Personal Finance Rule #2
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.
- 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).
- 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.
- 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.