How to Amass the First $100,000 of Your Portfolio
No statement better sums up the emotional and practical struggles average people face when trying to build a better life for themselves and their families. It is attributed to a very successful investor, Charlie Munger, vice chairman of Berkshire Hathaway and one of the wealthiest people in the world, with a fortune of about $2 billion as of February 2020. He is said to have quipped about starting out in the investing world: “The first $100,000 is a bitch.”
There are many reasons Munger's lament is true. One is the federal tax code. It requires a significant chunk of working people's income—particularly those who are self-employed—to go to the government. Another is the high levels of debt many people face.
Yet another problem is lack of knowledge when you're just starting out. Imagine the hours, effort, and heartache you could save yourself if you could go back in time and pass on your wisdom about money—and life in general—to your teen-age self.
This article offers some tips on how to put aside your first $100,000 in investment capital, free and clear. For further advice, you can always consider consulting a financial planner.
Know the Tax Code
You don't have to be a tax expert to start investing, but you should know how much of your income will go to the government.
Income of $137,700 or less is subject to a 6.2% payroll tax for Social Security in 2020; the threshold increases to $142,800 in 2021. Income of all levels is subject to a 1.45% payroll tax for Medicare. For each worker on the payroll, employers pay another 6.2% for Social Security and 1.45% for Medicare. And those who are self-employed must cover the 15.3% ([6.2% x 2] + [1.45% x 2]) total tax on their own.
The good news is, half of your payroll taxes are deductible from your income taxes. But the net effect is that many Americans still pay far more than their stated income tax bracket would have them believe. As you get wealthier, the tax burden as a percentage of disposable income begins to decrease. That's despite it being higher in absolute dollars. In other words, if you make $800,000 and pay $350,000 in taxes, you will feel a big bite, but your standard of living will still be high. If you make $20,000 and pay $2,800 in taxes, your standard of living and ability to save are greatly affected.
The Internal Revenue Code allows you to invest pre-tax or tax-deductible money into a traditional IRA or 401(k) plan every year to save for your retirement. For example, if you contribute $5,000 to a 401(k) and are in the 24% bracket, you won’t have to pay $1,200 in federal income taxes on that money because, for now at least, the government acts as though it never existed. If you were to use that same amount of money—only after taxes this time—to pay bills, you would have at most only 76 cents on the dollar.
Go After Free Money
If your employer offers 401(k) matching, take advantage of it. If you were to get dollar-for-dollar matching on your contributions amounting to, say, 5% of your earnings and you make $30,000 per year, you would get $1,500 in a bonus match added to your account.
You got $1,500 from your employer, invested $5,000, and saved $1,250 in taxes on that investment. So by putting $5,000 in your 401(k), you have a total of $6,500 of capital working for you. That's $2,750 more than you would have if you had taken $5,000 from your paycheck, paid taxes on it, and put the money in a brokerage account.
Create Income Just for Investments
One way to save more money is to grow your income. If you have a talent or skill, maybe you could freelance on the side to pick up a couple hundred dollars per month. If you make an hourly wage, perhaps you could put in some overtime. You could invest your extra earnings in, say, blue-chip stocks and buy sizable positions over several years. With dollar-cost averaging, you could lower the average price you pay per share when compared with buying large numbers of shares at one time.
By bringing in more money rather than just reducing expenses, you fund your investments without greatly affecting your day-to-day life. That’s important because you’ll likely be more willing to stay the course it you don’t feel deprived.
For most people, wealth is built a few dollars at a time. If you can save just $10 a day to invest, you would have more than $200,000 over 25 years at a 6% rate of return.
Manage the Liability Side of Your Balance Sheet
Growing your income is important, but you can't lose sight of the other side of your personal balance sheet: liabilities. It makes no sense to invest money in stocks or bonds if you are paying 20% interest for debt on credit cards. Focus on paying off high-interest debt before you think of committing any of your funds to investments.
On the other hand, if your interest rate on a student loan or mortgage is very low, it would probably be a mistake to focus on paying off that debt. After factoring in inflation, missed tax savings, and the opportunity cost of not investing in better assets, paying off this debt at the expense of investing could result in hundreds of thousands of dollars of lost wealth over a long period of time.
Reinvest All Dividends
One of the most important things you can do to increase your returns in the stock market is reinvest your dividends rather than take the cash. It might be tempting to spend a dividend check on something fun. Plowing dividends back into the stock that issued them is often the smartest move you can make.
This advice applies to firms with a long track record of paying dividends and, even better, increasing them regularly. If a company has recently cut its dividend, you might consider selling the stock altogether and investing the proceeds in a company with a better dividend-paying history.
Keep Costs Low and Consider Indexing
While you're trying to reach that $100,000 milestone, it's important to keep your costs of investing low. That's why it might make sense to begin putting your money in a rock-bottom-fee index fund offered by a giant such as Vanguard or Fidelity.
Index funds track the performance of a benchmark such as the Standard & Poor's 500 Index. Because it costs less for the fund manager to simply mimic an index rather than actively picking stocks, index funds have very low costs: They should be less than 0.15% of your assets and may be as low as .015% per year.
You can sign up for a plan on a fund company's website that automatically and periodically invests money from your bank account into the fund. And you won't have to be concerned that big annual fees will eat away at your gains.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.