The formula to obtain financial success in the United States (and the world) is not a secret. To know the secret, just observe how wealthy people obtained their wealth. Look at what they do, what they own, what they invest in, and how they spend their time.
Take the richest people in the United States for an example. The top 1% of income earners figured out the formula to become wealthy and the rest are still trying to play catch up – still stuck in the rate race of working a 9-to-5 job.
The wealth formula can be summed up with the acronym – POISE. To obtain wealth, you have to practice and possess POISE.
Poise stands for Property, Ownership, Investing, Saving, and Entrepreneurship.
Property
Property ownership has created more millionaires, and maybe billionaires, than probably anything else. What’s interesting is that these property millionaires did not have to be that smart. They did not need the IQ of Albert Einstein to become wealthy. In a way, property ownership levels the playing field. Property ownership allows you to become wealthy without having to have a college degree from an Ivy League University, be employed as a Doctor or Lawyer, or own a business like Amazon.
Over time, the value of property increases. Property can be affected by the business cycle and the economy. The value and price of property can rise and fall. However, in general, the value of property always goes up. Any drop in value will recover and eventually reach a new high. The people who buy property when prices are low will make money when the value rises. It’s that simple. Buy property when the value is low and sell it when the value is high.
For most Americans, your home is your biggest asset and most expensive investment. When you pay your mortgage each month, provided you are not making just interest-only payments, you create equity because the amount you owe the bank goes down. During this time, the price of your home will generally rise. Therefore, the amount of equity you are building is accelerating, benefiting from your monthly payments plus the natural appreciation in price. When the time comes to sell your home, you get to pocket the difference.
The government recognizes homeownership as a tool for wealth creation. Therefore, if you live in your home, you can escape paying capital gains taxes when you sell your home. What you don’t have to pay in taxes is free money!
The IRS typically allows you to exclude up to:
- $250,000 of capital gains on real estate if you’re single.
- $500,000 of capital gains on real estate if you’re married and filing jointly.
For example, if you bought a home 10 years ago for $200,000 and sold it today for $800,000, you’d make $600,000. If you’re married and filing jointly, $500,000 of that gain might not be subject to the capital gains tax (but $100,000 of the gain could be).
One of the best ways to profit from owning real estate is to start off with buying a starter home – something like a small 2 bedroom home. After you have lived in it for a few years and created some equity, upgrade to a larger house. But don’t sale your starter home. Rent it out instead. Use the rent you receive from your tenant to pay the mortgage. In affect, you are using your tenant’s money to reduce the amount you owe on the loan, which creates equity. One day, your tenant(s) will have helped you own your property free and clear. Each penny of income you receive from that point going forward will be 100% passive income.
Your first purchase does not have to be a single-family home. If you can, purchase a duplex or a 4-unit apartment building and live in one of the units for a few years. The rent you receive from the other units will help to pay the monthly mortgage. When you move to another accommodation, you can apply the rental income from the unit you vacated to accelerate the payments. Once again, the rental income you receive from the other units will pay off the loan on the property. You’ll be using other people’s money instead of your own. Meanwhile, you will be creating a nice residual, passive income stream.
Ownership
Ownership in a profitable venture is one of the keys to wealth. As a business grows and becomes more profitable the value of the business increases. The value of your equity grows with it.
For example, let’s say you own 10% of a furniture store that is valued at $1 million. Sales increase each year and after eight years the company reaches $10 million in annual sales revenue. A larger furniture store decides that they do not want to compete against you and makes an offer to purchase your store for $20 million. If you and your partners accept their offer, your 10% stake – once valued at only $100,000, is now worth $2 million.
The same can be said about owning stock. When Amazon went public in 1997, its stock was priced at just $18 per share. What if you had purchased $1,000 worth of shares (approximately 55.5 shares) in 1997? At today’s share price of $1,343, your investment would now be worth $74,611.
