Source: Flickr user pictures of money.
The wealthiest retirees didn't become wealthy overnight. Instead, they accumulated their riches over decades of consistent saving and budget-minded decisions. Here are some of the best practices of those who have been there and done that, and how to follow in their footsteps.
No. 1: Use the tax code to your benefit
Tax-advantaged retirement accounts provide the single best vehicle for building long term wealth, yet many Americans fail to maximize their benefits. These accounts include traditional IRAs, Roth IRAs, and employer-sponsored retirement plans, such as a 401(k) plan.
Traditional IRAs provide qualifying investors with an opportunity to write off an annual contribution of $5,500 in 2015, and Americans who are older than 50 can add an additional $1,000 catch-up contribution. Roth IRAs don't offer a tax advantage up front, but they do provide tax-=free withdrawals in retirement. Contribution limits to Roth IRAs are the same as for traditional IRAs.
Retirement accounts such as 401(k) plans allow investors to salt away even more pre-tax money than a traditional IRA. In 2015, people can contribute up to $18,000 to a 401(k) and people over 50 can add an additional $6,000 courtesy of the catch-up provision. Self-employed? Consider establishing an SEP-IRA plan that can allow you to contribute up to the lesser of 25% of income or $53,000 in 2015.
Source: Flickr user Mauro Sartori.
No. 2: No swinging for the fences
Before sinking your entire nest egg into that next great investment, consider the source of the investment idea and remember that if you're considering it, others are, too.
Obviously, discovering the next Netflix early on can boost your portfolio value significantly, but for every Netflix you think you've found, you're bound to find a dozen companies that prove to be more promise than profit.
A better investing approach is to build a portfolio of big-cap leaders in their industries that are growing revenue and earnings, and then sprinkle into your portfolio small stakes in potential game-changers. This way, if your next big idea becomes as successful as Netflix, you can benefit without the risk of imploding the rest of your retirement account.
No. 3: Don't stretch for yield
Although its been shown that dividend-paying stocks outperform their non-dividend-paying peers, investors should be careful not to focus too much on dividend yield.
Often, high-dividend paying stocks are troubled companies with faltering businesses or shaky finances. Sometimes, you'll find a down-on-its-luck big-cap dividend stock that's a bargain, but pick the wrong high-dividend-paying stock and you're likely to lose more because of a declining stock price than you're making in yield.
Instead, concentrate on stable dividend-paying companies that generate plenty of operating cash flow and offer a rock-solid balance sheet. Looking for an example? Consider Microsoft Corporation (MSFT +2.13%).
Thanks to its dominant position as the maker of the globe's top-selling operating system, the company continues to be a Goliath in productivity software. Windows 10 is Microsoft's most successful launch yet, and it integrates other Microsoft products deeply within it, giving it additional moneymaking revenue streams. Sure, its 2.58% dividend yield may not be as enticing as that volatile energy stock, but it's still a half percent higher than the SPDR S&P 500 ETF (SPY +0.81%) and it's far less likely to cut its dividend payout down the road than that other stock.
No 4: Curb your credit
While you're maximizing investments on the plus side of your ledger, don't forget to right-size the minus side, too. Managing your personal income statement the way your favorite companies manage theirs will give you more financial flexibility to bulk up your personal net income.
Start by analyzing your debt. Homes historically appreciate in value over time, and home loans are tax-deductible for many Americans, so home-loan debt is less worrisome than other forms of debt. Credit card debt and auto-loan debt, however, are incurred buying things that usually decline in value and they offer no tax advantages, so it makes sense to pay that debt off.
To pay off credit cards, consider a plan that includes at least doubling the monthly minimum payment and making two extra payments every year. A similar strategy can be used to pay your car loan off sooner. Once those debts are gone, repurpose those hundreds of dollars a month toward your investment accounts.
Source: Flickr user Sean MacEntee.
5. Build a rock-solid reputation
Most people are aware that a credit score is important because it allows you to get credit, but don't overlook the fact that a high credit score can save you big money over your lifetime.
Fair Isaac Corporation (FICO +2.54%) is the company behind the FICO score most lenders use to evaluate your creditworthiness, and according to them, the interest rate you pay over the life of a loan can vary dramatically based on your credit score.
For example, a person with a credit score north of 750 will pay 3.65% per year in interest on a $200,000 30-year home loan, or $915 per month. Over 30 years, the borrower will fork over $129,411 in interest to the bank on that loan. However, if the borrower's credit score is below 640, that person will pay 5.24%, or $1,103 per month, and over the loan's lifetime, he or she will be on the hook for a whopping $197,141 in total interest. That's a $67,730 difference, and that's far from chump change.
Tying it together
There's no guarantee that these moves will make you rich, but embracing a formula that reduces taxes, maximizes investments, and eliminates debt could be the best formula for accumulating wealth and living a truly golden retirement. Making decisions like these can make a significant difference in your financial security, but only if you stick with them. Consistency in employing investing and credit best practices may be the single biggest reason rich people get rich.
