Do you know where most people build up their biggest pile of wealth?
Most people who work for a company or are otherwise employed and paid through wages often accumulate their greatest wealth in a company-sponsored retirement plan.
There are a few lucky inheritors of wealth, although it’s been my observation that if you can’t save it and accumulate it well, then you probably can’t keep it if it falls into your lap as an inheritance (or the result of a winning lottery ticket). More on that in another post.
Business owners also are often an exception because their capital was put to work in a profitable business enterprise and significant earnings were reinvested, leaving little for retirement or investment accounts. Their retirement wealth is held in their business.
But most of us, financial advisers included, have their biggest source of wealth in their retirement plan. Why, you ask?
Here are my reasons, which also are the very reasons you should consider accumulating savings in this manner if you are not now doing so:
- It’s an automatic and automated way to build wealth because money is silently taken from your pay before you can get your hands on it to spend it. It takes any lack of discipline out of the equation!
- If you are investing for the long term, you can hold equity-growth investments, such as stock mutual funds, that can offer attractive returns over multiple decade-long periods. It’s not guaranteed, and past results aren’t a predictor of future performance, but take a few minutes to check out historical equity returns over 20, 30, or even 40 years.
- Monthly or weekly contributions allow you to take advantage of “dollar-cost averaging,” an amazing strategy for long-term savers (there are risks, especially if you are short term in your time horizon, i.e., less than 20 years).
- It’s tax-advantaged! You can put away money and deduct it from your taxable income, putting 100 percent of the savings amount to work BEFORE paying tax. This money won’t get taxed until you pull it out years in the future during your well-planned-for retirement.
- Or … you can decide to NOT deduct the contribution by making after-tax contributions to your plan’s Roth option, if it has one, and then withdraw money in the future without income taxes (rules apply, of course).
- In either of the two preceding points, money placed into the retirement account is not taxed when dividends, gains, or interest is earned. This money grows and compounds without taxation (until, in the former case, it’s withdrawn).
- Your employer might even make matching contributions, often 3 percent of your earnings and sometimes more.
In my book, The Five Financial Foundations, I make a case for this “Wealth Workhorse” and the importance of starting this program as soon as possible in your working career.