Anyone can achieve wealth over time with the awesome tax-sheltered tools we have available, and it’s actually incredibly easy to do so. Individual Retirement Accounts, or IRAs, are my favorite vehicle for tax-free growth. If you don’t know much about IRAs, there’s a gazillion good resources out there to check out (all I will say here is that you should likely want to consider a Roth over a Traditional).
The only prerequisites to the dummy-proof plan are a steady income and a long-term, disciplined mindset. With those conditions satisfied, there are literally only a handful of steps:
1.) Open an IRA through a quality discount broker. You don’t need a full-service broker who charges you up the nose for commissions and account maintenance, and you definitely don’t have to settle for an IRA with the local bank- tax-free or not, the miniscule interest you’ll get won’t compound very fast. They love to promote their IRAs alongside their regular banking products, but you can do better.
I highly recommend TD Ameritrade; for a ‘discount’ broker, they are pretty darn impressive. Their web site is great, customer service is great, and they are just plain pleasant to do business with. There are no account maintenance fees and trading commissions are a very reasonable $9.99 per transaction. Full-service brokers have a lot to offer, with our dummy-proof plan none of those costly frills will be necessary.
2.) Divert a Portion of Your Income
Every dollar that you can manage to put into this account, do it. Of course we all have bills to pay, day-to-day living expenses, and other savings objectives, but funding your IRA should become a top priority as well. If you feel you can only start with 2-3% of your income, great- that’s better than nothing. You should strive to gradually increase the percentage of your income deposited into your IRA; if you can get up to 10%+, you’re well on your way.
There are two big rules here:
A.) Pay yourself first. Don’t wait until you spend your paycheck on everything else and then try to save what’s left over; it’s very likely there won’t be any. Set up an automatic payment plan and pay yourself before doing anything else with your income. After a while you won’t even realize the money is being withdrawn.
B.) Always save a percentage of your income, not a dollar figure. This way your savings are guaranteed to rise in locks-step with your income. Parkinson’s Law of Finance will therefore be extinguished entirely.
3.) Dollar-Cost Average into Exchange-Traded Funds (ETFs)
When I think all the awesome relatively recent innovations in the financial world, ETFs are close to the top of the list (sorry mutual funds; your glory days are long gone). Barring a complete economic collapse, if you dollar-cost average into diversified ETFs over a significant period of time, you will become wealthy.
By far my favorite provider of ETFs is Vanguard- here’s a link to all the ETFs they offer. With a small amount of money, you can literally own thousands upon thousands of different companies over all the globe. Gone are the days when small investors, looking for diversification, were at the mercy of underperforming and over-expensed mutual funds.
Simply pick and choose the ETFs that suit you (consider a foundation around the market indices), and begin dollar-cost averaging on a regular basis. Your only real concern is the commission you pay on each transaction (for example, don’t buy $100 worth of shares with a $10 commission). Other than that, it’s extremely straightforward.
4.) Repeat, repeat, and repeat some more.
Once you get the habit firmly engrained, it’ll become second nature to contribute on a consistent basis and the thought of quitting will be ludicrous. Until that point arrives, its imperative to keep at it. I normally hate clichés, but slow and steady does win this race.
5.) If you are maxing our your IRA, open a taxable account and invest there as well.
There’s no use settling for what the government says you can put away, so follow steps 1-4 in a taxable account as well if you’re maxed out. It really won’t change too much. The buy-and-hold strategy means you don’t have to worry about paying capital gains taxes until the way distant future, although you will have to pay taxes on dividends just like you do bank interest.
The other difference is that now you have some more options regarding your dividend income. In an IRA, you reinvest 100% of your dividends by default (whether it be the same holding or not). In a taxable account, you can use the dividends in any way you see fit, giving you the opportunity to begin using a portion of them for passive income if you elect to do so.
6.) Start steps 1-5 as early as possible.
Every day that you fail to put money away is a day that compound interest won’t be working for you. Don’t wait- start today.
That’s pretty much it. It really is incredibly easy, so there’s absolutely no reason why you shouldn’t be on the road to financial abundance!
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