How to Build (or Rebuild) Wealth
Our 11-part plan will help you establish a solid financial foundation or take stock of your progress.
As distressing as the past year has been, most Americans’ balance sheets have survived more or less intact. But even if your finances are still healthy, take note: Amid the ups and downs and twists and turns of the economy and stock and bond markets—plus all the other forces that buffeted your finances—there are lessons that could help you make better decisions the next time calamity strikes.
Building wealth helps you reach your goals as well as survive setbacks—stock market corrections and bear markets, recessions, health emergencies, and job loss. Your wealth-building refresher course should include an honest assessment of whether you allowed emotional, psychological or other behavioral miscues to nudge you to make money moves you may now regret, such as exiting the stock market near the bear-market low and missing the rebound. “Our brains are not wired to easily make rational decisions when our fear is through the roof,” says Michelle Spaziani, a certified financial planner and founder of Summit Behavioral Wealth. To avoid making the same mistakes next time, she says, determine the triggers that can push you to upend your plan. The good news: Mistakes are learning opportunities that can put you on track to accumulate even more wealth.
Stick with stocks
Bailing out of the stock market might have seemed like a good idea last spring, when the economy was in pandemic lockdown, major cities resembled ghost towns and job losses were piling up. Stocks were heading for the first bear market in more than a decade. But selling turned out to be a terrible idea—especially for investors who never got back into the market. They missed out on the fastest recovery ever and a 75% rally from the low point for the S&P 500.
A costly retreat to the sidelines only reinforces the mantra that trying to time the market is not a winning strategy. The lightning-fast, 16-session COVID-19 stock bust and the boom that followed offer a reminder that timing an exit from the market is just the first of a two-part decision. The second, more important part is deciding when to get back in.
Often, that means missing big gains, such as the S&P 500’s 9.3% spike on March 13, 2020, and a 9.4% surge 11 days later (the 9th- and 10th-best daily jumps ever). Missing big up days can crimp returns big-time. An investor who missed the best 10 days for the S&P 500 in the 20 years ending in 2019 would have earned an annualized 2.4% return and turned a $10,000 investment into $16,180, compared with a buy-and-holder’s 6.1% gain and account balance of $32,241, according to J.P. Morgan Asset Management. It’s true that dodging the worst 10 days would have produced 10.1% annualized, turning $10,000 into more than $68,000. But it is unreasonable—if not impossible—to believe that anyone is capable of consistently divining market highs and lows.
The takeaway: “You can’t control market moves, just your own,” says Lindsey Bell, chief investment strategist at Ally Invest.
Spread the wealth around
Another lesson for investors from the pandemic is that the market is unpredictable. And that highlights the importance of having a diversified portfolio. Diversification won’t protect you from losses, especially over the short term. But it should smooth out your ride in the long run. Spreading your assets among a number of investments will keep a downturn in one of them from tanking your whole portfolio. The counterintuitive rule of thumb is that if part of your portfolio isn’t underperforming at any given moment, then you’re not diversified enough.
Start with an asset-allocation plan. Set targets for how much to hold in stocks, bonds and cash or other assets appropriate for the length of time you have to invest and your risk tolerance, says Eric Walters, a CFP in Greenwood Village, Colo. A portfolio for a moderate-risk investor with a 10-year time horizon might hold 40% in bonds, 35% in U.S. stocks, 15% in foreign stocks and 10% in cash; an aggressive investor with a longer time frame might put 60% in U.S. stocks, 25% in foreign stocks and 15% in bonds.
Having allocation targets will force you to be disciplined about rebalancing your portfolio by periodically skimming off some of your winnings and deploying the profits into lagging assets, which basically ensures that you’ll sell high and buy low. Rebalance once a year, or whenever your allocation strays 10 percentage points beyond its target. “Whatever your trigger, it doesn’t matter much,” says Paul Winter, a certified financial planner in Salt Lake City, Utah. “It matters more that you just do it.”
Even with stocks waffling lately, most investors will need to sell stocks and buy bonds to rebalance these days. Which bonds you buy will depend on the role you expect them to play in your portfolio—say, a foil to stocks, a safe place for cash you need soon, a source of income or an inflation hedge. A high-grade bond fund such as Fidelity Investment Grade Bond (symbol FBNDX) can fortify your portfolio against a stock market downturn, for example. A short-term fund, such as iShares Ultra Short-Term Bond (ICSH), can preserve capital.
