Personal finance is just that – personal – but the goals remain the same: To protect and grow your wealth. It’s also a journey of values, habits, and strategies that are constantly learned and evolved. From beginners to experts, there is always something to improve upon. And when it comes to money, it may be best to look towards those who have already built significant wealth. After hundreds of conversations with our clients, we examined some of our wealthiest and selected ten actions we frequently see many of them doing with their money.
Here’s what we found and how you can attempt to replicate it in your own portfolio:
1. Wealthy investors tend to prioritize time, not timing
Our clients with the highest net worth are the more likely to say that they have a long-term mindset when it comes to their investments. This means they are holding investments or planning to hold investments for upwards of 30 years, instead of trying to time the market. There are two key reasons long-term investments can end up being a smart way to build wealth:
Key reason 1: Long-term investing statistically decreases the risk of losing principal.
If you look at the history of the S&P 500 dating back to 1929, the likelihood that an investor would have lost money decreased the longer their money was in the market. On any given day, the index declined 46% of the time. Over the course of one year, losses occurred only 26% of the time. After 10 years, the chance of a loss dropped to just 6%. Historically speaking, the longer you hold, the less risk you have of losing.
Key reason 2: Holding an investment for longer gives you momentum from compound interest.
To put it simply, compound interest is the interest you earn on interest. For example, if you put $10,000 into an M1 plus checking account earning 2.5%, at the end of the year, you will have $10250. The next year, you’ll continue to earn interest on the added interest you earned last year. Without any additional investments into the account, at the end of 5 years you’ll have $11,314 in your M1 checking account.
The longer you let your money sit, the longer it will grow, and the more momentum it gives you. The same compounding can be found in retirement and investing accounts when you reinvest dividends. Many of our wealthiest clients prioritize reinvesting their dividends, either through a Dividend Reinvestment Plan (DRIP) plan or using the auto-invest feature at M1.
2. Wealthy clients expect failures, so many diversify
Often in investing and business, one success will make up for a lot of failures. According to The Psychology of Money, a book by Morgan Housel: The Russell 3000 has increased 73-fold since 1980. About 40% of the companies in the index failed, but the other successes more than cover the losses.
Housel also writes about expectations in a separate article for Collab Fund, “What generates all the emotion is just how big the gap is between expectations and reality.”
The same thing is true when building a portfolio. Smart investors know to expect failures, so diversification can be a great option to keep emotions in check with reality. We see some of our wealthiest clients diversify at M1 in three ways:
Diversifying asset classes
Owning a combination of assets can hedge against market risk. While many asset classes react similarly to macroeconomic events, some have inverse relationships. For example, when interest rates rise, the stock market tends to fall, but the bond market may improve or thrive. In these instances, spreading money across different assets may be a smart move. A portfolio with diversified assets may include owning stocks, bonds, ETFs, cryptocurrencies, real estate, and more.
Diversifying sectors and industries
Another way to diversify is to invest across different sectors and industries in the market. This hedges against business risk. Business risk is the risk that any given business may fail or be negatively affected by macroeconomic events. For example, during the pandemic, industries like airlines and commercial real estate saw declines, but biotechnology and streaming services saw gains. Owning a variety of stocks and ETFs across sectors decreases the impact that poor performance in one industry will have on your overall portfolio.
Diversifying within an industry
Diversifying within an industry is another way to hedge against business risk. If one company in an industry fails, their competitors may be able to capitalize the customer base made available. This in turn may raise the stock price for the competitor and can potentially cancel out losses from the company that failed.
3. Some use tax minimization strategies
Increasing wealth typically correlates with increasing taxes. However, there are plenty of ways to minimize tax implications and they are not reserved only for the wealthy. Here are five strategies we see many wealthy clients using.
1. Company-sponsored 401(k) or 403(b) accounts
The most common form of income deferral is through a 401k or 403b. With these types of company-sponsored plans, money is withdrawn from your paycheck before it is taxed. Your investments will not be taxed until you take the money out. In general, many people will max out their company investment plans while their income is high, with the understanding that when they decide to take the money out of the account, they will be in a lower tax bracket.
2. Individual retirement accounts (IRAs)
Traditional and Roth IRAs are a form of self-directed retirement planning that offer great tax benefits. A traditional IRA operates similarly to a 401k; it keeps money tax-deferred until you take it out during retirement, when you may be in a lower tax bracket. A Roth IRA is funded with post-tax dollars, and it allows your money to grow without being taxed on gains made if you wait until the distribution period begins at age 59 ½. The caveat is that you can only contribute up to $6000 per year (or $7000 if you are over 50) and the limit can decrease based on income.
