Although Wall Street can be a complicated place, growing a million-dollar portfolio is actually fairly straightforward. There are only a few important steps to get right. The biggest problem is often that humans, as a group, tend to focus on today and have a hard time thinking about the long-term future. Here are three simple steps to follow to create massive wealth (pay extra attention to step three).
1. Spend less than you earn
Delayed gratification is an important skill to learn if you want to build long-term wealth. Essentially, you have to put off spending today so you can spend more in the future. Another way to frame that same idea is that you save money by spending less than you earn. Simply put, you will never be able to create a nest egg if you don't save money.
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Although you have to find the method that works best for you, a fairly straightforward way to do this is to pick a percentage of your salary and automatically push that money into savings. If you are just starting out, you might want to use a low percentage (say 5% or less) and build that up over time. This is what many people call "paying yourself first". The goal should be to save 10%, or more, of your take-home pay.
There's one caveat here. If you are young you have more time to save and can, thus, save less aggressively. If you are older, you will need to save more to build up the savings needed to achieve millionaire status.
2. Put the money you save to work
The first thing you'll want to do with your savings is to build an emergency fund with roughly three to six months of living expenses in it. It can be in a bank account, CD, or money market fund. The idea is that this money is a backstop against adversity and should be relatively easily accessible, but not in an account you use for everyday spending. Ideally you will never have to touch this cash, but at least it will be there if you need it.
After you have an emergency fund, you should start investing. For many, the best path will be the simplest one. That might mean buying a balanced fund that owns both stocks and bonds, like Vanguard Balanced Index Fund (VBINX). That fund follows a 60% stock and 40% bond split using index funds. If you prefer active management, you might go with Vanguard Wellington Fund (VWELX), which has a similar stock/bond target, but human beings pick the stocks. Or, if you are more conservative, you might go with Vanguard Wellesley Fund (VWINX), which targets a 40% stock and 60% bond mix.
More active investors can pick their own stocks and/or bonds. The goal is simply to put your savings to work in assets that have a history of growing in value over time. The best option is stocks, with bonds offering diversification and safety. Clearly, these are broad generalities, since there are risky bonds, too. The point is to find something that feels right for you, which could mean investing for growth or focusing on value stocks. If you are going to pick your own individual investments, dig in and understand yourself and what approach is appropriate for your temperament.
VBINX Total Return Level data by YCharts.
3. Repeat no matter what
Steps 1 and 2 are fairly simple matters and pretty easy to understand. Things get hard when it comes to step 3. You have to keep doing steps 1 and 2 over and over again. You have to save and invest when Wall Street is in a bull market and when it is in a bear market. You need to keep going when you yourself are in a good mood and when you are in a bad mood. This is why it is so vital to pick an investment approach that feels right for you. If you don't, and you follow investment fads, it will be easier to give up when times get tough.
While you have to do steps 1 and 2 if you want to build a million-dollar portfolio, it is step 3 that will likely end up being the most important step. For the vast majority of people, getting "rich" slowly is the best path. That requires consistency and an ability to control your emotions. Setting your investment plans on autopilot (which is where paying yourself first and mutual funds come in) so you don't have to think about step three as much is likely to be a winning move. Basically, try to keep your emotions out of the equation and focus on the long-term value you are working to create.
Remember, however, that you are human. You will probably make mistakes along the way. It's OK, just get back on the right path as quickly as you can. And try to learn from the mistakes you made. Why did you stop saving? Maybe you need to examine your spending habits again because they have changed over time (for example, you may have started a family). Why did you choose to sell an investment? Maybe you were being more aggressive than you could really handle emotionally (a more conservative approach might be a better fit).
Repeating steps 1 and 2 isn't actually something that is static for most people. You have to fiddle along the edges over time to keep yourself on the right path because life changes and so do you.
Get started as soon as possible
Creating a plan to get to millionaire status is pretty simple, as the three steps above highlight. The hardest part is often just getting started. The sooner you do that, the better off you'll be. And remember, if you want to set yourself up for success, you should try to keep emotion out of the process as much as you can. Autopilot is your friend when it comes to building wealth.