With rising inflation worries, a 5% to 10% allocation (taken evenly from your stock and bond slices) to an inflation hedge might be in order. Treasury inflation-protected securities, which you can buy directly from Uncle Sam, are one option. Commodities, another traditional inflation hedge, may be timely, says Winter. Aberdeen Standard Bloomberg All Commodity Longer Dated Strategy K-1 Free ETF (BCD) tracks the Bloomberg Commodity index, and as its name suggests, there’s no K-1 tax form to tangle your tax return. (For more on commodities, see Street Smart.)
Save more for retirement
A well-funded retirement plan will provide peace of mind and, ideally, provide something left over for your children so they can start building wealth on their own.
But even disciplined savers were thrown off their game by the pandemic. Layoffs, furloughs and reduced hours forced millions of workers to reduce contributions to their 401(k)s and other savings accounts or take withdrawals to pay the bills. Others who managed to keep their jobs tapped their savings to help family members. More than one-fourth of parents took money out of their retirement plans or investment accounts in 2020 to help pay their children’s rent or other living expenses, according to a survey by the National Association of Personal Financial Advisors.
To get your savings back on track, start by repairing any damage inflicted by the pandemic. If you took a coronavirus-related hardship withdrawal from your 401(k) or other tax-advantaged retirement plan, the Coronavirus Aid, Relief, and Economic Security (CARES) Act gives you up to three years to repay the funds you withdrew, as long as your employer allows it. The repayment will be treated as a tax-free rollover. (If you repay the distribution after you’ve paid taxes on it, you can file an amended return and get a refund.) The sooner you repay the money, the more time it will have to compound and grow.
Similarly, if you took a loan from your 401(k) plan last year, resolve to repay it as soon as your finances allow. While the CARES Act gives you six years instead of five to repay a 401(k) loan, replacing the funds you borrowed as soon as possible will pay off over the long term.
As the economy improves—and with it, your own finances—step up your savings. During the pandemic, many Americans who managed to keep their jobs saved more than ever. However, a lot of that money is gathering dust in low-interest (or no-interest) bank savings accounts. Improve your wealth-building chops by using some of that money to increase contributions to your retirement savings plans. In 2021, you can save up to $19,500 in a 401(k) or similar workplace plan, or $26,000 if you’re 50 or older. (For suggestions on deploying nonretirement savings, see the next item.)
There are other strategies to boost your retirement nest egg that will also lower your taxes in retirement—a key to building wealth. In 2021, you can invest up to $6,000 ($7,000 if you’re 50 or older) in a Roth IRA, as long as you meet income thresholds. Withdrawals from a Roth are tax-free as long as you’re 59½ and have owned the account for at least five years. If your employer offers a Roth 401(k) plan, divert at least a portion of your contribution to that account. Contributions to a Roth 401(k) won’t reduce your taxes now, but as is the case with a traditional Roth, withdrawals will be tax-free when you retire. There are no income limits on Roth 401(k) plans.
If you have an eligible high-deductible health insurance plan, you can fund a health savings account—a valuable wealth-building tool. Contributions are pretax (or tax-deductible, if your HSA is not employer-sponsored), the funds grow tax-deferred in the account, and withdrawals are tax-free for qualified medical expenses, without a time limit. If you don’t use the money for out-of-pocket expenses while you’re working, you can take tax-free withdrawals to pay for medical expenses after you retire. In 2021, you can contribute up to $3,600 if you have self-only coverage or up to $7,200 for family coverage. If you’re 55 or older by the end of the year, you can put in an extra $1,000 in catch-up contributions.
Put more money into savings
For those who suffered financial setbacks during the pandemic, saving has been tough. But overall, Americans have been putting away more money as they stay home and spend less. As measured by the U.S. Bureau of Economic Analysis, the personal savings rate spiked to a record 33.7% of disposable income in April 2020 as COVID-19 swept the country and Americans received government stimulus checks. The rate has remained well above 10% since then—higher than it was for years before the pandemic hit. Banks have been flooded with deposits. You can use any extra cash that you have on hand to save for a rainy day, the post-pandemic vacation you’ve been waiting to take, a down payment on a home or other goals.
