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How to accumulate wealth?

Updated: Oct 19, 2022

Young woman works from home

In order to accumulate wealth, firstly you have to have some savings. Savings can be obtained by having extra income after paying all the bills. Most people earn an income through nine to five jobs. Some people may already have quite large savings from inheritance or other sources.

Once you have that savings, you need to use the savings to buy assets that can generate more income. The more savings you have, you have more choices to buy different assets that generate higher returns.

Savings are the most safe assets but with the least returns. Bond investing may have higher returns than savings, and not risky. Stock investing doesn’t require a lot of money, and may get an annual average of 10% nominal return (before inflation) if you invested in the S&P 500 index fund. Real estate investing requires a lot of fund because the houses are not cheap anymore, but usually with more consistent and higher returns than stocks. Cryptocurrencies are probably the most risky assets and currently only good for traders. Gold and silver are traditional assets, which can offset the effect of hyperinflation and war, but the average annual return is just so so.

The other forms of wealth, including patents, copyrights, arts, collections, and businesses, usually require more specific knowledge and skills, which may not be easy for regular people.

The essence of accumulating wealth is to invest your savings in an asset portfolio, which can either generate income (such as interest income, dividend income, and rental income) or capital gain (sale of the assets with higher price). Your wealth will be increased each year, and then you will reinvest with those money to buy more assets.

Assume you have $100,000 savings invested with 10% annual return, you will have $1,000,000 by the end of year 25. There is an easy way to calculate how many years you can double your wealth, and it’s the rule of 72. You divide 72 by the estimate annual return, the result is the years that you can double your wealth. In this case, with 10% annual return, you can double your wealth in 72/10=7.2 years.

Usually, 10% is a pretty good annual return for a big fund. However, if the money is small (for example, just $10,000), it may not change much to your life.

For small money, you have to use some leverage to increase your return. Leverage means you use other people’s money, such as mortgages, loans from bank, or derivatives (options and futures for stock market). Most businesses use some leverage for expansion. Real estate investors can use leverage to gain more properties through BRRRR method (Buy, Rehab, Rent, Refinance, Repeat).

Assume you only have $10,000, but you have $90,000 leverage from other people. If you can get the same annual return of 10%, but the interest rate for the leverage is only 2% per year. You can double the money in 7.2 years, with the total wealth of $200,000. After deducting the leverage cost of about $100,000, you still have $100,000 wealth which belongs to you only with initial investment of $10,000. So basically, you wealth increases 10 times with only 7.2 years. That could be the best return available in the market.

However, leverage is a double-edge sword. A lot of businesses went bankrupt because of leverage. Sometimes, they are over leveraged and can’t pay the debt interest with income. Most of the time, they are just not lucky experiencing a recession, which resulted in lower or negative returns.

The trick here is you have to understand cycles. All asset classes have their own boom and bust cycles. When interest rate is low and monetary policy is loose, economy will be good, and it’s more favourable environment for leverage. However, if inflation is high, it may cause deflationary bust with increasing interest rate, tight monetary policy, and economic recession, which would be a nightmare for leverage.

There is an investing method called crash investing. The logic is when an asset class crashes, there usually may be high quality assets with lowest price (maybe 80% off). Investors can buy the assets and wait until the assets recover their prices. Many wealthy people are born during the process.

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