Hopefully, by now you understand that money is simply an agreement about value, and that providing value is the only real road to riches. But the practical question remains, what paths can you follow to accumulate significant wealth? The key to providing value over the long-run, and the point at which many people get confused, is that there are only 4 basic strategies for accumulating wealth. There may be various combinations and a few exceptions (you might win the lottery!), but there are only 4 primary ways to create or attract wealth. The first method is through employment. This means getting a job with a good company, hopefully doing work you enjoy, and earning promotions and pay raises over time, until you are rewarded with various bonuses and a substantial paycheck.
In most countries, this is the most common and least efficient strategy for making money. Income is taxed at very high levels, and taxes are deducted from your paycheck, so there is no chance to invest before the government takes it’s share.
There are very, very few jobs that pay enough after taxes to facilitate the accumulation of significant wealth. For most Americans (and citizens of other post-industrial nations), taxes on earned income are simply too high. And, as you get the raises and bonuses, the percentage of income lost to taxation actually goes up, usually even faster than your raises. A “progressive” or graduated income tax is specifically designed and intended to do exactly that!
There will always be a few CEO’s, movie stars, and others who are paid large salaries, but it’s worth noting that the few people who are paid at that level usually insist that their salaries be paid as a “compensation package” that takes advantage of stock options, deferred income or other techniques for reducing income taxes. And remember, employers must pay you less than your skills are worth. Employers rightly expect to make a profit on the capital, management skills, and risks they invested to create your job. Additionally, as we discussed in Chapter 5, in the global economy, there will be more and more competition for the good-paying, high-value jobs that are available. As a result, both salaries and job security will go down as we enter the new century.
For most people, earned income (a job) is an inefficient way to provide value or accumulate wealth. While there are many reasons to work as an employee (security, convenience, mobility, etc), making large sums of cash is not one of them.
The second path to financial independence is Self-Employment. This is the choice of many professionals and home-based businesses. From an income perspective, there are two main advantages. As the self-employed owner of a small business (often called a “micro-business”), you can set your hourly rate, and you have some freedom to work when and if you choose. You can adjust your schedule and workload according to family responsibilities, your personal preferences and take a day off when you want to.
And, the government offers substantial tax advantages in exchange for the risks you take in creating your own job. As your own boss, you are responsible for your own office, your tools, marketing, management, billing and production. The government recognizes that this represents substantial risk (most new businesses ultimately fail), and it represents lots of hard work. As your “partner” the government expects to be paid (in taxes), but will cooperate with you in permitting some accounting and tax benefits.
The down-side is that, while we refer to it as a business, in fact, it is usually still a job. For most self-employed people, their income stops the moment they get sick, take time off, or retire. And, many people find that being both the boss, and the most important employee, is very stressful. As a self-employed professional, with perhaps a small number of employees working for you, the bulk of the responsibility is on your shoulders. If you take a leave of absence or are not able to do your work as an attorney, accountant, sales person or graphic designer, your income usually stops. “No work, no pay” is the rule, and very few self-employed professionals ever move past this level.
Many independent contractors, artists, multi-level marketing professionals and other smalloffice, home-office business are in this category. The freedom and independence are wonderful, but it is a hard path to financial wealth.
The third path to financial independence is business ownership. This is a much rarer and
riskier, but potentially more rewarding path to wealth.
Businesses are systems that deliver value by organizing and combining the efforts of many people. Creating a business requires leadership, organizational and management skills, and capital. It means taking risks, and reaping the rewards if things work out. Restaurants are great examples of systems that multiply effort, create jobs, and create wealth. Going back to McDonalds, the system delivers burgers, and makes money whether the owner is present or not. Most self-made millionaires are business owners.
There are many disadvantages and difficulties in starting a business, particularly compared to the simplicity of having your own company as a self-employed professional. (Remember this distinction: all businesses are organized as a “company”, but not every “company” is run as a business!) Starting or running a business requires great skill at understanding and managing people, inventory, cash flow, and sales. As a business, you’ll have employees to hire, train, supervise and sometimes, fire. There are legal and accounting complexities and you’ll need talented (and expensive) professionals to advise you.
But, the huge advantage of owning a business is that the system, if it is designed and managed appropriately, can largely “run itself”. The owner of a well-run restaurant does not have to be physically present every moment the restaurant is open for business. The owner of a manufacturing plant does not personally box and ship every widget that goes out the door. Once a business is running smoothly, it creates value (and cash) indefinitely. The critical value-added component of a business is rarely the product or service it produces directly, but rather the value of the jobs it creates and the business’s ability to organize and focus effort to get a specific result.
