1 Twenty Steps to Seven Figures Barbara ONeill, Ph.D., CFP Rutgers Cooperative Extension

2 Class Objective: To discuss 20 research-based strategies to accumulate wealth over time 10 investment steps 10 lifestyle and financial planning steps

3 Wealth Accumulation Takes Time l Average age of millionaires: late 50s to 60 l Compound interest over time, especially in tax-deferred or tax-exempt investments l One study: millionaires have been investing for 30 years l First million is the hardest (Rule of 72)

4 Step1: Set Measurable Financial Goals l Without goals, investing is hard to sustain l Have a why to invest (whatever it is) l A goal should be personally meaningful l Break a big goal into mini goals: » $1 million by age 65 » $500,000 by age 57 » $250,000 by age 50

5 Step 2: Start Paying Yourself First - Starting Today l Time is an investors biggest ally l Compound interest is awesome l To accumulate $1 million: » 20 year olds must invest $67/month » 30 year olds must invest $202/month » 40 year olds must invest $629/month » 50 year olds must invest $2,180/month l For every decade an investor delays, the required investment triples

6 Step 3: Diversify Your Investment Portfolio l Diversification reduces- but does not eliminate- investment risk l Select different asset classes and different investments within each class (e.g., stock) l Mutual funds and unit investment trusts (UITs) are already diversified l Keep investing: up or down markets

7 Time Diversification l The risk of volatility (i.e., ups & downs) in investment value is reduced as an investors holding period increases l Dont worry about day-to-day or month- to-month (or even year-to-year) fluctuations l Dont panic and sell during market downturns

8 Step 4: Invest Regularly by Dollar-Cost Averaging l Takes the emotion out of investing: forces you to buy during market dips l Make regular deposits at regular intervals, regardless of market levels » Buy more shares when market is down » Buy fewer shares when market is high l Invest what you can afford (e.g., $100 per month)

9 Step 5: Buy & Hold Stock For the Long Term l Carlson survey: 75% of millionaires surveyed held stock for more than 5 years l Frequent trading is expensive: commissions, short-term capital gains & reinvestment risk l There arent that many good ideas: financial markets are efficient (i.e., stock prices reflect company value)

10 Reasons to Stay Invested l Very difficult to be right twice (getting out of stocks and getting back in) l You have to be in the market when bursts (big price increases) occur l Market declines provide buying opportunity l Historically, stock market bounces back reasonably quickly

11 Step 6: Take Prudent Investment Risks l Prudent risks are risks that have real potential to increase your return (e.g., quality blue-chip stocks) l Biggest risk: avoiding risk (100% cash and/or bonds) l Low-maintenance strategy: Buy the market with index funds or exchange traded funds (e.g., i-shares)

12 Other Prudent Investing Strategies l Add to investments consistently l Dont get greedy for unrealistic returns l Avoid the urge to check daily returns l Use discount or online brokerage firms and no-load stocks and mutual funds l Start investing today: dont wait for market to drop

13 Step 7: Choose Quality Stocks l Better to get steady12% to 15% average return per year than very volatile returns l 12% -15% returns double money every 5 to 6 years (Rule of 72) l Singles sometimes produce home runs l Quality companies dominate their industries and have consistent profits

14 Step 8: Minimize Investment Expenses l Use DRIPs and no-load stocks (DPPs) to bypass brokers (watch their fees) l About 1,100 companies allow investors to buy stock directly (28 of 30 in DJIA) l Maximize payroll deductions (no cost) l Use no-load mutual funds without an up-front sales fee l Avoid mutual funds with 12(b)1 fees l Consider low-cost index funds

15 Costs Matter! l $50,000 in an average stock mutual fund with a 1.5% expense ratio: $50,000 x.015= $750 (annual expenses) l $50,000 in an index mutual fund with a.20% expense ratio: $50,000 x.0020= $100 (annual expenses) l Over time, the difference is magnified

16 Step 9: Take Advantage of Tax Breaks l Research: millionaires maximize tax breaks, including: » Long-term capital gains rate on stocks held for 12 months or more » 401(k) & 403(b) plan contributions with pretax dollars (no federal tax): $2,000 contribution actually costs $1,440 (28% marginal tax bracket investor) » Roth IRAs

17 Step 10: Invest Cash Windfalls l Income tax refunds l Retroactive pay l Bonuses l Prizes, awards, & gambling proceeds l Inheritances & gifts l Divorce & insurance settlements l Other

18 Step 11: Live Below Your Means and Invest the Difference l Spend less than you earn l Distinguish needs from wants l Step Down Principle (i.e., different spending levels for the same item) l Buy cars new-used l Toys & trinkets versus lost wealth l Automate investments so money is not spent

19 Step 12: Develop a Spending Plan l Track income and expenses for 1 or more months l List fixed, variable, & periodic expenses l Calculate savings required to fund goals l Create a spending plan Expenses + Savings = Income

20 Step 13: Work Hard l Organize your life with the future in mind l Set realistic life goals and steps to achieve them l Expect seasons of hard work l Follow your passions l Take calculated risks l Search out opportunities & network

21 Step 14: Increase Human Capital l Education and income strongly related l Greatest return on early years of education l Learn skills that are in demand by employers l Networking expands opportunities l Never consider your education finished

22 Step 15: Grow Your Net Worth l Increase assets l Reduce debts l Aim for a 5% annual increase (e.g., $200,000 net worth x.05 =$10,000) l 10% (or more) is even better l Calculate net worth annually to measure progress

23 Step 16: Practice Stability l Interruptions = wealth loss (rob portfolio of time and compound interest) » Divorce » Job hopping (e.g., reduced pension vesting, 401(k) delays, lump sums) » Frequent moves l Carlson research: millionaire investors had three different jobs during career

24 Step 17: Take Care of Yourself l Health care costs are another financial shock l Exercise, eat right, get enough rest,and reduce stress l Healthy people are more productive, likely to get promoted, and earn more l Make sure health insurance is adequate l Longer life: better return on $ (SS)

25 Step 18: Believe in Yourself l Develop qualities like discipline & focus l Identify & address investing obstacles l Maintain a positive attitude l Shed common myths: » You need a lot of money to invest » Investing is complicated » You can get rich day trading » Its too late to start

26 Step 19: Pass the Wealth Test l Multiply age by realized pre-tax income (excluding inheritances) l Divide by 10 l Result is what net worth should be for age and income l Example: age 35 with $40,000 income » 35 x $40,000 = $1,400,000 » $1,400,000/10 = $140,000 minimum net worth

27 Step 20: Be Patient l Ordinary people do become millionaires l Accumulating $1 million could take several decades l Like the Who Wants To Be a Millionaire? game show, greatest gains are at the end (e.g., $250,000 to $500,000 to $1,000,000) l Get started today: compound interest is not retroactive!