3. IRA conversions
Because many wealthy people exceed the income level allowed to contribute to a Roth IRA, many will opt for an IRA conversion. They can prioritize contributions made to their 401k or 403b, and when they move on from the job providing that plan, they can roll it over into a traditional or Roth IRA. Rolling it into a traditional or Roth IRA can continue to protect the money from being taxed, while giving you more options with investments.
It is also possible to convert a traditional IRA into Roth IRA. This type of conversion is known as a backdoor conversion. Because traditional IRAs do not have income limits, anyone can contribute to one. This gives the wealthy an opportunity to fund a Roth without directly funding a Roth. Doing a backdoor conversion may require you to pay taxes on the money you convert, but it will prevent taxation later down the road.
4. Tax-loss harvesting and other similar practices
Tax-loss harvesting is a topic brought up frequently by our wealthy clients. Tax loss harvesting allows people to offset income using losses from their investments. For example, let’s say you have a realized gain from Stock A of $300 and an unrealized loss from Stock B of $45. You can sell Stock B so you can use the $45 to offset your gain to have a net taxable gain of $255. You can read more about tax-loss harvesting here.
At M1, we don’t automate tax-loss harvesting but we do have a tax-minimization strategy that will prioritize selling securities from the lowest tax burden to the highest. Tax-loss harvesting is an investment decision that you can make and implement your strategy on M1’s platform or in consultation with a tax advisor.
5. Triple tax-free income from investing in municipal bonds
Another way wealthy clients might make the most of tax planning is to invest in municipal securities. A municipal security is a bond issued by a municipality, state, or county. They are often used to raise capital to fund infrastructure and community projects. Many municipal bonds are triple-tax free, meaning they are exempt from taxes on the municipal, state, and federal levels. They typically hold a lower rate of return, but high-income earners take away a greater benefit when it comes to taxes. Municipal bonds are not available at M1, but many clients we speak to make use of these investments elsewhere.
4. Many high net worth clients know how much cash to keep on hand
Having cash on hand can be incredibly important for financial health. In fact, many investors prioritize having a certain percentage of cash on hand to prepare for times of uncertainty. Nowadays wealthy people are putting cash into high yield savings accounts (HYSA) or money market accounts. According to the FDIC, a regular savings account earns, on average, .13% APY (Annual Percentage Yield). On the other hand, a HYSA can earn from 2-3%. When using a HYSA, your money starts growing without the risk of losing capital. M1 has a checking account that already has rates on par with many HYSAs and we will be launching a traditional HYSA for our M1 Plus customers earning 4.5% APY* in 2023.
But how much is too much cash on hand? The answer will differ for everyone, based on expenses, dependents, and personal preference, but having too much cash on hand can hurt potential for long-term wealth. A study done by T. Rowe Price, found that a $10,000 investment in a three-month Treasury bill grew to $21,351 over a 30-year period ending in December 2020. If that same $10,000 had been invested in the S&P 500 stock index, it would have grown to $211,000 after 30 years.
5. When credit cards don’t cut it, some use leverage
Many people aren’t comfortable borrowing money, especially during an economic downturn, and that is okay. Those who are comfortable know that leverage can be a very handy financial tool. Many wealthy clients know they can use leverage to increase their buying power. Instead of having to sell out of investments (and pay capital gains taxes), they can use a portfolio backed line of credit, otherwise known as a margin loan, or a personal loan to power purchases. This type of leverage might help buy a home, make an investment, pay for college tuition, or even pay a large tax bill.
Historically, wealthy clients have had better options when it comes to low rates and terms, but options are improving for everyone. It’s possible to find flexible borrowing terms with competitive rates, even if you are not in the 1%. You can check out M1’s margin loan here.
6. Many wealthy clients are smart with their credit cards
Wealthy people know they can make their credit cards work for them. There are thousands of credit card options available to consumers, many of which come with benefits like cash back, rewards points, and airline miles. Those with good enough credit to have lots of options in the credit card department and can pick one (or multiple) that will give them the most bang for their buck.
A person who loves traveling might have an airline credit card to maximize travel rewards and miles. Others may want more flexibility and might get a card like the Owner’s Rewards Card by M1 that gives 10% cash back on a variety of popular brands used for groceries, gas, airfare, shopping and more.
