Dirty secrets of filthy rich. Part 1.

Dirty secrets of filthy rich. Part 1.
http://dazko.com/dirty-secrets-of-filthy-rich-part-1/


The capitalist class consists of households with incomes of at least $350,000 to $500,000. Often, they are successful business owners, politicians, athletes, and executives. With 90% of wealth not inherited in the United States, almost all are self-made.
As you learned in Class in the United States and Household Income in the United States, the capitalist class represents the top 0.9% of income. Sometimes called the super-rich, members of the capitalist class often have incomes of at least $350,000 to $500,000 per year, which would require several million dollars in assets to generate. Since we know that more than 90% of wealth in the United States is not inherited, how did the men and women who make up the capitalist class get to where they are? What can we learn from them?
In this step-by-step guide, part of our How to Get Rich guide for new investors, we’ll reveal the secrets of the capitalist class. You’ll learn what they do differently that results in building wealth. You’ll find out the philosophies that helped them reach a place where they are financially independent enough to spend time with family or travel the world.
A High Income Isn’t Enough to Truly Join the Capitalist Class
Before we begin, let me reiterate the example I provided in Class in the United States to illustrate the difference between merely having a high income and truly being a member of the capitalist class.
Imagine two men, Greg and John. Greg is a medical doctor and earns $300,000 per year. He has to show up to work regularly, using the rare skills he’s acquired through a very expensive medical school education and years of on-the-job training. If he dies, or goes into a coma, his family will receive little or no income because he’s unable to work. John, on the other hand, owns a $3,000,000 limited service hotel that generates $300,000 per year for him. He doesn’t have to run it or be involved in any way because he pays a management firm to set rates, staff the property, and maintain the standards required by his franchise agreement. If John suddenly passes away or is incapacitated, his property will continue to mint money, drowning the family in cash. The family also has the option of borrowing against the equity they have in the property to acquire another hotel or expand, increasing profits further.
I’ve always said that the purpose of investing is to make your money work for you so that it generates cash regularly instead of (or in addition to) you having to sell your labor. In this case, John is truly a member of the capitalist class because he owns assets that generate cash for him as a result of providing needed services to the economy. In other words, John is not important or respected because he is rich; he is rich because what he has built fills a necessary need in society and the money is evidence of that. Greg, however, is very well off and experiences a standard of living among the highest in history. But he is not a true member of the capitalist class. To be, he would need to take his earnings from practicing medicine and build a collection of cash generating assets that could work alongside him, pumping out money as he focuses on healing people at the hospital
The single biggest distinction between the capitalist class and the lower classes is that the members of the capitalist class focus their efforts on projects that will continue to generate dividends for years, if not decades. The lower classes do the same work, but exchange it for a paycheck that is gone once they’ve spent the money.
This philosophy explains a great deal why I was wealthy enough to launch a series of companies following college instead of going to work for a firm such as Goldman Sachs or Merrill Lynch. During my undergraduate days, as my friends got jobs at a local coffee roaster and Banana Republic, I focused on growing a small online company. While not in class, I’d take my computer to Starbucks, sit in the reading chair by the window, and work on expanding the business. Many of them thought I was crazy for not getting a job (and some thought it laziness). Yet, today, they’ve long spent the $9 an hour they received for their labor and that same online company delivers upwards of $60,000 per year in earnings to me despite requiring less than two or three hours of work each week.
To be perfectly honest, I don’t even remember some of the projects I did, but like clockwork, the cash is deposited into my brokerage account each month. At the end of the year, I pay my self-employment, Federal and state taxes, and the balance gets added to my investment portfolio of stocks and bonds.
I didn’t work any harder than my friends. In fact, I had a much better work environment and had total control over my time. They were frightened of failure, whereas I was willing to take that risk. The single philosophy of focusing only on projects that would result in me collecting income for long periods of time after I’d completed my work allowed me to move back to the Midwest and start my holding company. Although we began with letterman jackets, today, we have a range of subsidiaries selling everything from diamond-tipped fountain pens and upscale baby gifts to wedding supplies and cashmere scarves. The money from these operations gets paid up to me at headquarters, where I can redeploy the cash into new ventures, acquisitions, or investments such as stocks, bonds, or real estate.
This philosophy is used all the time by the capitalist class. Take the Drury Inn. The highly acclaimed upscale limited service hotel in the Midwest was began by a family that owned a construction business. They finally realized that instead of building hotels for other people, they could construct their own property, earning money for decades on the guest revenues. To borrow a phrase from a very wise business consultant: In effect, the construction company got paid once for every nail that was pounded into the building. Now, the nails are more like an annuity stream. The same cost. The same effort. Far different consequences for the owners, who receive huge monthly cash flows from the properties, some of which are valued at $15 million or more.
You often hear the financial media, as well as stock brokers and financial planners, talk about the importance of diversification. But they almost always focus on diversification of assets. The capitalist class realizes that the much bigger danger is focusing on diversification of income source. We discussed this powerful concept in How to Utilize the Berkshire Hathaway Model In Your Own Life.
