Historically, the cost of goods and services has increased by about 3% per year on average. Over the past 100 years, the S&P 500 has netted investors an 8% return on their investment. This means that your net worth would see an actual increase of about 5% each year if you had invested in that index. Let’s look at some additional ways to build wealth and how to decide if a given investment class is right for you.
What Type of Investor Do You Want To Be?
The first step in developing an investment strategy is to decide whether you want to manage your portfolio in an active or passive manner. A passive investing strategy can be ideal for those who take a more conservative approach to growing and preserving wealth.
Examples of passive investments include index funds and real estate that is managed by another person or entity. Putting money into an IRA or 401(k) may be another method of building wealth in a passive manner.
Active investing strategies tend to be better suited for those who are looking to maximize their returns over a period of several weeks or months. In some cases, active investors are referred to as traders or scalpers.
What to Know About Personal Retirement Accounts
The federal government allows you to place a percentage of your annual taxable compensation into an individual retirement account (IRA). A traditional account can be funded with pre-tax dollars while a Roth account is funded with after-tax dollars.
While it is possible to have more than one IRA, total contributions across all accounts cannot exceed the limit for a given tax year. In 2021, those under the age of 50 can put away up to $6,000 while those over 50 are allowed to contribute up to $7,000.
Generally speaking, funds in an IRA are invested in mutual funds and other conservative investment vehicles. However, if you want more freedom to manage your money, it might be possible to create a self-directed IRA. This enables you to put your money into stocks, startup companies or any other investments that have long-term wealth-building potential.
If you are under the age of 70 1/2, you will need to start making the required minimum distributions (RMDs) from your traditional IRA. Failure to comply with MRD requirements could result in penalties that equal half of your account balance. Any funds left in your account at the time of your death can be transferred to a beneficiary.
An Overview of Qualified Retirement Plans
Any retirement plan that meets Section 401 requirements is generally referred to as qualified. The 401(k) or 403(b) offered by your employer is a common example of such a plan. Typically, you must be at least 21 and accrue at least 1,000 hours of service before you are eligible to take part in such a program.
These types of plans typically invest in real estate, individual stocks, and index funds. In 2021, you can contribute up to $19,500, and if you are self-employed, you can likely make both an employer and employee contribution. There is an RMD requirement for those who have a traditional 401(k), and you must typically start withdrawing funds when you turn 72 or immediately after retirement.
If your employer offers to match your contributions, it is generally in your best interest to take advantage of that offer. An employer match represents a guaranteed 100% return on your investment without having to do anything to earn it.
Real Estate Can Provide Multiple Revenue Streams
Acquiring real property can be an effective wealth-building strategy because there are so many different ways to generate a return on your investment. Getting started as a landlord can be easy as renting out your home’s garage, attic, or basement. Doing so will allow you to collect a monthly rent check while also benefiting from the appreciation in your home.
Buying land can also be an effective way to earn passive income over a period of several years or decades. If your lot is vacant, you won’t need to pay a monthly fee to a property management company to oversee it.
Investing in commercial buildings can be advantageous because commercial tenants tend to do a better job caring for the buildings that they occupy. Furthermore, companies that make use of office, warehouse, or retail spaces are generally responsible for the cost of maintaining them. Therefore, you get to maximize the return on your investment while offloading most of the risk associated with owning the property to another party.
Alternative Investments Can Be Attractive to a Passive Investor
Stocks, bonds, and cash are what financial professionals think of when they imagine a traditional investment. Depending on who you ask, acquiring residential or commercial properties can either be labeled as a traditional or alternative investment.
Looking into alternative asset classes may present you with an outstanding opportunity to generate a passive income and diversify your portfolio at the same time. In some cases, you won’t have to store the asset on your property or even take delivery of it.
For example, an art collection might be stored at a local art museum while a bottle of fine wine can be kept in a secure cellar. If you like to invest in coins or other precious metals, your holdings can be kept in a vault at the bank as opposed to in your home.
As long as your items are kept in good condition, they will appreciate in value regardless of where they are stored. It may be in your best interest to purchase an insurance policy on any asset that you purchase for investment purposes. If an insured item is lost, damaged, or stolen, the policy will help you recoup a portion of your losses.
Buy a Professional Sports Franchise
If you’re a millionaire who is passionate about both sports and making a passive return on investment, you should strongly consider buying a football, hockey, or basketball team. As the owner, you have the freedom to appoint a president or other executives to run the team on your behalf.
At the same time, you’ll still be able to have input on who the franchise should draft to play quarterback or should be named as the next head coach. Franchises typically make money from a ticket, merchandise, and concession sales, and they may also make passive income from television deals and other sponsorship agreements.
If you can’t afford to buy a team on your own, it may be possible to buy a minority stake in an existing franchise. This might be easier than actually owning an organization outright because you won’t have any significant role in running it.
Should You Keep Money in a Savings Account?
As a passive investor, your goal is to make as much money while doing as little as possible to earn it. Depositing checks into a bank account may be among the least strenuous activities that a person can engage in. These days, depositing or transferring money into a checking or savings account can be done with a few taps on your smartphone.
However, just because keeping money in a checking or savings account is easy doesn’t mean that it will meet your passive investing goals. It isn’t uncommon for banks to offer annual yields of less than 1% for balances of $1 million or more.
Generally speaking, it is a good idea to keep at least some of your money in a bank or credit union. This is because up to $250,000 per account is protected by the Federal Deposit Insurance Corporation. Furthermore, having cash on hand can make it easier to buy stocks or make other investments in a timely manner.
How to Properly Diversify Your Portfolio
Ideally, you’ll invest in a combination of stocks, real property, and alternative investments. Doing so allows you to maximize returns during periods of economic prosperity and minimize losses during economic downturns.
Of course, simply buying a bunch of different assets isn’t enough to protect your money. Instead, you’ll want to take a look at how those assets are correlated to each other. For example, the price of gold tends to move in unison with the price of the S&P 500. This means that a portfolio that is primarily invested in stocks and gold has the potential for outsized gains as well as outsized losses.
However, the price of oil tends to move opposite of the price of gold. Therefore, it may act as a better hedge against any potential losses in the stock market. It is important to note that most of the global stock indices are roughly correlated to each other. Therefore, this type of strategy could work whether you have money in the S&P 500, the Dow 30, or the Nikkei 225.
There are few greater joys in life than watching your bank balance grow despite the fact that you spent zero hours at work today. In addition to securing your financial future, passive investment strategies may allow you to spend more time with family members or volunteering in the community.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.