Twenty Steps to Seven Figures :1 Twenty Steps to Seven Figures Barbara O’Neill, Ph.D., CFP Rutgers Cooperative Extension


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


Millionaires Are In The News! :3 Millionaires Are In The News! Game shows Best-selling books Millionaires are rare: of U.S. population of over 274 million, 4.6 million households have a net worth of at least $1 million (1998) Median U.S.household net worth is $71,600.


Wealth Accumulation Takes Time :4 Wealth Accumulation Takes Time Average age of millionaires: late 50s to 60 Compound interest over time, especially in tax-deferred or tax-exempt investments One study: millionaires have been investing for 30 years First million is the hardest (Rule of 72)


Recent Publications: :5 Recent Publications: Eight Steps to Seven Figures (Carlson) Getting Rich in America (Lee & McKenzie) Rags to Riches (Liberman & Lavine) The Millionairess Across the Street (Flores & Sander) The Millionaire Mind (Stanley) The Millionaire Next Door (Stanley & Danko)


Step1: Set Measurable Financial Goals :6 Step1: Set Measurable Financial Goals Without goals, investing is hard to sustain Have a “why” to invest (whatever it is) A goal should be personally meaningful Break a big goal into “mini” goals: $1 million by age 65 $500,000 by age 57 $250,000 by age 50


Make Your Goals SMART :7 Make Your Goals SMART Specific: who, what, where,when, why? Measurable (e.g., progress benchmarks) Attainable (within your ability to achieve) Realistic (goals that “fit” lifestyle) Tangible (visualization = motivation)


Step 2: Start “Paying Yourself First” - Starting Today :8 Step 2: Start “Paying Yourself First” - Starting Today Time is an investor’s biggest ally Compound interest is awesome 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 For every decade an investor delays, the required investment triples


The Most Important Dollar You Invest is the One Invested Today :9 The Most Important Dollar You Invest is the One Invested Today There are plenty of low-cost investments: Employer payroll deduction plans DRIPs (stock purchases) Low-minimum mutual funds “Automate”your investments The first million is the hardest (Rule of 72)


Step 3: Diversify Your Investment Portfolio :10 Step 3: Diversify Your Investment Portfolio Diversification reduces- but does not eliminate- investment risk Select different asset classes and different investments within each class (e.g., stock) Mutual funds and unit investment trusts (UITs) are already diversified Keep investing: up or down markets


Time Diversification :11 Time Diversification The risk of volatility (i.e., ups & downs) in investment value is reduced as an investor’s holding period increases Don’t worry about day-to-day or month-to-month (or even year-to-year) fluctuations Don’t panic and sell during market downturns


Step 4: Invest Regularly by Dollar-Cost Averaging :12 Step 4: Invest Regularly by Dollar-Cost Averaging Takes the emotion out of investing: forces you to buy during market dips Make regular deposits at regular intervals, regardless of market levels Buy more shares when market is down Buy fewer shares when market is high Invest what you can afford (e.g., $100 per month)


More Dollar-Cost Averaging Tips: :13 More Dollar-Cost Averaging Tips: Make deposits at beginning of the month rather than end: adds up over time DCA with low-expense mutual funds (e.g., index funds) and solid blue-chip stocks Avoid speculative stocks Use “automated” investment programs Modify occasionally, as needed


Step 5: Buy & Hold Stock For the Long Term :14 Step 5: Buy & Hold Stock For the Long Term Carlson survey: 75% of millionaires surveyed held stock for more than 5 years Frequent trading is expensive: commissions, short-term capital gains & reinvestment risk There aren’t that many good ideas: financial markets are efficient (i.e., stock prices reflect company value)


Market Timing Increases Investment Risk :15 Market Timing Increases Investment Risk The biggest risk of investing is being out of the market when it goes up Example: DJIA increased 24% in just three months in late 1998 (many investors missed this because they panicked and sold out) One study: S&P 500 index,1991-1998: 21% return Miss 10 best trading days: only a 16% return Missing 5% on $10,000 investment (compounded monthly): $195,266 penalty after 17 years


Reasons to Stay Invested :16 Reasons to Stay Invested Very difficult to be right twice (getting out of stocks and getting back in) You have to be in the market when “bursts” (big price increases) occur Market declines provide buying opportunity Historically, stock market bounces back reasonably quickly


Step 6: Take Prudent Investment Risks :17 Step 6: Take Prudent Investment Risks Prudent risks are risks that have real potential to increase your return (e.g., quality blue-chip stocks) Biggest risk: avoiding risk (100% cash and/or bonds) Low-maintenance strategy: “Buy the market” with index funds or exchange traded funds (e.g., i-shares)