To take an extreme example, Microsoft is generally acknowledged to be among the most successful businesses in modern history. But the little CD’s they sell have almost no intrinsic value. In fact, the cost of producing CD’s is so low that many companies give them away as advertising freebies. Bill Gates’ genius is in organizing a diverse army of programmers, engineers, visionary thinkers, shipping clerks, lawyers, janitors and advertising executives to produce and deliver thousands of CD’s that contain code to make our computers work. The company is immensely profitable because it has been able to organize the talents of many different people. By bringing the contributions of different people together, Microsoft produces value-added software that has made Mr Gates, and thousands of his employees and stock-holders, rich.
Starting, organizing and running a business is one of the most reliable paths to wealth. There are tax incentives, and if things turn out well, it can create a stream of cash that lasts for generations.
It is interesting to note that for over 200 years in America, immigrants have been among the greatest beneficiaries of this pattern. Whether it was the Irish or the Italians or the Eastern Europeans of the 19th century, or more recent immigrants from Asia and Latin America, immigrants have traditionally arrived poor, and they have suffered from discrimination.
Many don’t speak English, and they are often prohibited from entering the professions or other high-skill, high-salary jobs. So what do they do?
They open family owned businesses. They become florists or landscapers or dry cleaners. They own the local gas station or the janitorial service that cleans our homes and office buildings. Families will often pool their capital to buy a taxi or, especially in New York, to buy a push-cart and sell hot-dogs or pizza or deli sandwiches. And, with the profits they buy another cart, and then another, until within a generation, the family becomes an “over-night success”!
Business ownership is clearly not for everyone, but it is one of the most reliable paths to wealth.
The only other path to wealth is investing, or using your money in ways that create value and wealth over time. The classic American investments have been land and buildings, stocks and bonds, and precious metals or other commodities.
The key to creating wealth through investing is that you are permitting other people to use your money (your accumulated and easily transferable value) to create businesses of their own. In return for the use of your money, you share in the wealth created by their business. In the case of investing in an office building, for instance, you use your money to create a physical location where other people can conduct business. In exchange for your investment in the property, they pay you “rent”, which is really a part of the proceeds from the business they transact inside the building.
If you buy stock in a company, or loan it money in the form of bonds, the relationship is even more specific. The managers of the business take your money (and pool it with money from many other investors) and add their organizational and leadership abilities to create a business. If there are profits, you are entitled to share in the proceeds.
Non-investors often think investing is an easy way to make money, but that it requires lots of cash to get started. In my opinion, the reverse is true. You can begin investing for less than $1000, but it does take skill, knowledge and discipline to understand great investments. Too many beginning “investors” are really gamblers, and like gamblers, they eventually lose everything.
Serious investing is not gambling or a matter of luck. Skilled investors educate themselves about the property, stocks, or other ventures they are considering for investment. They read, compare one investment with another, and seek expert advice. Often, the best way for new investors to start out is through mutual funds, which is a form of investing where the risk (and later, the profits) are shared among many investors, and the investments are managed by a professional.
Gamblers, who would never go near a poker game or bet on a horse-race, will nevertheless, bet on a “hot tip” about a stock, or rush to buy shares of the latest miracle story on wall street. That is not investing!
Investing is a carefully considered decision to invest your accumulated skills, effort and abilities in a specific business venture, in the form of cash. Over the years, I’ve observed that the investors who make the most money, those who routinely get returns of 50% to several hundred percent on their money year after year, are very cautious. They read and study investing, and they learn from both their own mistakes and by observing the wins (and the losses) of other skilled investors.
Investors like Donald Trump, don’t gamble. They build the casinos where other people gamble. Important distinction!
Throughout history, investing in land and buildings, stocks and bonds, or commodities, has been a reliable and efficient way to accumulate wealth. And, much like owning your own business, the government has traditionally created tax advantages of various kinds to reward investors for the risks they take. “Capital gains” taxes, which are much lower than income taxes, and various credits and incentives for specific types of investments are a few examples.
It’s often been said that the poor and middle class work for money; the wealthy have their money work for them. That’s a cliché, but like most clichés, there is great truth in it. And, this reminder that investing is complex and there are risks. Even highly skilled investors occasionally get an unpleasant surprise. Consult with experts and develop your skills through practice and education. But to accumulate great wealth, do invest! Learn the skills and practice until you gain confidence. Start small if that’s appropriate in your situation, but do let your money work for you. More about that in the next chapter!