Source: Flickr user Philms.
For Warren Buffett, money isn't a huge concern. Although the "Oracle of Omaha" lives a modest lifestyle as a reminder of his upbringing, it's not as if the world's second-wealthiest man has to worry about coming up short on the bills.
For the average Joe, however, that can be a primary concern.
According to data released in August by Sentier Research, the typical American household is bringing in more annual income than it did in 2011 (3.8% more, to be exact), but a median household income of $53,891 doesn't necessarily mean that Americans have a lot of spare cash to work with after their bills are paid.
What's even more troubling is that since 2009, only senior citizens -- the age group in our country that has the majority of wealth -- saw their median income increase. Americans approaching retirement saw their median incomes drop 6.4%, while those aged 35 to 55 suffered a drop of 3.1%-5.2%. The plain-as-day truth is that these pre-retirees need to make increasingly smart decisions with their money in order to ensure financial security in their golden years.
With that in mind, let's take a closer look at five things the average Joe should do to ensure their financial security.
No. 1: Make, and adhere to, a budget
The first step to removing the fear of living paycheck to paycheck is to develop a budget. Having a set monthly or yearly budget sounds simple, but you'd be surprised how few people actually use one. Based on a Gallup poll from last year, just 32% of Americans actually developed and stuck to a monthly budget. And trust me, this lack of follow-through shows when it comes to saving for a rainy day.
Source: PT Money via Flickr.
Based on the June 2014 Financial Security Index, a monthly survey conducted by Bankrate, just 23% of respondents claimed to have enough in their checking, savings, or money market account to cover six months or more worth of expenses. This means 77%, including those who refused to answer or who didn't know, can't pay their bills six months into the future if something unexpected happens, such as the loss of a job or a major unexpected cost.
A budget can actually be created quickly and easily using personal finance software. By sticking to a budget, you'll have a far better idea of where you stand financially, and you'll potentially be able to save money to cover emergencies as they arise.
No. 2: Never turn down free money
If we want to remain financially secure in retirement, we need to plan ahead and save as much as possible. Unfortunately, data from the Investment Company Institute shows that a third of Americans aren't taking advantage of the "free money" offered by tax-advantaged retirement plans.
Source: Southwest Airlines.
First and foremost, if your employer provides a 401(k) plan, find out whether your employer also matches 401(k) contributions. By contributing at least the maximum amount your employer will match, you can really juice your retirement account. Southwest Airlines (LUV 3.24%), for instance, will match its employees up to a whopping 9.3%, according to Bloomberg.
In addition, the average Joe should consider taking advantage of a Roth individual retirement account. A Roth IRA allows an individual to contribute up to $5,500 in 2014 (or $6,500 if aged 50 and up) and invest that money without having to pay a cent in taxes on the gains thereafter. The only catch is that the money can't be withdrawn for any unqualified reasons prior to age 59-1/2, lest the account holder face a steep penalty on those withdrawals.
Between contribution matches, a get-out-of-taxes card, and more, tax-advantaged retirement accounts are the best way for the average Joe to build an enviable nest egg.
No. 3: Buy companies that you know and that make a difference
Third, consider investing your hard-earned money in one of the world's greatest wealth-creators: the stock market.
Understandably, buying individual stocks doesn't fit everyone's risk tolerance or investment plan, but there are simple, low-risk ways the average Joe can participate in the market's historically strong performance.
Source: Apple.
To begin with, investors should stick to businesses they know and understand. Apple (AAPL 0.17%) continues to revolutionize how businesses and consumers interact with our surroundings. First with smartphones and now with wearable devices and Apple Pay, Apple remains on the cutting edge of tech and convenience.
Remember, you're not buying a stock; you're investing your money in a share of the business itself. We should evaluate potential investments based on whether the company is making the world better over time. Asking these questions can help weed out a lot of businesses that don't have staying power over the long run.
If individual stocks are too risky or time-consuming, the average Joe can always turn to mutual funds, which come in a variety of risk classes and can cover the broader market or specific sectors of the investor's choosing. Given the stock market's historical annualized gains of almost 10%, avoiding the stock market completely may be an unwise decision.
Source: TaxRebate.org.uk via Flickr.
No. 4: Supplement your retirement with dividend reinvestment
In addition to buying companies that make a difference, the average Joe should focus on finding businesses that pay a high-quality dividend.
On the surface, a dividend yield may not look like much -- 2% here, 3% there, and so on. However, dividends, when reinvested back into the company in the form of additional shares, can be the "X" factor that allows Americans to retire comfortably.
To demonstrate the power of dividend reinvestment, here's a hypothetical example that makes the following assumptions:
- Joe purchases 100 shares of a stock at $100 per share.
- This stock has a dividend yield of 3%, and its dividend increases by an average of 2% per year.
- The stock appreciates by an average of 8% per year.
Based on this scenario, Joe's initial $10,000 investment would be worth $235,728 after 40 years, including the dividends, which he put straight into his wallet. However, if these same dividends were reinvested in new shares, Joe would walk away with $342,257 -- that's an extra $100,000-plus compared to the alternative! That's a smart way to ease your financial-security concerns.
No. 5: Avoid "quick money" scenarios.
Lastly, avoid get-rich-quick investment ideas. Timing the stock market and making profitable short-term trades is nearly impossible to do with any consistency.
The most secure way to enhance your wealth is to buy and hold quality investments over the long term and use time and compounded gains to your advantage. This is how great investment moguls like Warren Buffett have amassed billions in net worth. Although you probably won't catch up with Warren Buffett anytime soon, there's no reason to believe that, by following the steps outlined above, you can't also put yourself on the path to financial security.
