Laura Bickimer, a retired 93-year-old Cleveland school teacher, never earned more than $40,000 a year. But she surprised her friends and family when she donated $2 million to her alma mater, Baldwin-Wallace College.
How could a school teacher accumulate so much money on such a small salary? Anyone can do what Ms. Bickimer did, by following three simple rules:
Rule 1: Start Early
Saving money early is hugely important in building wealth, because of the power of compound interest. When you put money in a savings account or other investment, you receive a return on the money, called interest. If you leave the interest in the account, then that money earns interest as well.
Imagine that you began your first job at age 22 and contributed $120 every paycheck into a mutual fund. At retirement this account would be worth $1,081,146 at an 8 percent return – - not unreasonable for a period this long.
Now imagine that a co-worker held off saving in the same way for 10 years. She would have accumulated $467,168 at retirement – - less than half as much.
But even if you didn’t get an early start, you can start now. Use the Compound Interest Calculator to see how compounding makes your money work for you.
Rule 2: Buy and Hold
This means that you have to hold on to your long-term savings or they won’t compound in the same way. Moving money in and out of your savings rarely works—even when the stock market tanks.
To buy and hold, you have to keep your finances in order:
- You can help yourself to spend less by keeping track of where your money is going; then you can cut back in places where you can save small amounts painlessly.
- Manage your credit properly. Limit the number of credit cards you have. Limit your purchases to what you can pay off each month. Your credit score will rise with time, making it possible for you to borrow for less.
Rule 3: Diversify
Everyone has heard the advice: “Don’t put all your eggs in one basket.” If you put all your savings into a new start-up biotech company, you could get rich if the company succeeds. The flip side, of course, is that you could lose all your money if the company fails. It’s much better to diversify.
When you diversify, you spread out your risks over a wide variety of investments. It’s less likely that you’ll make huge returns, but also less likely that you’ll lose everything. And when it comes to saving for retirement, isn’t peace of mind worth something on its own?
You don’t have to buy lots of individual stocks and bonds to diversify your savings. You can buy share in mutual funds, which buy financial assets in bulk, on behalf of many individual investors. A mutual fund gets a pool of money by accepting funds from thousands of investors. It invests its pool of money in a collection of assets. Because of its large size, a mutual fund can efficiently buy large numbers of different stocks and bonds.
All mutual funds aren’t created equal, however. Watch out for funds that promise consistently high returns, or who charge high fees for their expertise. Studies have shown that low-fee funds actually outperform expensive funds over time.