How To Build Wealth

Introduction

When you hear the word “wealth,” what comes to mind? If you’re like most people, money is probably at least part of the equation. But it can also include possessions, resources, and more (like a wealth of information).

Of course, the concept of “building wealth” usually means the financial aspect. But it’s not just about your income. Sure, having a bigger income might make it easier to accumulate wealth, but other pieces are important too. Like saving money and investing.

Building wealth isn’t a sprint, though. It’s a full marathon that requires a long-term mindset to pull off. So let’s take a look at what’s involved in reaching that finish line.

What Is Wealth?

The dictionary definition of wealth is “an abundance of valuable material possessions or resources.” So it includes money, but it’s not just money. And it’s important to understand how money fits into the equation as well.

Assets vs liabilities

Assets are things you own that are worth something. Liabilities are things you owe.

So your positive bank balance, or capital, would be an asset. So are possessions like a car, a house, a boat, or anything valuable that you own outright. You’ve either paid off the loan used to buy the asset, or you purchased it without borrowing.

A negative bank balance would be a liability. So would the same car, house, or boat if you still owe money on them. Other debts can also be liabilities, like outstanding student loans, unsecured personal loans, and credit card balances.

Net worth explained

Net worth measures your financial health by subtracting your total liabilities from total assets, or your debts from what you own.

Assets - Liabilities = Net Worth

The goal is to end up with a positive number, which indicates financial stability or solvency. But it’s possible to have a negative net worth if your liabilities are more than your assets, meaning you owe more than you own.

For an extremely simplified example, if you own a car that’s worth $25,000 but you owe $30,000 in student loans, you have a net worth of -$5,000. That’s a negative net worth. On the flip side, if you own that car and you’ve paid all your debts down to $5,000, your net worth is $20,000.

Of course, that’s just the basic idea. A lot more numbers and calculations are involved in a real-world scenario. For example, a car goes from being a liability to an asset when your resale value becomes worth more than the loan balance. But it’s considered an “encumbered asset” because the lender still has a lien on it.

It turns into an “unencumbered asset” when the loan is completely paid off and every dollar of the resale value belongs to you. Now you own it free and clear.

Income vs wealth

Income is what you have coming in. But wealth is what you have, period. In other words, your income is how much you make in a certain period of time, while your wealth is your total net worth —­ including that income minus expenses, or your assets after subtracting liabilities.

While your income may come and go, or rise and fall, the ideal goal with wealth is to keep growing it over time.

Now, here’s a chicken-and-egg scenario. Your income could help you grow your wealth. But your wealth can also supply your income. Let’s say your parents are retired and no longer have income from a job or profession coming in.

However, they’ve invested $2 million and receive interest from that investment on an annual basis. So now the wealth they own is providing an income through a return on investment (ROI). In this case, the more the wealth grows, the more the income likely will too — because a bigger investment often provides a bigger ROI.

When To Start Building Wealth

It’s never too early to start building wealth, and the earlier the better. But obviously you can’t go back in time, so the time to start building wealth is now.

The reason to start as soon as possible is that whether you’re saving or investing, money compounds over time.

The power of compounding

Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn’t, pays it.” And you want to earn it, so it’s important to understand it.

Compound interest lets you earn interest on your interest, not just the principal amount or deposit. Your compounded rate is often shown as an annual percentage yield (APY).

Because compounding creates a growing snowball effect as time goes by, starting early makes a huge difference. But it’s really never too late to begin the process of building wealth.

How To Build Wealth Over Time

We’ve established that this is a marathon. So let’s focus on ending up in a good place by the time we cross the metaphoric finish line.

Build a strong financial foundation

A good financial foundation gives you solid grounding to build upon. And it needs a few things to be effective.

• Controlling debt: If you’re paying high interest rates on funds you’ve borrowed, that needs to be paid off as soon as possible. The more you carry high-interest debt, the more you end up paying. Consider using the snowball or avalanche method to pay down debt.

• Saving consistently: The best approach to saving is often putting aside a little bit each week, or each paycheck. You can even set up automatic transfers from your checking to savings account if you don’t want to think about it. You may be surprised at how much this can add up if you stay consistent. 

• Building an emergency fund: Once you have the momentum going with your savings habits, the next step is funnelling some of it into an emergency fund. This isn’t for dipping into when you want to buy something — it’s to save for when you have a personal emergency like a broken appliance, car repairs, or unforeseen medical needs.

Understand saving vs investing

For building wealth, savings are a great start. But adding investments to the equation can be a good move as well. So what’s the difference between saving and investing?

• Saving is putting aside what you have to keep it safe and secure.

• Investing is purchasing assets with the hopes of making a return.

Ideally, you want to have both in place. Saving is a low-risk way to keep your money, especially if you use a savings account (as opposed to stashing it under your pillow). Most major bank accounts are FDIC insured, meaning the government covers your funds for up to $250,000 per account owner per bank.