On the downside for savers, interest rates are bottom of the barrel—the average savings account pays 0.07%, according to Bankrate—and they will likely remain depressed for a few years. But you can look for above-average yields on accounts in your area by visiting DepositAccounts.com. Some high-yield checking accounts offer rates of more than 4% if you meet certain requirements, such as using your debit card several times monthly and receiving electronic statements. Laddering certificates of deposit—in which you invest money in CDs of varying maturities so that a CD comes to maturity each year, allowing you to withdraw or reinvest the cash—is another smart strategy.
Take control of your debt
About half of U.S. adults with credit card debt have added more to their debt load during the pandemic, and 44% of them blame the pandemic’s effects for it, according to a CreditCards.com survey. Credit cards often charge double-digit interest rates—a recent average of 16%, according to the Federal Reserve—and carrying a balance can quickly cause debt to pile up. Prioritize paying off such high-rate debts.
One way to reduce your credit card rate is to transfer the balance to a lower-rate card. Finding and qualifying for a balance-transfer offer has been more difficult lately as lenders have tightened their standards, but you may be able to get a 0% introductory rate if your credit score is north of 700. The U.S. Bank Platinum Visa card offers a 0% rate for 20 months (then a variable 14.49% to 24.49%); the transfer fee is the greater of 3% of the amount transferred or $5. Other options include paying off the card debt with a lower-rate personal loan or home equity line of credit.
Check in on your other debts, too. Because of the pandemic, borrowers of federal student loans have benefited from a moratorium on payments and interest accrual. The moratorium is currently set to expire at the end of September, so as autumn approaches, get ready to restart payments. (For tips, see Student Loans: Pay Down or Hold Pat?) With 30-year mortgage rates recently averaging about 3%, now is a good time to refinance if you haven’t yet (see below).
Keep your credit healthy
Last July, the average FICO credit score hit an all-time high of 711. That may seem counterintuitive in light of the pandemic and a spike in unemployment, but less spending and more income in the form of stimulus checks and enhanced unemployment benefits have been a boon to credit scores.
A healthy credit history will help you secure the best interest rates on loans, get lower insurance premiums, and boost your ability to rent an apartment or get a wireless phone plan. To help lenders evaluate your creditworthiness, companies such as FICO and VantageScore calculate a credit score based on the information in your credit report. Generally, a credit score of about 750 (on the standard scale of 300 to 850) qualifies you for the best loan terms. You can push your credit score higher by following a few basic rules: Pay all of your bills on time, use a low percentage of the credit available to you on credit cards (the lower, the better; try to stay below about 20%), and don’t apply for multiple credit cards at once.
If your score has taken a hit or could use a lift, follow these steps: The number one factor in evaluating your creditworthiness is payment history, so don’t skip payments, even if it means paying only the minimum amount due. If the minimum isn’t manageable, ask your issuer whether it will lower the amount, allow you to defer a few payments or otherwise modify the terms until you’re in a better financial position. One way to add positive payment information to your credit reports is to connect Experian Boost, a free service designed to help increase your credit score, to your bank account and allow it to add positive information about your payment history for utility and cell-phone bills—and even for your Netflix subscription—to your Experian credit report.
Also check your credit report for mistakes, and dispute any if necessary. You can access a free credit report from all three of the major credit bureaus—Equifax, Experian and TransUnion—on a weekly basis at annualcreditreport.com until April 20, 2022.
Recheck your insurance
Insurance doesn’t help you build wealth, exactly. But it protects your assets: Without adequate coverage, a fire, car crash or health emergency could decimate your savings or push you deep into debt. Life insurance helps ensure the financial independence of your dependents if you die, and disability insurance provides income if you can’t work. In addition, consider buying an umbrella policy for more protection from lawsuits. The first $1 million of coverage generally costs $200 to $400 a year; the next $1 million runs an additional $75 to $100.
