If you’re wondering how to build wealth, you’re not alone!
In this article, I’ll share five methods for how to build wealth. Each of these strategies I have personally done. While every attempt hasn’t succeeded, I’ve learned the most from the ventures that didn’t go well.
It goes without saying that the more money you save, the more wealth you’ll accumulate. The last method below, however, doesn’t require first building a big investment account.
The time frame will vary for the different wealth building strategies.
1. How to Build Wealth the Slow and Simple Way
The simplest way to build wealth is to put money into the stock market steadily over long periods of time. From 1986 through 2017, the amount of annual return the stock market in the S&P 500 index has varied somewhere between negative 37% to positive to over 37.6% for any one year.1
Long term stock investing is the common method of wealth building promoted in the financial mainstream. It involves saving a percent of your income and investing it into the stock market each month.
When left alone to grow for many years, the annual return will vary between 6 and 10% for most very long time frames. This is an ever changing number since the market value changes daily.
Shortly after a bear market the long term annual return is closer to 6%. During the later phases of most bull markets, the long term annual return is closer to 10%.
It’s challenging for me to write about investing in the stock market without providing the following cautions. You can unknowingly put your money near the top of the stock market cycle, leading to a large loss of value initially. It can take a few years to climb back to where you began. This can create a major problem, especially if you plan to retire soon.
There is no way to know exactly when the market will go into a bear market. A bear market is a drop of over 20%. Bear markets, however, have had drops of over 50% in their entirety. Here is a video about investing in stocks when they are cheap.
There are factors that have been present at the start of most previous bear markets. This includes certain economic factors, such as the yield curve showing interest rates over varying time frames. And there are technical “indicators” that are seen on stock charts. The PE ratio is also used to show if stocks are over valued based on earnings. Here is my video on the PE ratio.
It makes sense to investigate these factors before putting money into the stock market. They are fairly easy to understand.
These factors can guide you as to how much of your wealth to put into the market. In other words, if you see that these factors are signaling a riskier market, you may decide to put 20% of your money into the stock market instead of 40%.
By becoming familiar with these bear market warnings, you can also be realistic about the probability of favorable returns in the near future.
Probability is one of my favorite investing words. Probability is all we have with investing. Stocks drop. Companies go broke. Bonds loose value.
But stocks also rise. Bonds increase in value. Real estate prices rise. The question to ask yourself before you make any investment is this: Based on the valuation of this investment, what is the probability that it will go up, or down, in your chosen time frame.
Asking this question before investing is proactive. It can enhance wealth creation and accumulation.
The problem with stocks is that everyone expects that often quoted 10% annual return. The reality is that 10% annual return number includes dividends and capital gains compounded over many years.
Investors think that what happened in the recent past will keep happening in the future. It’s human nature.
People like to go with the crowd. It feels right. By nature, humans want to stick with the crowd. Before a bear market, everyone expects the 10% annual return. After a bear market, people are very concerned about stock market risk.
Investors avoid buying into stocks following a bear market. This is because they may have lost money. Everyone hates the stock market. Yet this is when prices are cheap. Again, it’s hard not to go with the crowd.
One important factor with this slow and simple wealth building strategy relates to time. If you won’t need the money you’re investing in stocks for forty years, the bull and bear moves are less important. This is because they will average out over time.
If you will need the money that is invested in stocks in five or ten years, the price you pay to buy into the market matters more. Having said that, proactive investors know that the price you pay for anything is the most important factor in making money.
When you buy something at a cheap price, odds are much greater you’ll be able to sell it at a higher price. This is a simple wealth creation principle.
This wealth building method can be ideal if it works for your time frame and goals. It’s simple, but it’s slow. It also requires a lot of discipline.
This leads to my next strategy for how to build wealth with some effort, but not a lot. This wealth building strategy is related to Method 1.
2. How to Build Wealth with Cheap Assets
I came to love this method in the 1980’s when I sold a Peugeot. I had bought this car with cash at a bargain price. I sold it for a profit after driving it for eighteen months.
Remember that conventional wisdom holds that cars are always a depreciating asset. This is a perfect example of thinking outside of conventional wisdom.
I applied this same principle to a Rolex® watch I bought in the 1980’s. I haven’t sold it yet, but it has more than doubled in value over the decades that I have enjoyed it. I can sell it at a 100% profit.
Sure, if I had invested the $500 I spent on the watch it would have compounded and grown. On the other hand, I didn’t have to spend $100 to $200 on five or more cheaper watches over the decades.
Let’s look at bigger assets. This wealth building method can be applied to almost any asset class. I’ve used it with stocks, bonds, and real estate.
Click here for more details about these transactions in my free eBook, How and Why We Created Multiple Income Streams with our favorite strategies.
You can apply the Cheap Asset wealth building strategy simply by really focusing on the value of any investment you make. It requires little effort, yet it can be powerful.
Here’s how to build wealth with this method.
- Compare the value you’re considering paying to the historical value.
The price of almost everything moves in cycles. Stocks, bonds, gold, oil, real estate rentals, and homes are all assets where you can apply this wealth building method.
- Take a look at the factors that indicate overvalued or undervalued assets or markets.
- Stocks move down as a result of the overall market moving down.
Individual stocks get beaten up for less than valid reasons frequently. Examples are overreactions to earnings reports or political issues.
