I’ve recently had a few newer readers ask what some of the tricks are to build considerable wealth while young. While my priorities and focus have been more directed to getting myself to a level of passive income that would help me become financially independent at a relatively young age, its a topic that I thought I would address.
To start, I thought I’d set some out some parameters around my definition of building wealth young. To me, this suggests reaching $1M of assets (including home equity) by the age of 40.
Some of you may scoff and say 40 isn’t young, and frankly more power to you if you can attain that by 30!. CNN Money suggests that the average net worth at 40 is approximately $51K, so if you happen to be anywhere near $1M by 40, you are doing extremely well. Believe it or not, the average net worth for those at 30 years of age is just $8,500!
I wracked my brain to see how I’d structure things if I was someone new to the workforce and what moves I’d make to attain rapid wealth. For me, its a given that you’d have to start early (ie early 20′s or so) to think about attaining wealth anywhere close to $1M by 40.
Become an asset owner, not an input provider
In my view, this one is key to generating serious wealth early and the sooner you make this shift, the better off you’ll be. This is actually a very important principle and not necessarily something that is very obvious to most people. Owning assets is actually far more lucrative than being an input to someone else, which you effectively are as an employee. Why is this?
For starters, the tax consequences associated with asset ownership are far more favorable than those associated with earned income. Consider the effective rates of tax for capital gains and dividend income versus wage income for starters, as well as all the extra taxes that you pay on your wage income.
Even more than the tax consequences, the rates of increase in dividend growth and profit are far higher for company owners versus wage income. While you are lucky if your wage goes up much above the rate of inflation on an annual basis, corporate profitability increases and general stock market returns have historically increased at multiples beyond these levels.
The long term total return of the Dow Jones year over year is approximately 9-10% p.a. Property appreciation, while probably slightly less than this, is anywhere between the mid-high single digits over an extended period of time, depending on which area you are in.
Compared to nominal increases in wage income of 2-3% per annum, you can see why its much more fun to be a stockholder and an owner of capital than working as an employee for a living.
As an owner of assets, or the owner of a business that manages assets, I’m as focussed on squeezing as much value out of these assets as I can so that I can keep all the excess return. I “sweat the assets” to get as much out of them as possible so I can juice my total returns on equity.
You can see why being an employee and receiving a fixed return for your labor can be a pretty raw deal. If I’m one of the things that the corporation is “sweating”, it probably means longish hours for minimal returns.
Use other people’s money
Many people have a natural aversion to debt, which I’ve never fully appreciated. When I first started out in my 20′s, I couldn’t think of a better scenario than to use someone else’s money to help me juice up my returns.
Of course, you need to be responsible with how the debt is managed and used, and not get too carried away with too much debt, which can be easy to do if markets keep going up. Smart, tactical use of debt not only helps you build wealth more rapidly, but do so in a tax efficient manner. I’ve happily used debt to drive my investment in dividend stocks over time.
The theory is that both stock prices and property prices increase over time, and if you have invested in stocks that pay dividends, you will be building wealth and a dividend income stream much faster than you could investing on your own.
The long term return of the Dow Jones helps bear this out. All markets (stocks or property) move in zigs and zags. Nothing goes up linearly, much as we’d like it. But the long term trend for the last few hundred years has been grinding upwards.
Using someone else’s money to access rising asset prices to build wealth allows you to magnify your own return on your equity. When you are young and just starting out, odds are that you probably don’t have a lot of excess capital, so having other people’s money to earning rising returns is a great way to get a leg up.
I’ve often thought that I should have invested more into property assets when I was in my early 20′s, precisely for the reason that you can typically get more leverage with your investment and juice up your return on equity. Having said that, I always end up coming back to the fact that I understand what drives a business and valuation more than what moves property, so I stick with what i know.
The other advantage with property is that there’s no real time trading, unlike the stock market. You don’t get the stomach inducing churn feeling of seeing your $500k property move 1-2% in a day, or in amounts of $5-10k like you do in the stock market. That can certainly help keep your sanity and avoid some premature grey hairs!
Avoid dumb credit moves
This can really hurt your when you’re young, and delay your ability to start generating some serious wealth. There are two aspects to the credit game and they are both interrelated in my view.
Going out of your way to wrack up a ton of credit card debt which is spent on things that don’t appreciate in value (tv, car, stereo system etc) just doesn’t make much sense. Certainly wracking up the debt at rates of interest that are 25% or more makes even less sense.