Other Prudent Investing Strategies :18 Other Prudent Investing Strategies Add to investments consistently Don’t get greedy for unrealistic returns Avoid the urge to check daily returns Use discount or online brokerage firms and no-load stocks and mutual funds Start investing today: don’t wait for market to drop


Step 7: Choose Quality Stocks :19 Step 7: Choose Quality Stocks Better to get steady12% to 15% average return per year than very volatile returns 12% -15% returns double money every 5 to 6 years (Rule of 72) “Singles” sometimes produce “home runs” Quality companies dominate their industries and have consistent profits


“Millionaire Maker” Stocks (Carlson Research) :20 “Millionaire Maker” Stocks (Carlson Research) Lucent Technologies General Electric Merck Intel Microsoft Cisco Systems Dell Computer Exxon Mobil Eli Lilly IBM America Online Pfizer AT&T Home Depot Walgreen Amgen BellSouth Wal-Mart AFLAC American Express


Step 8: Minimize Investment Expenses :21 Step 8: Minimize Investment Expenses Use DRIPs and “no-load stocks” (DPPs) to bypass brokers (watch their fees) About 1,100 companies allow investors to buy stock directly (28 of 30 in DJIA) Maximize payroll deductions (no cost) Use no-load mutual funds without an up-front sales fee Avoid mutual funds with 12(b)1 fees Consider low-cost index funds


Costs Matter! :22 Costs Matter! $50,000 in an average stock mutual fund with a 1.5% expense ratio: $50,000 x .015= $750 (annual expenses) $50,000 in an index mutual fund with a .20% expense ratio: $50,000 x .0020= $100 (annual expenses) Over time, the difference is magnified


Step 9: Take Advantage of Tax Breaks :23 Step 9: Take Advantage of Tax Breaks 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


Tax Deferral Pays! :24 Tax Deferral Pays! Tax-deferred money continues to grow The longer you defer paying tax,the more you accumulate Money contributed to a Roth IRA grows tax-deferred and is withdrawn tax free Roths: no mandatory withdrawals at age 70 1/2 and can contribute if earn income Roths: can leave tax-free income to heirs (estate-planning tool)


Step 10: Invest Cash Windfalls :25 Step 10: Invest Cash Windfalls Income tax refunds Retroactive pay Bonuses Prizes, awards, & gambling proceeds Inheritances & gifts Divorce & insurance settlements Other


Keep Lump Sum Distributions Tax-Deferred :26 Keep Lump Sum Distributions Tax-Deferred Tax data: only 34% of workers with a lump sum distribution rolled it over into another tax-deferred account Small lump sums more likely to be spent Small amounts add up: $5,000 distribution at ages 25, 35, 45, & 55 8% annual return Worker would have almost $200,000 at age 65 if distributions were invested


Step 11: Live Below Your Means and Invest the Difference :27 Step 11: Live Below Your Means and Invest the Difference Spend less than you earn Distinguish needs from wants “Step Down Principle” (i.e., different spending levels for the same item) Buy cars “new-used” “Toys & trinkets” versus lost wealth Automate investments so money is not spent


Step 12: Develop a Spending Plan :28 Step 12: Develop a Spending Plan Track income and expenses for 1 or more months List fixed, variable, & periodic expenses Calculate savings required to fund goals Create a spending plan Expenses + Savings = Income


Step 13: Work Hard :29 Step 13: Work Hard Organize your life with the future in mind Set realistic life goals and steps to achieve them Expect “seasons of hard work” Follow your passions Take calculated risks Search out opportunities & network


Step 14: Increase Human Capital :30 Step 14: Increase Human Capital Education and income strongly related Greatest return on early years of education Learn skills that are in demand by employers Networking expands opportunities Never consider your education finished


Step 15: Grow Your Net Worth :31 Step 15: Grow Your Net Worth Increase assets Reduce debts Aim for a 5% annual increase (e.g., $200,000 net worth x .05 =$10,000) 10% (or more) is even better Calculate net worth annually to measure progress


Step 16: Practice Stability :32 Step 16: Practice Stability 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 Carlson research: millionaire investors had three different jobs during career


Step 17: Take Care of Yourself :33 Step 17: Take Care of Yourself Health care costs are another financial “shock” Exercise, eat right, get enough rest,and reduce stress Healthy people are more productive, likely to get promoted, and earn more Make sure health insurance is adequate Longer life: better return on $ (SS)


Step 18: Believe in Yourself :34 Step 18: Believe in Yourself Develop qualities like discipline & focus Identify & address investing obstacles Maintain a positive attitude Shed common myths: “You need a lot of money to invest” “Investing is complicated” “You can get rich day trading” “It’s too late to start”


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


Step 20: Be Patient :36 Step 20: Be Patient Ordinary people do become millionaires Accumulating $1 million could take several decades 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) Get started today: compound interest is not retroactive!