3 Tricks Billionaires Use to Make Their Money Work for Them
Kailey Fralick, The Motley Fool
Updated
People have a lot of opinions about billionaires, but there's one thing that no one can deny: They're good at making money. This sparks envy in many hearts, but the truly wise try to learn from the way billionaires manage and grow their money to help them improve their own net worth. Here are a few of those money-making tricks that anyone -- including you -- can use to grow your savings and achieve your financial goals more quickly.
1. They start investing their money as soon as possible
Investing carries an element of risk, but when done correctly, it can help you grow your savings over time. Leaving money in a savings account might seem like the safer option, but savings account interest rates typically can't keep up with the pace of inflation, which has averaged 3% per year historically, so you end up losing money in the long run. By contrast, the average annual stock market return is 10%.
Wealthy young man in suit counting money.
Image source: Getty Images.
Beginning to invest while you're still in your 20s or 30s gives you a big leg up compared to those who wait until their 40s or 50s to start. This is because the money you contribute in your earlier years has longer to grow and ends up being worth more in the end.
Consider a $100 investment. If we assume a 7% annual rate of return (10% average annual stock market return minus 3% for inflation), you'd have $140 after five years. But if you'd waited 10 years before you touched the money, you'd now have nearly $197. And if you invest money in your 20s and don't touch it until 40 years later when you're ready to retire, that initial $100 will now be worth nearly $1,500.
2. They choose the right investments
Those interested in getting rich quick are more likely to sink their money into what they think is going to be the next "hot" company that skyrockets to fame, but all too often, this costs people money instead of making them wealthier. The wisest investors understand the importance of diversifying, choosing well-established companies that will be around for decades to come, and sticking to their "circle of competence."
This is a term Warren Buffett coined to describe the industries and sectors that a person understands. For example, if you work in energy, this would fall within your circle of competence and you'd be able to make educated decisions about which companies within this sector to invest in.
Smart investors also don't try to time the market. Instead, they practice dollar-cost averaging, where you purchase a certain dollar amount of a stock or another investment product on a regular schedule. Sometimes, you'll buy when prices are higher and sometimes when they're lower. In the end, you'll pay a fair price for the stock instead of potentially losing money by investing at the wrong time.
If you don't know how to choose your investments, you can enlist the help of a financial advisor. Many wealthy people do this once they no longer have the time or interest in managing their money themselves. These advisors work with you to understand your long-term goals and come up with a personalized plan to help you achieve them.
Choose a fee-only advisor if you're considering this route instead of a fee-based advisor. Fee-based advisors may earn commissions when you buy certain investment products and this can cause them to put their financial needs ahead of yours.
3. They make smart choices about the accounts they use
Your retirement accounts are your best option for long-term savings you don't plan to touch for decades. These accounts offer special tax advantages that can help you save money over the long run.
Traditional IRAs and most 401(k)s are tax-deferred, so your contributions reduce your taxable income during the year you make the contribution, but then you must pay taxes on distributions in retirement. These accounts make the most sense if you're at the peak of your career and think you're in a higher tax bracket today than you'll be in retirement.
Roth accounts work the other way. You don't get a tax break in the year you make the contributions, but then all of your distributions in retirement are tax-free, assuming you've had the account for at least five years and are 59 1/2 or older. A Roth account is a wiser choice if you think you're in the same or a lower tax bracket today than you'll be in retirement. You can contribute up to $6,000 to an IRA in 2019 and $19,000 to a 401(k). Adults 50 and older are allowed an extra $1,000 and $6,000 in catch-up contributions, respectively.
If you've maxed out your retirement savings or you don't want to be penalized for accessing your money before 59 1/2, consider a taxable brokerage account. These accounts don't give you the same tax breaks as retirement accounts, but if you leave the money in your account for at least one year, the funds become subject to capital gains tax instead of income tax. A detailed discussion of capital gains tax is beyond the scope of this article, but you'll lose less money by paying this than you would if you had to pay income tax on all your investment income.
For short-term savings, consider placing the money in a high-yield savings account. These accounts offer higher interest rates than traditional savings accounts while still giving you free access to your funds when you need them.
You don't need to be a billionaire to manage your money like one. The three above tips can help you increase your savings and avoid costly investment or tax mistakes. They may not change your financial state overnight, but if you're patient, you'll begin to notice the difference in time.
