A lot of things change as you start to rise up the income ladder. Most of them are good – the old junker is replaced with a comfortable new car, the apartment becomes a house, you order steak instead of a hamburger. At the same time, managing your money becomes more complicated. Savings strategies for high-net worth individuals can be different. Recognizing how that game changes as you start to earn more will help you make the most of your financial success.
As you start to find there is regularly plenty of money left over at the end of the month, the recurring financial topic shifts from “how do I pay my bills” to “what's the best way to invest these savings.” To help you with this transition, the following will walk through some of the changes high-net worth savers encounter, and offer some advice about how to handle these challenges.
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1. It's time to think beyond the savings account
A plain-vanilla savings account was fine when you were just trying to keep a little cash on hand for emergencies, but now you have think about meeting a variety of goals. Things like saving for a down payment on a house, funding your children's education, and building a retirement nest egg require different approaches, meaning you need a mix that includes both traditional savings accounts and more growth-oriented investments like stocks and bonds.
2. Yield matters much more now
According to the FDIC, the average interest rate on savings accounts is currently 0.06 percent. If you shop around, you might be able to find one closer to 1 percent, but there seems little point if you don't have much money in the bank. However, as your accumulated savings move from the hundreds into the thousands, those little yield differences start to make more of a difference. It is now more worth your time to shop around for a higher-paying savings account.
3. Positive cash flow can dilute growth
As you set your mix of stocks, bonds, and savings accounts to prepare for future growth, keep in mind that your high earnings will create positive cash flow which may dilute growth. If you can anticipate cash flowing into the account regularly, you can probably afford a greater allocation to stocks, because your future cash flows will tend to compensate for the higher risk.
4. Inflation is now a bigger enemy
The more wealth you accumulate, the more inflation becomes a bigger enemy. High earners can typically ride out the ups and downs of the stock market, but inflation can permanently erode the value of what they've earned. Trying to stay ahead of inflation means favoring a more growth-oriented asset allocation, and it also means moving ahead with major purchases such as a house in order to reduce the risk of prices rising more quickly than your wealth.
5. Asset allocation and tax status need to get on the same page
As you look over your investments, there are two major types of variable to consider: asset class and tax status. It is important to coordinate them. Since high-net worth savers often max out their contributions to tax-deferred savings vehicles, they typically have taxable investment accounts as well. Allocate your assets so that those likely to produce the highest tax liability – such as income-producing bonds – are placed in tax-advantaged accounts to the extent possible.
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6. Separate accounts may make more sense than mutual funds
Mutual funds are an efficient way for early-stage investors to diversify their stock and bond investments, but as your investment capital grows, you might want to consider the possibility of a separately-managed account. This allows for more customization so you can do things like pursue individualized tax strategies, fine-tune investment guidelines, and implement social investing restrictions.
What high-net worth savers find is that their financial situation tends to change more rapidly than it did when they were living paycheck to paycheck. This means it is vital to review your finances at least once a year. From finding better savings account rates to choosing more tax-efficient investment vehicles, more money means these decisions can have more impact.
Sure, that's an extra burden, but never forget – it's a nice problem to have.
Richard Barrington, CFA, is a 20-year veteran of the financial industry, including having served for over a dozen years as a member of the Executive Committee of Manning & Napier Advisors, Inc.