They have most of the same assets that everyone else has, just more of them; with one exception. The main difference is the balance between the different assets they own.
That one exception is equity in a private business. Whether it is a business they started or purchased, most wealthy people have equity in a small business of some kind. For many millionaires this is the biggest and most important asset they own, especially when they are younger. This is the key difference between most wealthy people and almost everyone else, they are able to build up value and wealth in their day to day jobs. If you have a normal salaried job, you can save some percentage of your income each year and invest it, typically into public stocks and mutual/index funds. So if you make $100k per year and save $20k you eventually accumulate a few hundred thousand dollars over a decade. For the small business owner, they can earn an unrealized capital gain each year as they grow their business, depending on the nature of the business. Imagine if you could forgo your current salary and build a career with a small business that earned profits equal to your salary, this would make the salary and the business equally valuable positions right? Probably not. The difference is that after several years, you can potentially sell the business, typically for 5–10x it’s annual cash flow. The job that pays me $100k per year will leave me with nothing when I decide to quit or retire. The business that took ten years to build and get to $100k in cash flow can potentially be sold for $1,000,000.
Most wealthy people owe at least part of their wealth to ownership of a small business, this typically being their greatest asset. They’ll accumulate stocks, bonds and real estate over time as well, but the value of the business can be staggering.
Aside from small business ownership, wealthy people usually have their assets balanced far differently than most. The average person has most of their net worth tied to the equity in their home. They also buy cars and other items that consume most of their would be net worth. They tend to be far less risky when it comes to investing and keep large amounts of cash on hand. Wealthier people are able to put much more of their money towards appreciating assets rather than personal goods. They spend a much smaller portion of their money on things like this:
Buying a personal home is not an investment and is highly unlikely to outperform other common investments. For most of the country, homes do not increase in value very quickly, they produce no cash flow and require constant maintenance, insurance and taxes. Middle class people who don’t have a lot of extra money tend to keep it safe. This means it sits in savings accounts and depreciates. Wealthier people can afford a little extra risk with their investments. This means they can keep a large portion of their wealth as equity in private businesses, stocks, and investment real estate. These relatively risky investments typically pay off dramatically in the long run.
Look at a sample for a middle class family vs a wealthy family:
$50,000 Home Equity— 50%
$30,000 401k/IRA/Stocks— 30%
$20,000 Cash Savings—20%
$200,000 Home Equity— 6%
$1,000,000 Family Business— 31%
$1,000,000 Stocks— 31%
$500,000 401k/IRA/Stocks— 15%
$500,000 Investment Real Estate— 15%
$50,000 Cash Savings— 1.5%
Obviously everybody’s situation is different but my point is there are a few major advantages that the wealthy typically have. The first being the ability to build equity through their work. Building a small business can pay off enormous dividends in the long run. The second is the ability to take additional risk. Think about how much cash you try to keep in savings and what percent of your net worth it equals. The rule of thumb is that you need savings equal to six months worth of expenses, for a middle class family, six months worth of money may be almost their entire net worth. This leaves very little to be invested for growth. The wealthy have the ability to invest their money into small business ventures that pay exorbitantly high rates of return when their are succesful. Think back to the salary vs. small business comparison. The salary person has little ability to use their capital to improve the value of their work, they are trapped in their employers environment. The small business owner can use their capital to raise the value of their efforts. They can buy equipment or machinery or advertising that will make their efforts more fruitful. These opportunities also typically have the ability to multiply their money rather than a small return from investing in a stock. $20,000 in your 401k/stocks might pay you 10% annually if you are lucky and be worth $32,000 in five years. The small business owner can spend $20,000 to open a new location, hire new employees, upgrade equipment, etc all of which have the possibility of generating a 100% return in under a year. According to census data, 40% of small businesses started with less than $5,000 and according to a 2014 Intuit survey, 62% of small businesses started with less than $10,000. There has been little to no evidence to suggest that spending additional money at the start leads to a higher rate of success. This means that if you can easily afford to risk $5–10,000 you can take risks on new business ventures that if they are successful can return multiple of the initial investment. Unfortunately most middle class families don’t have an extra $10,000 to risk and they get stuck in their salaried positions.
If you want to become wealthy, you must find a way invest like the wealthy. Start a small business, keep as much money as you can in appreciating assets, and take calculated risks that can pay out long term. Every successful entrepreneur at some point had to take the calculated risk to give up whatever they were doing and start their business. If all they did was consider the probability of success and weigh it against the potentially cost of failure, most of them would of never started. Starting a small business is more than just a math equation and there is more too it that just calculating the probability of earning your money back. Entrepreneurs calculate the amount of money they must risk (<$10,000) and consider the benefits of starting a potentially life changing venture.
For the ultimate study of how the wealthy make, spend and accumulate their money, read one of my favorite books by Thomas J Stanley The Millionaire Next Door: The Surprising Secrets of America’s Wealthy. Stanley does an in depth study of how the wealthy really make their money, how they invest and what type of lifestyles the truly wealthy live.
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