Families need to meet these 6 conditions to build wealth

The statistics and data on who holds wealth in America can be shocking to read: The bottom 50 percent of households only hold 2.3% of total U.S. household wealth while the top 1% of households hold more than a third of total U.S. household wealth, according to 2021 data from the Federal Reserve. 

Building wealth may be a far off thought for many of those struggling with medical debt, student loans, rising rent prices and inflation. However, knowing how families can grow wealth is key to understanding why so many American families are struggling to build wealth in the first place. A new report from the Aspen Institute identified one precondition and five conditions that low and middle income families need to meet in order to start generating wealth.

Select spoke with Ida Rademacher, Executive Director of financial security at The Aspen Institute, about what those conditions were and what individuals, employers and policymakers can do to encourage wealth building for families.

Wealth, simply put, is a measure of the value of assets, minus any debts and liabilities, that a person owns. You can calculate your wealth by taking the value of your assets (i.e. car, home, investments in a brokerage account) and subtracting your debts (like a mortgage, student loans, medical bills).

So why is it important for families to have wealth and to generate more of it? Well, there are a variety of reasons.

Wealth can improve your physical and mental health — having chronic medical conditions or disabilities and getting treatment can be costly, so having money can make it easier to afford healthcare or relieve the mental stress that comes along with being in a bad financial situation. Families also use wealth to help give future generations a leg up through properties, inheritances or investments. Additionally, holding wealth promotes financial resilience so families can quickly pick themselves back up after an unexpected event like a job loss or car accident.

The one precondition to wealth building that researchers identified was financial stability. Financial stability means having a positive cash flow, no harmful debt, an emergency fund and public and workplace benefits, says Rademacher. Families need to have a positive cash flow, or income that regularly exceeds the value of your expenses, and little or no debt, whether that's medical, credit card or student loan debt.

With the Federal Reserve announcing interest rate hikes in 2022, families should prepare to potentially owe slightly more interest on their debt in the coming months. While there are many methods for paying down your debt, it's important to find which one works best for you. Two popular processes for debt repayment are the snowball and avalanche methods.

The avalanche method is good for people who want to save the most money in their debt repayment journey. With this system, individuals prioritize paying off their high interest debt first.

With the snowball method allocate extra money towards paying off the smallest amount of debt first. While this might not save you as much money as the avalanche method, researchers found that this practice is more likely to keep people motivated to pay off debt because it makes them feel like they're achieving small wins.

The next step to achieving financial stability is building up your emergency fund. The tried and true wisdom around emergency funds is saving three to six months worth of expenses. However, saving that much may not be attainable for many households, and might not even be necessary. A study showed that low-income families who had just one month's worth of expenses saved were less likely to fall behind on paying debt in the future

If you have money leftover after you've made your debt payments, try allocating some of that money towards your emergency fund. You'll want to save your money in a checking, savings or high-yield savings account, so you can easily access it in case of an emergency.

With a high-yield savings account, you'll earn more interest on your deposits than you would with a traditional checking or savings account. Many of these accounts also offer a number of free withdrawals per statement cycle. Select found the top five high-yield savings accounts which offer above average interest rates and low (or no) minimum balances, among them are Marcus by Goldman Sachs, Ally Online Savings Account and Synchrony Bank High Yield Savings.

Rademacher also notes the importance of public and workplace benefits in ensuring financial stability for families. Workplace benefits include paid parental leave, paid sick leave and retirement benefits while public benefits could be unemployment insurance, the expanded child tax credit and Pell Grants for low-income students attending college. Without these programs, many low and middle income families have difficulty maintaining a positive cash flow when financial hardships happen.

Once a family has achieved financial stability by paying off their debt and building up their emergency savings, they must have leftover money to invest, says Rademacher. Having investable money is the first condition to building wealth, while having access to affordable assets is the second. These assets may be real estate, post-secondary education or financial assets like stocks or index funds. 

If you've never invested before, you're not alone: A little more than half of Americans own financial assets, but most of these investments are in employer-sponsored 401(k)s. Employers have a big role in encouraging people to invest for retirement such as through automatic enrollment in a retirement account or matching 401(k) contributions, says Rademacher.

Many personal finance experts recommend investing 15 to 20% of your annual income for retirement or other purposes, but if you're not able to contribute that much, try a smaller amount, like 3%, and slowly increase it over time.

If you're lucky enough to have an employer that offers you matching contributions on your 401(k), your first focus should be on maximizing the match, as it's essentially free money.

After you've maximized your 401(k) contributions, consider opening a retirement account that's separate from your 401(k), like a traditional IRA or a Roth IRA, each which offer their own tax advantages.

Traditional IRAs can reduce the amount you owe in income taxes now, but you'll pay taxes when you make withdrawals in retirement. Roth IRAs, on the other hand, allow you to invest after tax money, so your investments grow tax-free. For both types of accounts you can contribute a maximum of $6,000 a year and if you're older than 50, you can make catch-up contributions, for a maximum of $7,000 per year.

