Let’s say you get an extra $100 in your paycheck, and you want to use it to grow your wealth, how can you make the most of that $100?
Disclaimer: The numbers used in this exercise are for an example only and based off historical averages, there are no guarantees on investment returns.
- First, reduce your tax burden for the year by putting it into a tax advantage account like a 401k or Individual Retirement Account (IRA). Right off the back, whether you do anything else with that $100, you saved yourself whatever your tax bracket rate is. If your tax rate is 20%, you essentially turned that $100 into $120 by putting into a tax advantage account because it means you don’t have to pay taxes on $100 of your earned income that year.
- Ok so you saved yourself maybe 20% on taxes, but you want to do even more with that $100, now is time to put it to work by investing it into the stock market. On average the stock market can give you 10% returns each year. Wonderful! Assuming the stock market maintains its average return, that $100 will grow by 10% each year. By putting that $100 into the stock market, based on historical averages, you turned that $100 into $110 + you saved $20 in taxes. Your $100 is now worth $130.
- But there’s more to keep an eye out for. What are you investing the $100 into? Mutual funds have expense ratios and sometimes other fees, but if you invest into an index fund, the expense ratios are often lower. This is where we take a small step back. If you invest into a mutual fund that has higher fees, you could give up some of that 10% in returns for fund manager fees. A decent fund manager fee could be 1.5%, but if you invest into an index fund, the fees are often closer to 0.6%. The difference seems small but can add up over the years. Your $100 is now worth $129.4.
- We’re not done yet. You’re saving money on taxes, paying less fees, and getting a return from the stock market, but there is one more step to make the most of this investment. Turn on your “automatically reinvest dividends”. Some companies offer a periodic dividend payment. It will go to your cash account unless you have it automatically reinvested. You can always take the money from your cash account and buy investments with it manually but setting up automatically dividend reinvestment makes it a nice self-sustaining money-making machine. If you invested in an S&P 500 index fund, the average dividend yield for 2020 was 1.97%. If you reinvested the dividends you received from your $100 of index funds, then you’d have $101.97. Your original $100, after a year, is now $131.37.
Maybe you think turning $100 into $131.37 isn’t that impressive. Maybe you know how to flip the money other ways. Do it! But once you’re done flipping the money, run it through these four steps. You can use these steps at any point in your money-making process.
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