Lately, I’ve been thinking about wealth and why it is so difficult for most people to accumulate it. This might sound small, but I think it is one of the biggest issues with which the world is currently grappling. Every day, we read about the divide between the rich and poor and how this divide is growing larger. We read about rich countries cutting tax rates for the wealthy and about poor countries getting into debt spirals. We hear about student debt becoming a national crisis in the USA and moments later we hear a story about a billionaire who bought a $10 million Ferrari. The world truly is out of balance! I’m not sure if this is a fixable problem, but at the very least, I can provide some of my insights to right the wrong, maybe if only for a few people. Maybe I can provide some ideas that might just put someone on the path to build wealth over time. After all, given that we are referring to something exponential over time, a small change now can increase exponentially over time.
The natural question is, why trust what I have to say on this topic? Why do I know more than any article that could reasonably claim the same on the internet? Well, I am quite young, currently 31, and have built a few businesses that can be considered successful, including Cash Flow Capital. More importantly though, over the last few years, I have sat on the credit committee for Cash Flow Capital. As a member of the credit committee, I have personally analyzed thousands of small businesses. I have seen what makes some entrepreneurs successful and others not. The answer is simpler than you might think. First, it appears that building and creating wealth is more of a habit than an active endeavour. Secondly, it can be simplified into a basic premise: reinvest your profits.
Let’s start with the first: Habits. Habits are interesting in that we do them automatically, without thinking about it. We don’t actively think about how to brush our teeth or tie our shoes; we just do it. Habits can also be considered good or bad, healthy or unhealthy. Furthermore, once a habit is formed, it is incredibly hard to break; just ask a long-time smoker who has been trying to quit. Interestingly enough, habits aren’t stored in our long term or active memory, but rather are a part of the brain known as the basal ganglia. What is interesting about this is that even if you are unable to store long term memories, you can still form habits, which might be one of the reasons why once a habit is formed, it is so difficult to break. Therefore, the first step is to form a habit of reinvesting your profits.
So, what do I mean when I say reinvest your profits? Another way to state this is to save and invest or to compound your return. We can think of this as the first principle of building wealth, just as the first principle of losing weight is to eat healthily and exercise. It is the most basic idea from which we can build. As an example, let’s consider buying a house that we rent out. When the investment makes a profit, instead of spending the profit, we use it to buy another house. We use the profit from the two houses to buy two more, and after that four more. The return becomes exponential. We go from owning one house to two, four, eight, sixteen, etc. This can be achieved in many ways. Instead of a house, we could consider a business or a salary as income or profit. The reinvestment also does not need to be in the same space. As an example, profit from your salary could be used to invest in the stock exchange; dividends from stocks could be used to invest in bonds. The principle stays the same, regardless of the method.
Given the above, the question then becomes, what do you invest in? Where do you reinvest your profits? To me, if you are still young, and you can take a reasonable amount of risk, stocks, which are just small parts of businesses, should over the long term have a greater return than almost any other asset class, including bonds or property. Also, when I refer to stocks, I don’t mean any individual stock, but rather a group of stocks such as the S&P 500. You should also not be limited by borders, but rather holistically look at the world. Given that roughly 50% of the world’s equities, including some of the largest companies in Europe and China, are listed on the New York Stock Exchange, it is an ideal place to invest.
Finally, I will leave the reader with this. If in 1942, your grandparents had invested $10,000 in a fund that tracks the Dow Jones Industrial average, something very similar to the S&P 500, they would have over $75 million today.