I love pulling out the plastic as much as anyone else, but it all gets paid off at the end of every month. Every single dollar. No matter how painful the damage . I’ve been doing this ever since I got my first credit card. Wracking up debt and not paying in full gives you these huge interest bills that spiral beyond your control. And when you don’t pay them, you get dinged with bad credit.
Getting dinged with bad credit also hurts your ability to use other people’s money to build wealth. If you are paying rates of 6-7% to borrow and invest your money, while you could have been doing it at 2-3% if you had excellent credit, then not only have you just lost your margin of safety for building your wealth, but you’ve probably greatly worsened your payback period as well. On a $400k loan, 4%p.a extra interest over a 30 year loan life will cost you several hundred thousand dollars!
Bad credit will probably blow your chances of realistically being able to tap into leverage as a strategy to boost wealth.
Invest in yourself?
Ordinarily, this one would be at the top of my list. I love the idea of constantly improving my skill set and extracting more value for the labor I provide. Its all well and good to own assets rather than just be an input provider, but it takes some serious asset ownership to fully make up for the income that you earn as an input, or employee.
So in the meantime, while I wait for my asset ownership to replace the wage income I receive as an input, I want to be able to claim as much as possible for the labor that I’m providing, and the way that I try and do that is by making myself more valuable.
I think the problem with this strategy as far as building serious wealth young is the payback period for investing in yourself takes considerable time to recover. You may have a couple years of lost income, tuition expenses to consider, depending on what course you do.
This will take out several years of potential income that could have been deployed building wealth producing assets. If I want to build maximum wealth by 40 and then cash out, I’d probably be tempted to bypass investing in myself in favor of deploying what I had and build maximum asset ownership short term.
Happy wife equals happy life
Going from a single wealth builder to a pair of wealth builders is a good way to accelerate getting to a wealth goal pretty young. If both of you at least directionally share common goals, you’ll probably find that your expenses don’t double, but all of a sudden you’ve got two incomes to throw at chasing down assets that will hit your target.
Of course more rapid wealth accumulation is just a natural and happy by product of everything else that makes up going from one dividend investor to a pairing (no doubt my wife will be reading this!). Make hay while the sun shines though, because when kids come along, watch that savings rate plunge!
While this one is going to be highly dependent on whatever your family circumstances may happen to be, I actually credit a shift to double incomes for helping us to accelerate our own wealth accumulation and dividend income.
Think like a private equity manager
The guys that have the greatest track records of being able to build wealth very rapidly are private equity managers. While we may despise them for selling assets into the public markets that they have fully priced or extracted all the value from (think Facebook), I admire their ability to pick trends or themes that generate significant value very quickly.
Ideally, if you have the talent or ability, most of us could start our own business, grow it and reap the rewards with 10 or 15 years time and attain huge wealth by 40. Unfortunately, the world doesn’t work this way, but the public markets give you the ability to essentially compile your own Private Equity fund by investing in a bunch of very early stage companies.
Sure small caps may be at a slightly more mature phase in their evolution than private equity investments, but many of them still have years of solid growth ahead of them that can give you the opportunity for very large gains.
I’m pretty content to harvest low double digit growth from my portfolio of mainly larger dividend stocks. but that’s not to say I don’t appreciate the rapid growth in capital and dividend income that is possible from smaller companies. United Guardian, which I previously profiled has returned close to 30%p.a in capital growth over the last 10 years.
Someone who invested $10k in the stock in 2003 would be sitting on close to $110k today. The way I accomodate these smaller and more volatile companies is having them nested within a core of more stable, wide moat, rock solid large caps with long dividend histories and sustainable competitive advantages.
Going all out for maximum wealth by 40 would probably see me shift my strategy and invest much more of my wealth in these smaller companies. It would mean significantly more risk, but the upside potential would probably be higher. Thankfully, thats not my goal
Avoid a wealth obsession
My final observation on this topic, and the one that’s probably the most counterintuitive is to avoid a wealth obsession.
Goals take time, dedication and persistence to achieve, and you need to follow a plan to get there. This is true for a goal to make it to $1M by 40 or $200k by 60. A net worth obsession, and periods of falling net worth in particular, cause you to question something when there may be no reason to do so. And it’s almost certain that you will have periods where things trend down, even if the health of your underlying investment is perfectly sound.
I much prefer tracking things that are less subjective rather than asset valuations on any given month, day or hour. Things that aren’t influenced by what some senator has said or rumors of who is going to war. Measurable things like how much I am contributing towards my saving? How much income am I getting from my investments? These are things that are more in my control and less subject to hourly or daily valuations.