Thursday, January 10, 2019
Delray Beach, FL.- When I “decided” to get rich, I didn’t know the first thing about creating wealth.
I was an editor. I wanted to be a novelist. I’d never taken a course in finance or economics. Plus, I was broke.
But I had a great advantage. I was working for a human wealth machine – a man who, at 43, had already created three hugely profitable businesses. He adopted me as a surrogate nephew and taught me everything he knew about making money. Eventually, he made me his partner.
I retired about 7 years later with a net worth well in excess of $10 million.
Eighteen months later, I gave up on retirement and went to work as a “growth” consultant for a publisher I much admired. By combining the marketing know-how I’d learned from my previous partner with this man’s ideas and generosity of intellect, I was able, about 10 years later, to retire again, my wealth having multiplied many times over.
In this, my second retirement, I focused on two long-put-aside lifetime goals: to write and to teach. I was able to do both at the same time by starting a blog called Early to Rise. In the ensuing 10 or 11 years, I wrote and published more than a dozen books and thousands of essays, “teaching” my readers what I knew about entrepreneurship, marketing, business management, and wealth building.
And even though it was no longer a priority, my net worth continued to grow.
At 60, I meant to retire again. But I got talked into going to work for someone who worked for someone who worked for me. (Don’t ask.) As co-founder of Palm Beach Research Group, I still write about wealth building. But I’m older now and have more experience.
I’d like to think that my observations and advice are somehow better now. At the very least, I’ve been able to go wider and deeper in terms of thinking about wealth, how it’s created, how it’s invested, and how it’s lost.
Why am I telling you all this?
Maybe because I’d like you to think that when it comes to the subject of building wealth, I have some insights that might be useful to you.
For example, I’ve come to believe that many commonly accepted “facts” about wealth building are, in fact, fallacies.
Take these examples:
* “Risk and reward are inversely correlated. If you want to acquire great wealth, you have to be willing to take great risk.”
* “Wealthy people are stingy for a reason. Pinching pennies is a necessary part of building wealth.”
* “The most important factor in building wealth is ROI – the rate of return you get on your investments. Therefore, when investing in stocks and bonds, look for high ROIs.”
* “A well-balanced investment portfolio is comprised primarily (80-90%) of stocks and bonds, with the rest (10-20%) in cash or cash equivalents.”
* “The surest way to acquire enough money to retire on is to buy the most expensive house you can afford and gradually pay off the mortgage.”
* “Asset allocation is the single most important factor in building wealth.”
If any or all of these statements sound true to you, what follows may be helpful. I may be able to show you not just why I think they’re false but also how believing them can keep you from acquiring the wealth you want.
I realize this is beginning to sound awfully pompous. So allow me to back up a bit and admit that I’m hardly the first or only person who went from broke to rich and then wrote about it. When it comes to the sort of advice I’m trying to give, you have dozens – even hundreds – of people to go to, some of whom are much richer than I am.
The point is, I don’t think I have the truth. But I have a truth: the way I personally went from broke to rich. And to be fair to you, that’s all I should write about because that’s all I really know.
I do occasionally read books about entrepreneurship, investing, financial management, and so on. And there have been times when I’ve written about someone else’s truth that made sense to me. But I have always tried to make it clear that I’m speaking about something that sounds true, not something that I have experienced as true.
What I know to be true is not quite science, but it’s as close to science as I can get. It’s based on things I’ve done or seen repeatedly in different situations. When I see a pattern confirmed time and time again, I begin to consider it to be a fact – not a universal truth, but fact enough for me to recommend it.
Here are some of those facts:
Fact No. 1
The intelligent wealth builder takes advantage of safe bets and avoids risky ones. He does this as an employee, a business owner, and an investor. He understands that smart financial decisions are cautious decisions. When he must take a risk, he does so with some sort of loss limit in place. He never loses more than he’s comfortable losing.
Fact No. 2
Spending money prudently is an economic virtue. But being stingy – i.e., paying less than market value for goods or services simply because you are in a position where you can take advantage of someone –is both morally detestable and financially foolish. The rich man who undertips does so not because he has learned the value of money but because he’s a cheap bastard. And the businessperson that underpays his workers or vendors because they are desperate is a financial dumbass that will eventually get what’s coming to him.
Fact No. 3
Contrary to what brokers and bankers and the financial media have been telling you all your life, the most important factor in wealth building is not the return you get on your investment (ROI). The most important factor in building steady, sizeable, long-term wealth is net investable wealth: the amount of money you’re able to put aside each week and month and year towards investing.