You inherently know this, even if you don’t follow it yourself. Who would you rather be: a highly paid executive earning $300,000 from a manufacturing company or a middle manager earning $100,000 at your job plus collecting another $200,000 in real estate rents, dividends on stock holdings, consulting fees, etc.? The latter is in a far safer place and much more likely to survive recessions or bear markets.
In fact, diversification of income not only lowers your risk, it makes it easier to get rich because you can use earnings streams to buy undervalued assets when everything crashes. If you had been the executive earning $300,000 and been laid off, you probably wouldn’t have been in a position to come up with money to invest when bank stocks such as Wells Fargo hit $10 per share. Yet, if you had been the middle manager, you could have used your profits outside of your salary to buy those cheap shares, even if you had lost your job, because you wouldn’t have needed every penny to cover your bills.
Members of the capitalist class value their time. That’s why they want the biggest chunk (if not every penny) of their cash to be generated from passive income sources. As you learned in Introduction to Passive Income, passive income doesn’t require you to actively be involved to earn a living, freeing you up to focus on more important things, such as your family.
Passive income can come from sources as varied as:
•Rent from real estate properties
•Patent royalties for an invention
•Trademark licensing fees for characters or brands you’ve created
•Royalties from books, songs, publications, or other original works
•Profits from businesses in which you have little or no day-to-day role or responsibility
•Earnings from Internet advertisements on a blog or website you own
•Dividends from stocks, REITs, equity mutual funds, or other equity securities
•Interest from owning bonds, certificates of deposit, other other cash and cash equivalents
•Pensions
•Residual income for a sales person on accounts that are typically renewed automatically such as a sporting goods representative that earns a commission on his accounts, bringing in a few thousand dollars per store per year for simply servicing the customers once they have been opened
Here’s an example of passive income in my own life. A few weeks ago, one of the new companies I founded in the summer of 2009 approached a local manufacturing business and signed a contract to create a software platform that would let this firm’s wholesale customers order through a password protected site, track the progress of their purchase orders, track packages in real time, send messages, pay invoices, and much more. In exchange, the company didn’t pay us a penny, but rather allowed us to add a 5% surcharge on all orders that came through. On the $1 million in revenue this generated, we should earn about $50,000 per year in profit because the system has no cost to us and there will be little or no maintenance going forward (perhaps a few hours each month). That money will go directly into expanding our other companies or buying shares of stock.
If we pay $18,000 in taxes on that profit, this leaves $32,000 for our shareholders. Assuming we can earn 15% on book value (easy for us) over the next 20 years, this stream of after-tax profit is worth nearly $3,278,200 to me and my shareholders. Every day we show up at the office, our goal is to find projects like that and have the money reinvested in cash generating assets. It’s extremely simple. There’s no reason you can find opportunities in your own life to solve people’s problems and make money doing it. The secret is you must focus on how you can achieve the objective without being actively involved. If you’re forced to work more hours, there’s no point!
The poor and working class see money as a finite commodity; there is only so much and then you spend it until there is none left. The rich members of the capitalist class know the truth: Money is like a seed. The same principles that farmers have been using regarding sewing and reaping to provide food for thousands of years hold fast for money. Each dollar that comes in to your hand has the potential to be planted, grow, and expand into far more money. It’s no different than a farmer growing corn. You can either eat your seed, or plant your seed. One gives you satisfaction today; the other can feed your family for generations.
Everyone wants to be a Warren Buffett. Yet, when you consider that an 18 year old today has 61 years to compound to reach the same age as Buffett (currently 79), it becomes clear how easy it would be to grow rich. If our teenager were willing to save $10,000 per year – an easy task for those who start out with that goal and avoid credit card debt – at a 12% annual rate of return, they’d have $83,692,000+ by the time they were Buffett’s age! Yet, for most people, they are simply unwilling to do that because three years into the journey, they decide to cash out of their Roth IRA or 401(k) and instead buy new furniture or a new car. They don’t realize that by spending their capital today, they are giving up the opportunity to have that $83.692 million and the corresponding $4.2+ million in annual dividends and interest it would generate! That is $350,000 per month before taxes without ever touching the principal, all from only $10,000 per year, or $834 per month. If our teenager utilized 401(k) matching by his employer, he may only have to come up with $5,000 per year in the case of a 100% dollar-for-dollar match. That’s $417 per month before taxes, which he or she would get a tax deduction on at the time of contribution!
The capitalist class understands that time is the friend of money. Like a great oak tree from a tiny acorn, the longer capital can be left to grow, the larger the ultimate fortune will be. The capitalist class also understands that rate of return is extremely important. Using our earlier example, if the same teenager could earn 15% on his $10,000 annual investment instead of 12%, that seemingly small difference of 3% per year over 61 years would result in more than $336,000,000 in wealth. Only 3% per annum meant an extra $252,308,000! That’s why the truly great investors ruthlessly control costs. Buffett himself tells the story of a man he knew who counted the total sheets of toilet paper on a roll because he thought a supplier was overcharging him (he was correct).