Photo by Eric Prouzet
There are basically only three main avenues from which someone can build wealth; owning real estate, owning businesses and owning paper assets such as stocks and bonds. Within these asset classes there are multiple different ways in which to build wealth; rental real estate, real estate development, hotelier, commercial real estate, retail, commercial, industrial, e-commerce, index funds, ETFs, individual stocks, and the list goes on and on and on.
The great news for those of us who have an interest in building wealth is that there is a method for each one of us based on our interests, our risk profiles and our skill sets. There really is not just one way to build wealth. In fact, there are as many ways to build wealth as there are ways that generate income that are in excess of expenses required to generate it.
That all said, what is truly interesting is that the fundamentals of building wealth are so much easier than having to figure out what mechanism(s) to use. The fundamentals of building wealth are actually quite uncomplicated.
The 3 levers of Wealth Building
To build wealth there are essentially just three levers that can be pulled; (1) the amount of money being invested in wealth building assets, (2) the amount of time in market and (3) the rate of which investments grow.
Surprisingly, the ‘complicated environment’ surrounding building wealth has been created in part by the financial industry itself by seemingly trying to make it much more complex than it needs to be. In fact, that’s how the financial industry makes money; by making things complicated.
As a result, they have created complicated ‘assets’ in which to sell consumers generating commissions and fees along the way. However, the truth of the matter is that the basics of building wealth still, and have always, point back to the three basic levers of building wealth.
The first lever of wealth building
The first lever is the amount of money being invested in wealth building assets. The obvious aspect about this wealth building component is that this one is left entirely up to the individual. The individual and the individual alone is in control of how much money they invest in wealth generating assets.
They can obviously choose to put as much money in these investments as they want to or they can choose to put as little money in as they want to.
Regardless of how much they choose to invest, the reality is simply that the more money that is put into investments the more it raises the probability of higher returns, due in large part to compound interest being earned.
The other reality is that the more money that is invested the higher probability that wealth will be built in a shorter period of time. On the other end of the spectrum, smaller amounts of money invested invariably require much more time to build wealth.
The second lever of wealth building
The second lever of wealth building is the amount of time in the market. Notice that I did not write ‘timing the market’. The amount of time in the market, to some degree, can be an equalizer for those individuals who may not have a large amount of money to invest. The reason for this is purely mathematical.
For example, an investor that invests $1,000 a month at 7% for 10 years will accumulate approximately $171,000. Conversely an investor who only has the ability to invest $500 a month can accumulate the same amount as the wealthier investor, assuming the same rate, in 16 years.
Clearly it’s going to take the $500 a month investor more than 50% more time than the $1,000 a month investor but the point here is this; investors with less money to invest can STILL build wealth, albeit over a longer period of time.
The other principle at play here is that in order to build wealth, regardless of the amount of money an individual has to invest, start investing as early as possible. If you don’t, mathematically you’re only left with one option assuming you only want the same level of risk and that is to invest a lot more money.
The third lever of wealth building
The third lever of wealth building is the rate at which investments grow. Whether this is the rate of return from investments like Index Funds or return on investment from a real estate deal or a business, this is the multiplier by which invested funds grow.
Other than how much money can be invested and how much time someone has in the market, which are controlled by the investor, this third lever is something that the investor cannot comfortably control without putting their very investment in jeopardy.
Unfortunately, an investor who might be interested in gaining a higher rate of return on their investment has to engage in more risk in order to get it. The old saying “more risk, more reward” is not just a saying.
It’s a real thing. As a result, these investors invariably start to move away from investments that have traditionally generated consistent returns, albeit lower perhaps than others, and start to stray into other investment vehicles that are less secure and more risky, yet perhaps more lucrative IF, and a BIG if, they are successful.
The risk of having to make up time
The difficult element of seeking higher rates of return normally is spurred by the characteristics of the other two levers. More specifically, when investors have less money to invest or less time in the market they tend to feel compelled to ‘make up’ for these two deficiencies by taking much greater risks to increase their rate of return and ‘catch up’ to where they might have been if they invested more money or were in the market longer.
Unfortunately, those individuals who put off investing and believe that they can build wealth in a shorter period of time later in their life increase the chances that not only will they not be able to build wealth but they also increase the risk that they will lose a substantial amount of money along the way.
Conclusion
Not being able to have time on your side forces many investors to be involved in highly speculative ‘investments’ such as currency trading, options, commodities and other speculative or time bound investments.
I would argue that this behavior is actually antithetical to using the three levers of wealth building. The reason is that an investor would be ignoring time in the market, foregoing a much more probable and stable rate of return, potentially incurring significant loses, and having to need a substantial amount of money to invest due to the uncertainty of returns.
This to me no longer is wealth building, it’s partaking in a game of chance.
Wealth building is not dark magic. It’s not mystical and it’s certainly not an unknown process. It is much more formulaic than we want to believe it is. It also doesn’t require any special ability, knowledge or background and this is what throws so many of us off.
Due to the fact that we currently aren’t wealthy we think that there MUST be more to it and by telling ourselves that it takes special ability, knowledge or background it gives us an excuse for not being on our own road to wealth building.
However, here’s the ultimate truth on building wealth and it may hurt to hear it; it takes commitment and discipline above everything else to build wealth.