Stock bargains are a bit trickier to spot unless you’re really into stock analysis. I seek out analysis gurus with subscriptions to get ideas. It saves a lot of time. Plus, this is what these gurus do daily, sometimes along with a team.
Then I do my own further analysis after I see their recommendations. I’ve learned more than once that my second layer of analysis is important for many reasons.
Alternatively, some wealth managers or funds specialize in this strategy. Funds can work for this method as long as they are not too huge.
Sometimes the price of an entire sector will go down due to decreased earnings, but certain pockets within that sector can still maintain their profitability. A good example of this is service based, or mid-stream MLP’s (Master Limited Partnerships) during oil downturns. Oil has to be transported regardless of the price. Not only this, but these MLP’s own or control valuable assets. Here is a video about how to live off dividend stocks with higher yields.
Another incredible example of this method was implemented by my dad. He worked full time, while paying attention to the financial markets. He read the Wall Street Journal and watched Wall Street Week.
By doing so, he saw that municipal bonds paying up to 25% tax free and selling at huge discounts (up to 50%) of their value were a once in a lifetime opportunity.
This unusual bargain occurred in the early 1980’s. Dad reduced his risk by researching the municipalities well. He also diversified among many different municipalities.
Talking this once in a lifetime opportunity allowed my dad to retire early. Back in the 1980’s, this was rare. Bonds were cheap because interest rates were high. People were fearful they would go higher. Here is my video about how interest rates affect bond investing.
This isn’t a fast strategy, but it’s much faster than long term buy and hold investing. Turnarounds in prices for undervalued stocks and most real estate buys usually take two or more years to generate a meaningful capital gain.
In the meantime, your capital is tied up. This is especially true with stocks. It’s less true with real estate due to leverage.
One income strategy I use sometimes is to sell covered calls against stocks I own. This involves selling an option contract. The income from the call option goes right into my brokerage account.
With the Cheap Asset method, I want to make money on the capital gain from the stock. To accomplish, I sell “out of the money” options.
3. How to Build Wealth with Anomalies
The Anomaly Method is similar to method three with one major benefit. Anomalies can be sold at a higher price immediately. This means that you can generate a capital gain in a few months. You can then use the funds to purchase another anomaly.
Be sure to consider the current tax law for capital gains that are less than a year.
More than once we have bought real estate as part of an estate liquidation during strong real estate markets. These were market anomalies.
The sellers just wanted a fast and easy close. We gave them what they wanted. They didn’t care that they were selling at less than market value.
4. How to Build Wealth with the Income Plus Method
This method can truly build wealth while also paying your bills. If you do it enough, it can pay for your lifestyle completely AND add to your net worth significantly. In other words, this method purchases income generating assets while also allowing you to have an eventual capital gain from the sale of the asset. For this reason, this is my favorite method for building wealth.
There are several variations of this method. They vary based on whether the investor is seeking passive income or more active income. It is an enhanced version of method three above.
- Almost passive income plus capital gains
Most beginners only focus on income when buying rental properties. With this method, you purchase real estate rentals with a high probability of increasing in value as an equally important factor. Examples of properties with a high probability of appreciating in value can be found in the following ways:
- Estate properties
- Properties on the edge of a high growth area
- Run down properties in a great location
- Properties bought near the bottom of the real estate cycle
- Misrun properties
- Passive Income plus capital gains
If you’re wondering how to build wealth with completely passive income, here’s a good example. You purchase undervalued, income generating traditional investments. This may include MLP’s, REIT’s or high dividend stocks.
These bargain prices are found:
- During bear markets
- After unwarranted bad recommendations by financial analysts
- During sector downturns
Wealth Alert: Be sure to do your research first. If something is paying a higher than market yield, it is because it is perceived as riskier than similar assets. The key is knowing when the perception is correct.
5. The Residual Income Method
If you’re wondering how to build wealth while putting in a little work, internet based small business can be an ideal strategy. I became aware of this strategy only recently after I spoke with a small business broker. I wanted to get an idea of how to value one of our internet companies on our net worth statement.
We had focused on this business for the cash flow it generated. After meeting with the business broker, I learned that it has become a very nice little marketable asset. Here’s why this wealth building strategy is so powerful.
- Little or no capital is required so it’s ideal for those with little savings
- There is very little or no risk since no capital is required
- The upside is huge when you get it right
- Companies are actively seeking to buy small websites, including bloggers and Amazon stores
- Companies pay a multiple of net income based on the industry when buying websites.
One of our online businesses was generating significant income after net fifteen months. We had, however, learned how to build an online business with our first idea. We began knowing nothing about internet businesses in late midlife.
Here is my video about factors to start a business online.
Internet businesses can take many different forms. This can include software, courses, memberships and consulting. This wealth building strategy can generate both income AND build an asset. It’s still an incredible opportunity given the low or zero capital requirement.
The reality is that it takes a while to start making residual income from an internet business. Residual income in this case means “extra”. An example would be selling a program from a website that was developed once, selling software, or selling a license to use your program.
If you’re wondering how to build wealth, you’ve got five different strategies. The strategies have different capital requirements and time frames. They also call for different levels of work. Decide which is best for your own circumstances and goals.
Click here to learn more about our wealth building adventures in my free eBook, with the top 9 ways to generate income while building wealth.
Sources
thebalance.com https://www.thebalance.com/stock-market-returns-by-year-2388543
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