ExtremePerspective

Common sense perspectives and finding a way to retire

How to get rich

Posted by Paul on December 15, 2006

One question that many people ponder over throughout their lives is the question of how to get rich or least financially independent. The vast majority of us have been schooled in the time-honored wisdom that the best route is to go to a good college and get a good job. Then we spend our lives exploring the stock market or real estate or network marketing or a business or buying lottery tickets or suing someone if all else fails, without really understanding the basic concepts that will realize our dreams.

I’m going to give you the secret (I sound like a salesman here, but I’m not selling anything) and it is so simple, welll….duh!

There are two immutable’s in getting rich:

  1. Leverage
  2. compounding (also known as interest or the time value of money)

If you understand these two concepts and use them positively, I can guarantee that you will be rich. Now most people spend their lives either not using these or using them in reverse. For example:

  • they work at a job (trade their hours for fixed dollars) and spend all that they make
  • they incur bad debt (reverse compounding)
  • they use leverage with extremely high risk/reward ratios (for example, lottery tickets)

Many of us have read stories of poor ministers or spinsters that die and have millions of dollars in their estate – these people lived on meager incomes but used compounding( the time value of money) in their favor to accumulate wealth. In WV I lived across the street from a 92 year old spinster who had several million dollars in AT&T stock. She had purchased some small amounts from her employer when she was working a summer job in high school and 70 years later – voila!

I want to distinguish between bad debt and good debt. My Chinese wife believes that all debt is bad, but I think it is correct to say that investment debt that has a reasonable risk/reward ratio is acceptable (think of your home). Debt incurred to buy that HDTV is bad debt (but damn do I want one ūüė¶ Guess I’ll have to achieve some financial goals first!)

So what is leverage? Basically it is when you use a tool to allow you to be more financially productive. There are many tools that you can use:

  • starting a business and hiring employees to get more work done (good risk/reward)
  • franchising your business (good risk/reward)
  • using the Internet to leverage your efforts (good risk/reward)
  • buying real estate with small¬†down payment¬†(good risk/reward)
  • investing in commodity futures (poor risk/reward)
  • using margin accounts to buy stocks (poor risk/reward)
  • investing in a college education (may be a poor risk if you choose the wrong major!)

What about ways to use the time value of money or compounding to your advantage:

  • saving 10-15% of your income -especially in a IRA or 401k (excellent risk/reward)
  • investing in stocks (could be good or poor risk depending on your diversification)
  • owning a completely paid for piece of real estate (good risk/reward)

I’m not so sure that college is the best use of investment dollars. With a typical education costing $40k/yr, the $160k invested at 9% for 35 years will yield $3,266,000.

So what should you do? Here’s my list:

  • put some money into an emergency fund
  • pay off all bad debt – use a snowball formula
  • accumulate 3 to 6 months of expenses into very liquid savings
  • invest 15% of your earnings into a Roth IRA or 401k (especially if its is matched)
  • buy a house from a motivated seller – don’t make an emotional purchase
  • start a business (our tax laws provide magnificent deductions for businesses not employees)
  • systematize your business (see E-Myth Revisted) so it doesn’t run you
  • invest in real estate

And stop buying lottery tickets! That’s my perspective.

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