have limited interest in business management, you may make an excellent partner in an enterprise that develops your ideas. A great idea doesn’t care where it comes from or who runs the business. Just make sure your partners complement, rather than duplicate, your skills. The right combination of ideas and day-to-day management forms the ingredients for many successful enterprises.

Other investments. Over the long term, a diversified portfolio of stocks, bonds, real estate, and other securities have proven to be good investments. But know thyself. If you can’t tolerate the ups and downs of markets and the economy, you may want to limit your investments to financial products that offer the safest and surest returns.

Tax-deferred assets. As your net worth and income grow, taxes will become an important consideration. You’ll want to take advantage of tax-deferred savings plans such as IRAs, SEP-IRAs (for the self-employed), 401Ks, 529 and other college savings plans, and capital gains exclusions when you sell your home. You’ll also want to investigate life insurance and annuity plans. Consult a financial adviser who understands these products thoroughly.

As you fold new assets into your Get-Rich-Slow Plan, you may find that money actually becomes less of a concern in your daily life. As your assets grow, your living expenses will become a smaller fraction of your net worth. You’ll have more energy to give to your family, community, and your work. Living well within your means, managing your debt, and putting cash flow to work productively will become habitual … and comfortable.

CHECKLIST FOR NET WORTH ACHIEVERS

• Limit your debts to buying things that appreciate or hold their value.
• Look for opportunities to be entrepreneurial.
• Understand the time value of saving and investing.
• Limit your investments to what you understand and can manage.
• Make profitable use of skilled financial advisers.

GUARANTEED NET WORTH KILLERS

• Too much debt at too high a cost
• Investments made without due diligence
• Law suits, divorce, tax problems
• Deals that are “too good to be true”
• Offshore trusts or tax shelters
• Pride – it goeth before the fall

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