Building great wealth is not easy and most people have insufficient motivation and persistence and too few of the skills. As an alternative though they should learn what they need to become wealthy enough.
Wealthy enough is the amount that gives you the comfort, the security and a margin for error that you wish to have. There is no standard. Everyone makes their own rules.
How much is enough? It has been said that anyone who thinks making $10 million is enough, lacks the requirements to make $100 million or a billion. Once you have some amount, more is useless unless you can find out how to use it or can find new things to spend it on. Clearly there is a diminishing marginal utility for money and so other things are needed to go beyond the limit.
Craig McCaw has said, “You can live as well with $4 billion as you can with 12”
We know that building some future amount depends on several factors.
- Capital. What you have now and what you can save
- Yield. What it will earn less taxes
- Time. What is the target date to have it available?
Capital can be in several forms. Money is obvious, but it also includes skills, and other talents like motivating people, selling, and leadership. Money capital is what you have now plus what you can save.
What you can save is a function of two things. What you spend and how much you earn. You can influence savings by changing either or ideally both. Make more, spend less.
Spending money to improve your skills and thus your income is a kind of capital formation. Usually it is more valuable than money because it is renewable and in most cases you cannot lose it. A person can lose money investing, but it is hard to forget how to be a doctor.
You cannot save what you spend on lifestyle. A more expensive bottle of wine with dinner is lifestyle. It has no future value.
Yield after tax matters. Most great wealth is built on capital gains with no tax until liquidated, so the raw yield is usually the one to focus on. You can determine the third amount In the time capital yield triad if you know two of them. Knowing capital and knowing time, you can determine yield. It can be done roughly using the rule of 72. 72 divided by yield gives the time to double.
For example. I have $50,000 and want $10 million in 30 years. 200 times my money. 8 doubles is 256 and 7 is 128, so about 7.5 doubles. One every four years. 72 divided by the time to double is roughly the rate required. In this case 18%.
That is lower than many people would guess. Using leverage and skill and diligence and discipline and luck, you could likely do it.
If you had 40 years to do it, then you would need to double once every 5 years or about 14%. Still not trivial.
The morals of the story is this:
Time matters, so start early.
Capital matters, so form as much as you can as quickly as you can. Do it by spending less, or much less, than you earn and invest some in developing skills that cause earnings to go up. Savings equals income minus taxes minus lifestyle. You can manage all three of the pieces. Do so.
Yield matters and it is a function of many things. Learn what matters. If you have great skill and a tolerance for risk and the ability to commit for long times and a creative idea a way to manage your taxes and some capital to begin with and are willing to share with others as more money and skill is needed, then you have a chance. A small one but definitely non-zero.
Discover what tools are available to help you with your plan. Use them or find someone who can help you with them.
Work first on what you can control. Invest in yourself and save some capital.
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.