Wealth BuildingIn financial lingo, wealth building typically comes from having realized capital gains. A realized capital gain occurs when you buy an asset and sell it for more than you paid for it.
Wealth Building and Net WorthUsually, the results from wealth building investments are reflected in your net worth while the results from income investments are reflected in your lifestyle. It’s super important to note here that your net worth will increase while you own an asset that increases in value even if you haven’t sold it yet. Note that when an investment you still own has increased in value, you have an “unrealized capital gain” in financial and tax lingo. (Read my related post How to Calculate Net Worth and How Much of My Net Worth Should Be in Cash for more on this.) On the other hand, if you sell the asset after it has increased in value, you’ll have a “realized capital gain”. Every investor loves realized capital gains since the increase in value is locked in and it becomes a confirmed gain; this is the essence of wealth building. It’s important to note that both realized and unrealized capital gains result in wealth building since the result is reflected in your net worth. Until the investment is sold, however, the increase in the value of an investment can easily swing back to or below the cost of the investment. When this happens, that temporary increase in wealth has evaporated. Unrealized gains can also turn into unrealized losses, which commonly happens during bear markets.
Wealth Building InvestmentsInvestments that build wealth are those that are expected to increase in value first and foremost. While traditional investing considers only growth stocks for wealth building, more alternative investors like us use other assets for wealth building, too. Examples of wealth building investments we’ve used are below.
Growth StocksStocks that are expected to increase in value due to stronger earnings are considered growth stocks. These are the staples for wealth building in popular asset allocation models. Many investors use an S&P 500 based index fund or ETF to represent the growth allocation in their portfolio. The iconic FANG (Facebook, Amazon, Netflix, and Google) stocks are perfect examples of growth stocks from the 2010 forward bull market. Similarly, in the late 1990’s, other internet and technology based companies were the overly popular growth stocks. A few decades ago, the Nifty 50 represented growth stocks. Growth stocks build wealth until they loose their glitter. Many, however, build wealth for decades for their investors.
Momentum based ETF’sMomentum based assets include growth stocks but I include them as a separate category of wealth builders here because they are often include assets besides stocks. The distinguishing characteristic for momentum stocks is that they are selected based on momentum as measured by technical analysis. Common momentum based assets that are used for wealth building are ETF’s for commodities, real estate and foreign markets, as well as stocks. Such stocks tend to be the growth stocks of course. At times, even bonds or other debt based ETF’s are momentum investments.
Real EstateWhile real estate ETF’s can gain high momentum status that builds wealth, individually owned properties can also build wealth. Rental properties, of course, fall into both the wealth building and the income investment categories giving them a nice advantage for investors willing to make the effort to own them. The real beauty is when the wealth building slows, the income keeps coming. While growth and momentum stocks often build wealth fast, real estate properties tend to build wealth slower.
Undervalued AssetsUndervalued assets that are bought with the expectation that they will increase in value build wealth if they do, in fact, increase in value. I include undervalued assets as a wealth building category because they can be ideal wealth builders. This wealth building strategy can be applied to any type of investment, including stocks, bonds, real estate or other alternative investments. Such investments can be in any form, including index funds, ETF’s or outright ownership as happens with real estate, metals or even small business.
Small BusinessSmall businesses are another alternative investment that has demonstrated excellent potential to build wealth. Internet companies, in particular, are shining as wealth builders in this century thus far. This can be witnessed by the millions of internet based companies that have increased in value. The failure rate among small businesses is high, calling for diversification and particularly careful selection, of course. Read my post Assets That Build Wealth for more about this.
Income InvestingIncome investing is done when an investment is chosen because it pays the investor some form of income as opposed to choosing an investment because it’s expected to increase in value.
Income SourcesInvestment income can come from many different sources. Here are some common income sources which I write about here at Retire Certain after being fortunate enough to have personally experienced them at some point in my life:
- Stock dividends
- Bond interest
- Real estate rental income
- Alternative investment income from REITs and MLPs
- Covered call income
- Business income of various types
Stability for Wealth Building Vs IncomeIncome investments are thought to be more stable than wealth building investments. This is because the value of many assets that are used to build wealth fluctuate in value, often daily. In fact, most stocks fluctuate in value within one second after purchase. Investors tend to continue to hold income investments because they always have the attribute of paying income, even when broad markets are decreasing, taking wealth building investments down with them. (Read my related post Are Stocks Safe for Retirement?) While bonds can certainly fluctuate in value due to interest rates and other factors, they tend to fluctuate less than stocks. The value of real estate tends to be even more stable since it is less liquid than stocks and bonds. Income investing doesn’t come without risk, however. You can read my post on the risks of income investing for more about this.
Time Frame for Wealth Building Vs IncomeWealth building usually takes years. Income, on the other hand, is usually received weekly, monthly or quarterly. You can even buy an asset and get income immediately. An example of this buying a stock at the dividend record date; many proactive investors buy stocks a day or two before the dividend record date just to capture the dividend. (Note that the stock tends to drop in value immediately after the dividend record date.) Income from covered calls is another example of immediate income. Wealth building sometimes happens immediately but it is less common than immediate income. Sometimes investors buy stocks that immediately jump in value. This may happen as a result of an earnings or merger announcement. It can also happen during a fast moving bull market, particularly with momentum stocks as addressed previously. Usually, however, wealth building or growth from stocks is a slow process. This is especially true of older companies, those which icon fund manager Peter Lynch called stalwarts. Such stocks aren’t bought for income, but rather for slow steady wealth building. Read my related post Are Dividends or Capital Gains Better? Smaller nimble startups have changed the time frame for wealth building from owning equity, however, as you’ll see next.
Saving Income to Build WealthMost investors assume wealth building comes over time from saving income and investing it in stocks but this isn’t the only way to build wealth. First, income isn’t always necessary to build wealth. And, second, stocks certainly aren’t the only way to build wealth as addressed earlier. For example, here are ways an investor can build wealth regardless of whether they have income. They could:
- Build a business, and sell it for a profit
- Inherit money and subsequently invest it successfully
- Sell real estate for a profit
Assets that Build Wealth and Generate IncomeMy favorite assets are those which build wealth and generate income, too. This is true of many assets, including the examples below:
- Dividend Paying Stocks
- Real Estate Rental Properties
- Online Business
Wealth Building Vs Income for TaxesWealth building and income are treated differently for tax purposes. Each have different categories and rules which affect the rate at which they are taxed. A core principle of wealth building is minimizing taxes. By being aware of how both wealth building from capital gains, and also the various types of income are taxed, you can lower taxes and thus be able to put aside more money to grow. Read my related post Owning a Business Vs. Real Estate.
Summary for Wealth Building Vs IncomeAs you have seen, wealth building and income are different priorities of investing your money. Used strategically, however, both can have a powerful impact on your ability to achieve financial independence.
The information on this website is for education only and is not to be construed as personal financial advice.