The simplest financial goal I ever set had the greatest impact on my wealth. I promised myself that I would find a way to get richer every day. After much trial and error, I found only one way: to steadily increase the flow of cash that went from my “golden wells” into my “golden buckets.”
Chasing ROIs is not just less effective than generating higher net investible income, it’s also intrinsically destructive of wealth. Countless studies have shown that individual investors chasing yield typically get ROIs that are less than half those of market averages. This is why the intelligent wealth builder devotes the lion’s share of his wealth building time to increasing his income and setting realistic goals for his stock and bond portfolios. By reasonable, I mean market averages plus or minus 10%.
Fact No. 4
The typical portfolio of stocks, bonds, and cash – however, allocated – is an inadequate approach to building and safeguarding wealth. The intelligent wealth builder will include other assets, such as income-producing real estate, tangible assets, alternative fixed-income investments, and direct investments in cash-generating private businesses.
Fact No. 5
Buying a more expensive home every time you get a big raise is a great way to ensure that you will never get rich. That’s because the cost of the house itself is only a fraction of the cost of living in that neighborhood. Lots more expenses. Lots more nosy, competitive neighbors. Lots less money left at the end of the year to increase your wealth.
What you want to do is find the least expensive house you can love and keep. The longer you keep it, the more income you’ll have to invest in the sorts of assets that will eventually make you rich.
Fact No. 6
Asset allocation is an important way to diversify your investments and, thus, reduce catastrophic, lopsided losses. But it is only one of three strategies that together should be part of every wealth builder’s tool chest. The other two are loss limitation and position-sizing.
Loss limitation is about setting automatic “stops” on your investments when you make them in the first place. Putting something into place – legal, technical, or otherwise – that will keep your losses to an acceptable number should the investment go bad.
Position sizing is about making sure that you don’t put too much money into any one investment. When I started out, my position limit was 10% of my net worth. Now it is 1%. The lower your size limit is, the safer you are.
4 More Facts
Okay, those are six facts that dispel the common fallacies. Got a few more minutes? Here are four more facts… some of which are very basic, but often ignored.
Bonus Fact No. 1
The biggest mistake retirees make is giving up their active income.
Yes, I know that’s exactly what you hope to do. If that’s the case, to keep your wealth for a lifetime, you will need multiple streams of passive income. Your goal should be to build each stream of income to a level where you can live on that and that alone.
Bonus Fact No. 2
The “miracle of compound interest” applies not just to money but also to skill and knowledge. If you want to get rich and stay rich, you need to invest as much of your spare time as possible in acquiring financially valuable skills and learning about your business.
As a general rule, buying makes you poorer, whereas selling makes you richer. If you want to develop a wealth builder’s mindset, develop the habit of asking yourself every time you buy or sell anything: Is this making me richer or poorer?
Bonus Fact No. 3
Every type of financial asset has its own unique characteristics in terms of growth potential, income potential, and risk. Expecting more growth or less risk than “normal” from any investment is a bad idea. Stocks, for example, will give you about 9% or 10% over time. (I’m talking about big, safe stocks here, not speculations.) If you work hard, you may be able to get 12% to 15% for a while. But if you try to double or triple your money with stocks, you will end up with the returns that most individual stock speculators enjoy – something less than 4%!
Bonus Fact No. 4
There are two ways that investments can build wealth. One is by the generation of income. The other is through appreciation – an increase in the value of the underlying asset. Certain asset classes are inherently structured to increase in value. Some to preserve value. And others to do both.
Investments that provide both income and appreciation are generally superior to investments that provide only one or the other. A good example: rental real estate or dividend-yielding stocks.
Investments that provide only income, but guaranteed income, are also a good, safe choice so long as the yields are good. Triple-A rated, guaranteed municipal bonds, when I was buying them, were giving me 5% or more tax-free. Today, I can’t get 3% on them so I don’t buy. But there are all sorts of safe debt out there that I can invest in and get a 7% or 8% yield. At my tax bracket, that’s as good as 5% munis… so I buy as much as I can.
For me, the risk/reward ratio in investments that give only growth potential isn’t especially attractive. I’ll invest in land banking if I know and like the land. And I’ll do the same with small business startups when I know the business, trust the entrepreneur, and have some control over the enterprise. But otherwise – as a group – appreciation-only investments are my least favorite.
You may find some of these facts instantly sensible. Others you may disagree with, be confused by, or see as unimportant. But please don’t just dismiss them. Give yourself a bit of time to think about them.
For me, they’re useful and important because they’ve worked for me and for people I mentored – over and over again. Which means, of course, that they might work for you, too.