But most standard savings accounts don’t pay out that much interest anymore. Yes, a high-yield savings account will typically give you a higher return than a traditional savings account, but it’s still relatively low compared to what you could potentially make with an investment.

However, here’s a big caveat: investments are not FDIC insured, and your funds are not guaranteed. Stocks, options, ETFs, crypto and other investments can be very volatile. Bonds and mutual funds are often slightly more stable, but still not guaranteed. Market fluctuations can send the value of shares or investments soaring or plummeting, and it may happen faster than you can react.

That means you can make a lot — or lose a lot. And if you invest and lose your money, nobody will pay you back for the loss. Because of this, the common wisdom often cited is to never invest what you can’t afford to lose.

Short-term vs long-term goals

In both saving and investing, you’ll likely have goals for the immediate future, and goals for a little further down the road.

Short-term goals are usually what you’d like to accomplish within the next few months or few years — up to 5 years tops.

These may include:

• Building an emergency fund

• Saving for a milestone or event like a vacation, graduation or wedding

• Gathering a down payment for a car or house

• Investing for short-term gain, like day trading or purchasing a certificate of deposit (CD)

Long-term goals are usually created for later benefit — at least 5 years or more in the future.

These may include:

• Saving for retirement

• Putting aside money for a future milestone, like a child’s college fund or paying off a mortgage

• Investing as a long game, like buy-and-hold stock market investments, mutual funds, and real estate

Invest for long-term growth

Despite the exciting lure of day trading, it’s very easy to lose money. Emotions often take the wheel, and it can end up being more like gambling than building wealth.

On the other hand, long-term investing can pay off — especially if you can resist the temptation of looking at the short-term rollercoaster of rising and falling values. Because even though zooming in shows all the volatility, stepping back often reveals a steadier climb over time.

A great place to start is with a retirement account, like a 401(k) or IRA. In this case, you typically just choose how risk averse you are, and then you hand over the keys and wait for the results.

• High risk aversion (low risk tolerance): You focus on capital preservation. You value stability over potential gain, meaning your wins may be small but major losses are less likely. 

• Low risk aversion (high risk tolerance): You focus on maximizing returns. You value potential gain over stability, meaning your wins may be large but major losses are also quite likely.

If you really want to take the reins yourself, self-managed or self-directed IRAs are available. But employer-sponsored 401(k) accounts are usually managed for you while the more hands-on solo 401(k) options are commonly just for self-employed people.

Whatever model you choose, you’ll still want to manage your risk as much as possible. One of the best ways to do that is diversification, also known as not putting all your eggs in one basket.

To diversify your portfolio, you could spread your investments across different industries and asset classes. A timeworn strategy is a 60/40 split between stocks for growth and bonds for stability. But however you divide it up, the main point here is to have a foundation of more stable investments to offset the volatility in your growth portfolio.

Further diversifying across industries and sectors — like technology, healthcare, financial services, and energy — can help hedge your bets even more.

Frequently Asked Questions About Building Wealth

Have questions? You’re not alone. Let’s look at some commonly asked questions about building wealth.

How do I start building wealth?

A good strategy is to start as early as possible so you can benefit from compounding interest. A retirement account like a 401(k) or IRA can help build a nest egg for your future.

And then automate the system so part of your income is regularly being transferred to savings or investment accounts without you having to manually send it. At the same time, work on paying down high-interest debt so you don’t derail your wealth-building progress.

How can I increase my income?

If you want to make more so you can save more, you could try increasing your earning potential through skill development and continuing education. You can also negotiate a higher salary or start a side hustle for extra income.

Most experts recommend having at least 3 to 6 months’ of living expenses in your emergency fund, but it’s OK to build that over time. A high-yield savings account is often recommended as a good place to keep and grow your emergency money.

What are the best investment strategies?

When people talk about “best” investment strategies, they’re typically referring to tried-and-true methods. But that doesn’t make them “best” for you and your situation.

Some classic advice includes focusing on the long game instead of chasing short-term gains, and diversifying your portfolio to manage risk. Diversity might look like investing 60% in more volatile assets (like stocks) for growth potential and 40% in less volatile assets (like bonds) for stability. You’ll also probably want to invest in a range of industry categories instead of putting all your money into one sector.

Bottom Line

Wanting to build wealth for the future is a noble objective, as long as you understand that it takes time and dedication to achieve. “Slow and steady” usually wins this race over “fast and furious” — this is the proverbial tortoise actually beating the hare for once.

Building wealth typically involves both saving and investing. Putting your savings into a high-yield savings account is highly recommended for growing your money in a safe environment. And diversifying your investments can be a great way to account for both growth and stability.

Now that you understand all the pieces required to establish a solid foundation for building on, the next step is to start the process. And then remain consistent until you reach all your short-term and long-term goals.