7. Wealthy clients tend to invest in knowledge
Being well-informed can make all the difference. It’s challenging to make money in the stock market or any other investment medium without a certain skill set or baseline knowledge. Wealthy investors take time to educate themselves. This may be as simple as taking time to read an investing book from time to time, but it could mean taking classes or even getting a degree. Starting with a book is a great first step. If you’re looking for recommendations, we think these are great books to learn a little more about money.
8. Many wealthy clients know how to stay wealthy
Whether someone is building wealth or maintaining it, their lifestyle choices and habits need to align with their goals. It is common to see professional athletes and celebrities quickly become rich, only to fall into debt because of frivolous spending and poor money management.
Often, smart, wealthy people live below their means so they can use the leftovers to save for retirement or increase their wealth in other ways. They choose to create good habits for themselves to keep on track. This might include setting up recurring transfers, reinvesting dividends, or creating a budget to follow.
9. Both partners tend to be involved
We frequently see our wealthiest married clients working as a team in their wealth management. This isn’t limited to having a joint investing and checking accounts. This means both partners collaborate on which investments they pick and manage the money together. There are a few reasons involving both partners can be a smart idea.
Teamwork makes the dream work
Collaborating on investment decisions can lead to making better investments, being more mindful about goals, and staying on track for financial success. It will also foster a sense of teamwork in your relationship. According to BetterHelp, practicing teamwork in a relationship makes couples better prepared to handle obstacles and strengthens your bond to each other.
It avoids conflict
When only one spouse is managing money, they can often have disputes about decisions made without the other. Instead, managing together can help find compromises and keep both spouses happy. Our Client Development team regularly has calls with couples to make sure both partners understand the platform. If you and your partner are interested in setting up time to speak with our team, you can set up some time here.
10. Many prioritize saving for their kids and having discussions about wealth
Finally, wealthy people prioritize passing on wealth to their children and preparing children for how to think about money. There are many ways to plan for your kids, such as starting a trust fund, using a 529 education savings plan, or using custodial accounts. Starting one of these accounts when a child is young can strategically build wealth for your child or grandchild and set them up to pay for expenses when they leave the nest. It can also be a terrific way to plan for passing along generational wealth and avoiding tricky probate situations.
It is important to keep in mind that these various account types might have different tax implications. Reviewing these ahead of time is crucial to opening these accounts.
Not only do we see wealthy people putting money away for their kids to enjoy later in life, but they talk to their kids about money, too. Talking about money has often been thought of as taboo, but talking about money can give kids a better understanding of money and wealth. In turn, as they grow up, they will know how to budget, how to prioritize savings, if it’s better to buy or rent, and the list goes on and on.
*Obtaining stated APY (annual percentage yield) or opening an account does not require a minimum account balance. Stated APY is valid from date of account opening. Account fees may reduce earnings. Variable APY rate subject to paid M1 Plus subscription. Stated APY (annual percentage yield) for M1 Savings accounts is subject to change prior to product launch due to changing federal funds rate.
**1.5% – 10% Owner’s Rewards cash back earned on eligible purchases subject to a maximum of $200 cash back per calendar month. Cash back rates of 2.5% – 10% require an active M1 Plus subscription (billed at $95 annually or at $10 monthly).
M1 Spend is a wholly-owned operating subsidiary of M1 Holdings Inc. M1 is not a bank. M1 Savings Accounts are furnished by B2 Bank, NA, Member FDIC.
All investing involves risk, including the risk of losing the money you invest. Borrowing on margin can add to these risks, and you should review the margin account risk disclosures before borrowing. M1 Margin Loans are available on margin accounts with at least $2,000 invested per account. Not all securities are available for M1 Margin Loans and the amount that may be borrowed against a security is subject to change without notice. Available margin amount(s) of M1 Margin Loans may require greater than $2,000 per Brokerage Account. Not available for Retirement or Custodial accounts. Margin rates may vary. Brokerage products and services are offered by M1 Finance LLC, Member FINRA / SIPC, and a wholly owned subsidiary of M1 Holdings, Inc.
M1 and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction
M1 Spend is a wholly-owned operating subsidiary of M1 Holdings Inc. M1 is not a bank. M1 Checking Accounts furnished by Lincoln Savings Bank, Member FDIC.
Credit Card not available for US Territory Residents. The Owner’s Rewards Card by M1 is Powered by Deserve and issued by Celtic Bank, a Utah-Chartered Industrial Bank, Member FDIC. Review Cardholder Agreement and Rewards Terms for important information about the Owner’s Rewards Card by M1