The following few sentences are taken from chapter 9 of my book What My Father Didn’t Teach Me: Lessons I Had To Learn On My Own.
‘Get ownership in something. Your initial investment may be small, but it will grow in size. A time may come when you decide to sell your business. It’s at this point when the value of your business is fully recognized – when the accumulated equity is converted into cash. Most cash millionaires, business owners that have millions in liquid assets, did not accumulate their cash by paying themselves a high salary. The cash is received when the business is sold. This is how the majority of small business owners become millionaires. If you cannot be one of the principal owners because you work for a publicly traded company, you should buy the company’s stock.’
This brings me to my next point about investing.
Investing
Money hidden under a mattress is not going to increase in value. With deflation, it will actually decrease in value. In order for your money to make money, it has to be invested. If you have money that you fail to invest, it’s like being in a sailboat with a strong wind behind you, but your boat doesn’t have a sail. You are not going to get very far very fast. You could always use a paddle, but everyone knows having a boat with a sail is more efficient than paddling. Why spend your own energy when there is a greater power that you can use to reach your destination?
It’s the same with idle cash sitting around. In order to get the most out of your free cash, it needs to be invested into something that will allow your money to make money. Leaving your money in a low-yielding savings account is like having a boat with no sail. With yields around 0.10%, a savings account will not give you a sufficient return to materially change your financial position. You need to invest your money in something that can move you along faster and give you a greater return. You need to invest in assets such as stocks, bonds, mutual funds, and real estate.
Also, remember that the US government gives you an incentive to invest by only taxing the capital gains from investments at 15% instead of the higher rates that are often applied on personal income.
Saving
In order to have money to invest you first have to save money. This means you have to spend less than you earn. Financial advisors recommend saving 20% of your income each month. Meanwhile, another 50% (maximum) should go towards necessities, while 30% goes towards discretionary items. This is called the 50/30/20 rule of thumb.
The “50/30/20 rule” for spending and saving was coined by Elizabeth Warren – U.S. Senator from Massachusetts in a book she co-authored with her daughter called: “All Your Worth: The Ultimate Lifetime Money Plan.”
If saving 20% of your income is too difficult, strive to save at least 10% and work your way up by adding 1% each year. Make saving easy by not allowing yourself to have access to the money.
Saving should be automatic. Invest in your company’s 401(k) or in a Traditional IRA or Roth IRA. When you have reached the maximum contribution limit for investing in your 401(k) and IRA, sign up for online banking and set up automatic transfers so that funds are deposited into a brokerage account each month. With this method, saving and investing becomes much easier because you won’t miss the money you don’t have easy access to.
Entrepreneurship
Having your own business is how you escape the 9-to-5 grind and achieve personal and financial freedom by living life and working on your own terms. You can get rich working for someone else, but you will not become wealthy unless you have something you own working for you.
Besides the financial rewards, there are many other benefits to running your own business. You don’t have to ask your boss for permission to take time off. You don’t have to work a schedule defined by someone else. You have more control of your work-life balance.
Entrepreneurship allows you to leave a legacy to those you love. Few things are more valuable than a successful family business. A family business is a storehouse of accumulated wealth that can be passed down to preserve wealth for future generations. Another reason why a family business is important is that it can eliminate the uncertainty of your children obtaining a good job.
Consider Donald Trump’s children, Don Jr., Eric, and Ivanka. They have never had to interview for a job. They had a high-paying job waiting for them the moment they graduated from university. Entrepreneurship allows you to do the same for your posterity.
You don’t have to start off with something big. Pursue entrepreneurship by engaging in a side hustle. I discuss the merits of having a side hustle in Pillar 3 – Business Income. In time, your business will grow and become more successful. You will gain confidence by knowing that you have the knowledge to create income for yourself independently. You don’t need someone to give you a job in order to make a living.
Conclusion
The formula to wealth starts with understanding and practicing P-O-I-S-E.
P – Property
O – Ownership
I – Investing
S – Saving
E – Entrepreneurship