As a refresher, an Asset as defined by Investopedia is a resource with economic value that an individual, corporation, or country owns or controls with the expectation that it will provide a future benefit. In order to build wealth, we need to be knowledgeable in three classes of assets.
Interestingly enough, the western world has grossly bastardized what an asset is. As it stands today, most Americans I would argue classify just about everything that has ‘perceived’ economic value in the market place as being an asset but that could not be further from reality.
For example, most individuals find it easy to classify purchases of such things such as automobiles, recreational vehicles, furniture and in some cases consumables as being assets because they had to pay money to purchase them. That is flawed logic from the standpoint of building wealth.
The litmus test for what is an asset
I like to think about assets within the strict confines of wealth building. My litmus test is simple:
Does the item have a reasonable expectation of providing a financial gain either in a lump sum or monthly distribution that amounts to being an acceptable return on investment (ROI) over the amount that I have expended to buy or control it.
The level of ROI percentage as to what is considered to be acceptable can be debated but for practical terms of discussion here let’s use a 10% net ROI.
That being said, we now have a much more focused filter from which to vet what is an asset and what isn’t. Therefore from a practical perspective, an automobile, furniture, jewelry and other items that DON’T provide for a reasonable expectation of appreciating in value or kicking off a dividend are not considered an asset to me. I go into greater detail of what an asset is in the following post https://thefinancialstoic.com/?p=223
To that end, looking at what I like to classify as ‘income generating assets’ are the only ones that I would consider as wealth building assets.
Don’t get me wrong, I have often disclosed that I too have a weakness for some of these consumable items. I do. I just don’t and can’t consider them as assets because they do not generate income nor offer a logical basis for being able to create appreciable value going into the future.
The 3 classes of assets
So as far as wealth building assets go, I like to believe that there are only 3 major buckets:
- Paper assets such as stocks (equities) and bonds,
- Real estate and
- Businesses
I have spoken to this before and I steadfastly stick by it; In order to build wealth, we should become highly knowledgeable in all three classes of assets and be able to build wealth in all three asset classes but also double down on one of the classes in particular when starting out to build wealth.
The reason for this in my opinion is that it takes a certain level of expertise in any one of the asset classes to become enough of an expert in order to build wealth in it.
It would be foolish to believe that you could spread your available time across all three asset classes when you’re starting out and still expect to reach a level of mastery in any of them in a reasonable enough time so as to build leverage, equity and an adequate enough network in that asset class in order to become successful.
Concentrate on becoming an expert in one asset class
In other words, if you have a particular love and talent building businesses double your efforts in that asset class until you find success building wealth. Then at a later point in time, diversify your interests by moving some of your resources over into the other two asset classes. Same thing goes for real estate.
If you have an uncanny ability to build wealth within real estate, double down on those efforts until you are building adequate wealth in which to then diversify some of the proceeds from that asset class into the other asset classes.
What is intriguing about our modern economy is that not one of these asset classes can guarantee an endless upwards growth pattern and positive return. There will be time in the economy where one asset class is up and the other two are down. Or when two are up and the other is down. Or sadly, when all three are down.
The key is to be in all three at some level so as to act as a hedge against a full-scale decrease in any one of the asset classes for a given period of time.
The other intriguing element to me about these asset classes is that there truly is a simple approach to each of them that will provide a worthwhile return on an investment.
Whereby there will be many ‘gurus’ out there spinning up crypto-currencies, currency trading strategies and other complicated investment strategies (anyone remember mortgage backed securities (MBS)?) these three asset classes offer an on ramp to ANY investor without the requirement of a sophisticated knowledge base or mastery in any of them. In fact, having a straight forward approach to their ownership is perhaps still the most profitable.
Active money managers don’t routinely beat the S&P 500 Index
There’s a ton of independent research out there that would otherwise suggest that active money managers don’t routinely beat the S&P 500, which is something that would take no knowledge or expertise to invest in.
More specifically, the data shows that from 2004 to 2019 that 92% of active money managers actually trailed the S&P 500. On average these money managers are highly educated, professionally credentialed, have years of experience on Wall Street or within the financial services industry and have the most sophisticated research on securities available…AND they still can’t beat the S&P 500 consistently year to year.
So what does this have to do with you? Quite frankly it affirms that although other people may know more about the financial markets than you do they don’t necessarily do better than the market as a whole or a large composite of the market like the S&P 500.
More specifically, as long as you’re content with mirroring the annual return of the S&P 500 instead of taking on additional risk trying to outsmart the market then you will have what you need in order to build wealth over time with this asset class.
As it relates to bonds, I am someone who believes that bonds are not a wealth building asset. I view bonds as a hedge against a drop in value in stocks.
Don’t get me wrong, there’s definitely a place for bonds in your asset portfolio but I would argue that bonds are a wealth protection asset and are to be added once you have wealth to protect, just not in the wealth building stage.
Then there’s real estate. Real estate as an asset is much more dynamic than paper assets such as stocks. For starters, real estate can be purchased directly, such as a rental income property, where you own title to the property and have the ability to make all the decisions regarding that asset. This is called a ‘direct asset’ due to the fact that you literally own and control the asset versus it being a share or interest in an asset like a stock. When you own real estate directly you are controlling the performance of that asset.
The other incredible thing about real estate is that it ‘comes’ leverageable. In other words, you can use Other People’s Money (OPM) and Other People’s Time (OPT) to purchase and operate it. For an example, with a multi-unit property you’re able to control 100% of the asset for what would normally be a 20% down payment.
You get all of the upside appreciation (although that’s NOT why we buy multi-unit rental properties!) and the monthly cash flow (THAT’S why we buy multi-unit rental properties!) and you’re doing it with 80% of someone else’s money.
And last but not least, the business asset class. Not only does a business have the ability of generating a daily income stream for the owner, it too also comes ‘leverageable’ from the standpoint that you can receive loans for the development and growth of the asset, hire other people to grow the asset on your behalf and you normally get to sell the asset at a multiple to what it generates for annual income.
Plus owning a business allows you to be in full control of the asset, like real estate, and theoretically there is an unlimited upside if it is highly scalable.
In addition as I’ve stated in other posts, businesses also offer an advantaged tax situation for their owners as it allows for deductible expenses and loss carry forwards to cover gained income. Business ownership also offers the owner additional tax advantaged retirement investing through higher annual contribution levels that are pre-tax (such as SEP IRA or Solo 401(k)).
This allows for a much quicker accumulation of retirement investments and overall taxation as these investments are pre-tax.
Conclusion
Unfortunately in the financial ‘theatre’, complicated investment strategies and sophisticated financial schemes tend to get all the attention and evangelists.
As a result, the average person doesn’t feel that they have a chance of ever being able to retire comfortably, yet alone retiring early.
But the truth is so much more uninspiring as it turns out…and that’s the problem keeping it from being widespread and the popular course of action.
When you get right down to it there are three ways of building wealth; stocks (equities), real estate and businesses. It’s that simple.
Furthermore, it can be done without an advanced degree or any particular knowledge of the financial markets. Heck, it can be done with only the ability to set up an automatic investment contribution from your savings account into your IRA or 401(k) and a little bit of hustle.