You can consult a financial planner or an insurance agent to help determine the types and amounts of insurance you need (find an independent agent at trustedchoice.com), and you can compare quotes using sites such as Policygenius.com, Insure.com and AccuQuote.com. If you buy health insurance on your own, take advantage of a special open enrollment period to reshop coverage.
Meanwhile, working from home and eliminating your commute during the pandemic may have changed your auto and homeowners insurance needs. Penny Gusner, of Insurance.com, suspects that auto insurance rates will stay low as folks continue to drive less, so reshop your policy if you haven’t already. (Raising your auto insurance deductible will also lower your premiums.) It may take time before the number of drivers on the road returns to pre-pandemic levels, but traffic deaths have actually increased during the past year. Your state’s minimum liability requirements could be too low to adequately protect you or other people hurt in an accident. If your net worth is more than $100,000, make sure your policy covers at least $250,000 per person, $500,000 per bodily injury, and $100,000 in property damage, says Gusner.
Homeowners who are working from home may want to consider adding equipment-breakdown coverage to their existing home insurance policy. If you add it to a standard home insurance policy, equipment-breakdown coverage will reimburse you for the costs of mechanical breakdowns, an electrical problem due to a power surge or a problem that stems from faulty installation. The coverage typically costs about $24 a year.
Hire a financial adviser
Consulting a pro to help you make important financial decisions—either on an ongoing basis or when major decisions loom—can help you avoid mistakes that could cost you big-time down the line. Advisers come with a wide array of designations, and some require more training and expertise than others. The most reputable ones include certified financial planner (CFP), certified public accountant (CPA) and chartered financial analyst (CFA). Some advisers hold more than one of these designations.
A CFP can take a broad look at your finances and may provide advice on everything from having sufficient insurance coverage to saving for retirement to managing an investment portfolio. Search for one at letsmakeaplan.org. A CPA specializes in taxation and may prepare tax returns or offer guidance on tax strategies; you can look for a CPA with the personal financial specialist (PFS) credential at aicpa.org/forthepublic.html. A CFA focuses primarily on investments. Search for one at cfainstitute.org/en/membership/directory.
Some advisers require clients to have a minimum asset threshold that they manage—say, half a million dollars or more—and compensation methods vary. You may be charged a percentage of investment assets the adviser manages for you (often about 1%) or by the hour, by the project, or on a subscription or retainer basis. You should also sort out whether an adviser receives commissions on the products he or she sells to you, such as mutual funds or insurance policies.
At napfa.org, you can search for fee-only financial planners. CFPs are required to act in their clients’ best interests for all the financial advice they offer. If you’re looking for one-time or occasional advice, a planner who charges by the hour may be a good choice. You can look for fee-only advisers who offer the hourly option at garrettplanningnetwork.com.
Advisers in the XY Planning Network use a subscription model to provide affordable financial planning services to younger adults. Monthly subscriptions vary, with some advisers basing their price on your income. Some planners in the network are also offering pro bono financial planning services to people who have been adversely affected by the pandemic. To find a planner in your area, go to xyplanningnetwork.com.
Protect your legacy
The pandemic nudged a lot of people to take action on an estate plan, but there’s still a long way to go: Only one-third of Americans have a will or other estate-planning document (such as a trust or advanced health care directive), according to the 2021 Wills and Estate Planning Study by Caring.com, a site offering resources for seniors and caregivers. The number rises with income: Some 39% of those with incomes of $40,000 to $80,000 have a will or estate-planning documents, and that jumps to about 46% of those who earn more than $80,000.
Having an estate plan is important for everyone, but it’s crucial as you approach retirement. You tend to have more assets at this stage of your life, and you’ll want to be certain that your spouse and family will be well taken care of if anything happens to you. Without a will, state law dictates how your assets are distributed after you die. Even with a will, going through probate—the court-supervised process of passing assets through a will or, in the absence of a will, distributing them according to state law—can be time-consuming and expensive.
You can avoid probate by setting up a trust, the most common of which is a revocable living trust. (The terms of a revocable trust can be changed if your wishes or circumstances change.) Not only does having a trust let you avoid probate and help ensure that your money goes to the people you choose, but it also lets you control how the money can be used and appoint a person to take control when you’re not available.
