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Personal Finance Rule #2

8 July 2011 23 Comments

This principle is sort of a two-for-one principle.  It has two parts that are related.  They are as follows: 1) you will never get rich off a salary, unless you are in the .001% that are executives for gigantic companies and make salaries in the millions, and 2) the key to wealth is rate of return.

Let’s start with the first part. With very few exceptions, you will not get very wealthy from being a salaried employee.  Now there are high paying jobs, and you can be very frugal and do well and save wealth over time, but you will not jump into higher stratospheres of wealth in a short period of time via a salary.  Some people can do very well in sales and make on the order of $500,000 and up in a single year, but again these are the exceptions.

So how do you get wealthy? By generating a high rate of return on your resources. What are your resources? Your time, your energy and your money.

When you are an employee, your time is being used to lever up a rate of return that doesn’t benefit you. It benefits the company you work for.  One of the best ways to see this is by looking at the classical definition of an entrepreneur. It’s very simple. An entrepreneur is one who allocates resources for higher rates of return. An entrepreneur puts capital at work to generate a high rate of return. An entrepreneur hires an employee to generate a high rate of return to where they will earn many times back in revenue versus what they pay the employee.

We often think that personal finance is just spending, budgeting and saving. No, that is just part one. That enables you to do what we’re talking about here. Starting a business, investing in property, investing in stocks, etc. All in the name of a high rate of return.

We all know that compounding interest is powerful on savings. Well, compounding rates of return on business is ridiculously powerful. This is all Warren Buffett has done over the decades. Find businesses that generate a high rate of return and continue to invest in them. His company, Berkshire Hathaway is just a massive holding company with a bunch of companies that generate growing amounts of cash each year.  Simple, but hard at the same time.

Unfortunately, because our politicians and leaderships are stupid, and hold all of their allegiance to the banking class and other politically influential groups, they have engaged in policies that brought interest rates to zero. The result is that your rate of return on savings is actually negative when you factor in inflation.

Typically you build your savings with two forces. The amount of money you save and the compounding interest. The compounding interest is non-existent now with the current rates. This means you’re basically flying with one engine. It sucks. Side note: This has helped fuel higher stock prices and commodity prices as people trying to escape the negative real return rates of idle money.

So, what’s the point? What does this all mean? What can you do now if you’re just a regular joe with a job and not much wealth. Here are some items to consider.

  1. Change your mindset from an employee to an entrepreneur. This doesn’t mean quit your job and start a business. Rather use your job to build skills and relationships that will benefit you down the road should you start your own business. Don’t be a mindless America content to be an employee your whole life and always looking for someone else to hire you (and consequently blaming someone else for your unemployment).
  2. Start learning about investing in some area. If you do things right, you’ll have some money that you’ll be able to invest into some area. This doesn’t mean only the stock market. That is just one area to invest. Business, real estate, stocks, etc.
  3. Study businesses that have compounding and increased cash flows year after year for decades. One of the best metrics to examine when evaluating stocks to buy is the ROIC (return on invested capital) as it indicates management’s effectiveness in allocating capital to grow the business.

Comments? Questions?


23 Comments »

  • Andy said:

    article in fit quite interesting to read so that adds new knowledge to my

  • Ginger said:

    I think you need to be an employee, at least for sometime. It teaches you how not to be (as a boss) as well as giving you health insurance. I plan to start a business at some point but paying health insurance would mean I would have to earn much more than my salary just to get my salary.

  • joe said:

    I agree with Ginger, it is a good experience to be an emploee. it sure easier:)
    IVF

  • Treppenlifte said:

    Not many economic rules can be applied today. As it turned out, the crisis has exceeded all expectations of the economical experts.

  • Treppenlifter said:

    In this global economic crisis, many people are content with the salary they receive and not through going to get rich. Treppenlifter

  • max said:

    There is no need to be an employee. Right out of high school I started my own ebay business, and that soon grew into bigger better things. I had a few od end jobs in high school, but after that I knew I would never work for anyone but myself the rest of my life. Its easy to get the ball rolling. Sorry for my bluntness, but their are two types of people in life, slaves and masters. What are you?

  • ilovequotesforhim said:

    It definitely stretches the limits with the mind when you go through very good info and make an effort to interpret it properly.
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  • rick said:

    I suggest you find something you enjoy doing, by working for someone else. When you have the skills, you will be ready to begin your own business. The training received working for another can be more valuable than the wages.

  • MacKenzy said:

    As an entrepreneur or small business owner you will not have the resources needed for effective and efficient allocations. So, being an employee at a "gigantic companies" is the ultimate first step towards becoming your boss and avoid cognitive dissonance.

  • Dentists Bellevue said:

    We often think that personal finance is just spending, budgeting and saving. No, that is just part one. That enables you to do what we’re talking about here. Starting a business, investing in property, investing in stocks, etc. All in the name of a high rate of return.

    We all know that compounding interest is power

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  • 1pts said:

    they have engaged in policies that brought interest rates to zero. The result is that your rate of return on savings is actually negative when you factor in inflation.

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  • AngelCanyo said:

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