After you've started saving for retirement and are ready to move on to other types of investments, you might consider opening an account with a robo-advisor platform (which also offer retirement accounts). With a robo-advisor like Betterment, Wealthfront or Ellevest, individuals enter information about their financial goals, investment horizon and risk tolerance, and then an algorithm builds them a custom portfolio of stock and bond funds.

Robo-advisors are a great option for people who are new to investing and aren't sure where to start when it comes to building a portfolio. Many robo-advisors offer automatic rebalancing where the algorithm will monitor and update your investments by buying and selling assets based on your financial goals.

Once you've started saving for retirement, you might be interested in making more substantial investments. For many, this may mean buying a home. The report identifies the third and fourth conditions for wealth building as 'access to consumer-friendly financing options' and 'information and confidence in making financial decisions.' 

Having 'consumer-friendly financing options' means having access to favorable loan terms, whether that's on a mortgage or a car loan. In order to get lower interest rates on your debt, you need a good credit score. Banks, credit card issuers and landlords use credit scores as a measure of how likely an individual is to pay off their debt so the better the credit score, the better terms you'll get on your loans. 

There are two types of credit scores: The VantageScore and FICO® Score. Credit bureaus Experian, TransUnion and Equifax collect data from creditors like your bank or your credit card issuer in order to calculate your credit score. For example, the FICO credit score considers five factors when building your credit score: Payment history, the total amount you owe, the length of your credit history, new credit and your credit mix. 

In order to achieve a good credit score, you'll want to pay off your bills on time and in full, keep your credit utilization low (the ratio of credit you use to the amount you're extended), have a long credit history and have different types of credit. 

However, for many that might not be possible. The report found that many low and middle income families are considered credit invisible — around 50 million U.S. adults don't have enough credit history to receive a credit score from the major credit bureaus. 

For those who have no credit history or who have a poor credit score, you might want to opt for secured credit card to start building credit. With a secured card, you put down a deposit that's equivalent to the line of credit you've been given. The deposit acts as collateral if you default on your payments and, in some cases, on time and in full payments can help you get your deposit refunded. For example, after 7 months of using the Discover it® Secured Credit Card, Discover automatically reviews your account monthly to see if you qualify to convert to an 'unsecured' card and get your deposit back.

If you're eligible for a regular credit card, you can use it to help improve your credit score and earn extra cash and points, but only if you make your payments on time and in full each month. Credit cards like the Wells Fargo Active Cash^® Card (see rates and fees), Capital One Quicksilver Cash Rewards Credit Card (see rates and fees) and the Chase Freedom Unlimited® all have a $0 annual fee and earn rewards for ongoing spend.

With the Wells Fargo Active Cash^® Card, cardholders will receive a $200 cash rewards bonus for spending $500 within three months of account opening. Plus, the Active Cash card earns 2% cash rewards on all eligible purchases, so you'll be able to earn a bit of cash back on every purchase you make. The Chase Freedom Unlimited® lets new cardholders earn an additional 1.5% cash back on everything you buy (on up to $20,000 spent in the first year) - worth up to $300 cash back!

Credit cards offer a variety of options when it comes to redeeming cash-back or points. You might use the rewards you earn for a statement credit to reduce your monthly bill or as miles to pay for holiday travel. Regardless of what you choose, credit cards are an easy way to earn money back on your everyday spending.

The Aspen report also points to the role of local community banks, community development financial institutions and credit unions in extending credit to low and middle income families.

When it comes to having confidence in making financial decisions, it's important that individuals have access to accurate information about personal finance. You might consider hiring a financial planner if you can afford it but if you can't, there are online personal finance communities and platforms specifically for low and middle income families like UpTogether.

The fifth and final condition for wealth building is wealth protection. Wealth protection refers to the ability of families to protect and maintain their wealth over time.

"There's a history of real wealth restricting stripping policies that have hurt families," says Rademacher.

Rademacher points to housing policies like redlining, which refers to the practice of banks denying mortgages to people of color, in urban areas, and preventing them from buying a home in certain neighborhoods. While the 1968 Fair Housing Act made it illegal for anyone to be discriminated against when renting or buying a home, the issue still persists today: Black Americans have the lowest rate of homeownership compared to other racial groups.

The researchers endorse wealth protection solutions like mortgage forbearance (or a pause in mortgage payments for individuals facing financial hardships), property tax circuit breakers, which limit the percentage of income someone spends on property tax, and having emergency savings.

In order to build wealth, families need to have little or no debt, an emergency fund, investable money and confidence in their skills as an investor, according to the report. Note that it's important to prioritize paying off debt and building up an emergency fund first before using leftover money to invest.

However, employers and the government have a vital role in ensuring that families, regardless of where they stand on the the socioeconomic spectrum, are able to build wealth. Researchers endorsed policies like paid sick leave, the expanded child tax credit and employer-sponsored retirement benefits to encourage wealth building for low and middle income families.

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Information about Marcus by Goldman Sachs High Yield Online Savings and Synchrony Bank High Yield Savings Account has been collected independently by Select and has not been reviewed or provided by the banks prior to publication. Goldman Sachs Bank USA is a Member FDIC.

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