The Tax Cuts and Jobs Act of 2017 doubled estate-tax exemption levels. Indexed for inflation, the exemption is $11.7 million per individual in 2021. But unless Congress extends a sunset provision in the tax-reform bill, it will automatically drop back down to $5 million (indexed for inflation) in 2026. And a number of states tax much smaller estates and inheritances.
Even if you don’t have a multi-million-dollar estate, if you have an IRA or another tax-deferred retirement account you want to leave as a legacy, your heirs (other than your spouse) will have to make withdrawals within 10 years of your death—and that could create a significant tax burden. One solution is to convert a traditional IRA to a Roth IRA; nonspouse heirs are required to deplete a Roth within 10 years, but withdrawals are tax-free. An estate-planning attorney can help you sort out tax implications and help minimize the impact on your estate and your heirs. For more estate planning tips, see Money Smart Women.
Build equity in your home
One of the surest ways to boost your net worth is to buy a home and watch your equity grow. If you take out a mortgage, as most home buyers do, you employ the power of leverage—a down payment that may be as low as 3% allows you to enjoy the benefits of homeownership, as long as you make monthly payments and keep up with property taxes and homeowners insurance. Every payment helps reduce the mortgage principal and boost equity, serving as a sort of forced savings account. Price appreciation also adds to the value of your home.
Amid a dearth of homes on the market, first-time home buyers are struggling to find affordable homes. But the scarce supply works in favor of homeowners, who have seen an increase in the median price of existing homes of 14.1% over the past year (through January), according to the National Association of Realtors. (However, that’s far higher than average; by one measure, homes have appreciated 3.4% per year since 1991.)
If you own a home and have a mortgage, the pandemic has been a prime time to lock in a super-low rate, as the coronavirus scare pushed the 10-year Treasury note to an all-time low and the Fed slashed the federal funds rate. By late January, the average 30-year fixed-rate loan had dipped to 2.71%, with 15-year loans averaging 2.2%.
Rates have begun to tick higher, but it may not be too late to lower your rate and use the cash you free up to pay down principal or boost savings. With the 30-year mortgage around 3% (as of early March), some 13 million Americans could lower their monthly interest rate by 0.75 percentage point by refinancing, according to mortgage-data firm Black Knight Inc. The average monthly savings would be about $300, the firm estimates.
To see if you’d benefit from a refi, crunch the numbers using a tool such as The Mortgage Professor’s refinance calculator. You can enter the details of both your current mortgage and your new loan to see how long you’d have to stay in your home to start saving money. Closing costs for refinancing typically run between 3% and 6% of your new loan amount, so it’s essential to know how long it will take to recoup those costs—and to have a good idea of when you plan to sell your home.
Uncle Sam also subsidizes the cost of owning a home with tax breaks. If you itemize deductions on your tax return, you can write off interest paid on up to $750,000 of debt ($375,000 if married filing separately) to buy, build or substantially improve your home (the limit is $1 million—$500,000 if married filing separately—if you took out the loan before December 16, 2017). Itemizers may also be able to deduct state and local property taxes, but there’s a $10,000 combined limit ($5,000 if married filing separately) on state and local income, sales and property tax that you can deduct.
Stash cash in an emergency fund
Job losses and reduced income resulting from the pandemic have thrown into sharp relief the need for a backup cash stash. More than four in 10 consumers with emergency savings have tapped the funds during the pandemic, according to a survey from personal finance site MagnifyMoney. Without a sufficient emergency fund, you may fall behind on bills or resort to high-interest debt or withdrawals from retirement savings to cover them.
The rule of thumb is to save at least three to six months’ worth of living expenses in a savings account. But if you’re the sole wage earner in your household, it’s wise to squirrel away six to 12 months’ worth of expenses. The backup money will serve you well not only if you lose income but also in case of a large, unexpected expense, such as a car repair or medical issue that racks up big bills.
Look for an easily accessible account with a relatively high interest rate and minimal or no requirements to avoid a monthly fee. Recently, the online savings account from Live Oak Bank yielded 0.6% with no minimum balance requirement or monthly fee. The money market deposit account from Axos Bank also yields 0.6% with no minimum or monthly fee, and it comes with check-writing and a debit card.