BUILDING WEALTH – Part 3

Building Wealth-Part3

By Gary John

In this series I would like to discuss how to build perpetual wealth, the reasons for diversifying your investments, how to approach diversification, and how to leverage different asset classes and diversification strategies to increase your wealth and ensure your personal prosperity, and how to tax-shelter your wealth.

(As a disclaimer, I am not a CPA, lawyer, or financial planner so it is in your best interest to seek differing opinions on the topics I present, so you can make your own decisions)

In Part 2 we learned the key differences the wealthy have. They constantly educate themselves in order to obtain income producing assets that have a positive cash flow. The key to their success is securing assets. They understand that Cash is King and they want those checks to keep pouring in. With this passive income they never sell off the principle but only spend the interest and earnings from their assets.

Building lasting wealth means you will never run out of money. It also means that you can leave your wealth to future generations and if they use it wisely, they will never run out of money either. What a legacy you can provide to your children and their children! You will teach them the value of money, how to use money wisely, how to keep their wealth machine working, and how to teach their heirs to do the same.

These are the Basic Concepts for Building Money Generating Machines:

1. Allocate a portion of your income to investing in assets (hopefully at least 10%).

2. Invest in assets that produce cash flow.

3. Reinvest the earnings into the same or different assets that produce positive cash flow.

4. Allow time and compounding returns increase your wealth (the earlier you start the better; but it’s never too late however!)

5. Spend only a portion of the cash flow that comes from your investments.

Let’s talk about diversification. As we were taught, ‘Don’t put all your eggs into one basket’. This is one of the hardest things I have to deal with. It is so tempting to put all your money into, for example, into the stock market if it is hot. But then comes a pandemic or a recession and it falls like a rock. That’s why you need diversification, to balance things out if one sector isn’t doing well.

Here are some of the different asset classes you should consider (more of these later):

1. Cash

2. Stocks, bonds, mutual funds

3. Businesses

4. Real estate

5. Farmland

6. Peer to Peer lending

7. Cryptocurrency

8. Precious metals

9. Collectibles

10. Annuities

Also try to diversify within the class. For instance, with the stock class, use different brokerages, investment platforms, market segments, different companies, dividend vs growth stock. Try to allocate a little into all classes. My favorite is a stock that has dividends. For me, this class is the easiest, least risky and most secure. You may have a differing option and that is okay.

Let’s go through the various asset classes in more detail:

Cash

You need to have cash; but there is good and bad to it. You need it because it is super liquid. You need it for everyday expenses, emergency funds, and opportunity funds. But you do not want too much of it sitting around however. When you leave money in the bank, it is worth less and less over time. Inflation eats away your cash like a moth in a clothes closet. Well, then how much do I need? Of course that depends on the individual. Start off with at least 3 months of living expenses, including mortgage or rent, utilities, taxes, car repair and so on. Put this in a separate saving account but keep it liquid in case you need to access it.

Stocks

This is my favorite class. I will have a whole segment on this later but for now I will speak in general terms. There are two reasons to invest in the stock market. One is price appreciation and the other is cash flow. I was taught that in your 401k to buy stock and or mutual funds and it will go up 8-9% on average per year and when you retire you can slowly withdraw it (about 4% per year). Boy, is this wrong. If you are investing in the market just for price appreciation you may be in a world of hurt. The pandemic market crashed almost 30% and it will take a while to recover. An average person will, however, continue to withdraw their 4% of their fund but now it is worth 30% less. How long will your funds last you now? Do the math; will it be 15 years, 10 years, or less?

Secondly, I might be old fashion but I want to leave an inheritance for my kids. I have awesome children and soon-to-be grandchildren and I want to leave them a financial legacy. If you run out of your money I guess they will still get your beat up house and car (Sorry, a little sarcastic).Or worse yet, you are forced to live in their house because you have no money left.

Here’s the good news about stock investing. You can easily achieve cash flow from stocks in what are called dividend stocks. Dividend stocks are stocks that pay you earnings (dividends) on a regular basis. In a market turn down like Covid, my dividends did not drop at all! My feeling is if you buy the right stock with a large established growing company they have a high amount of cash reserves that they are not impacted by a market turn down as in a smaller company. Also it seems that an established company rather die first before they lower or stop their dividends probably because savvy investors won’t buy their stock if there is a dividends drop.

When I don’t need the cash flow I reinvest the dividends back into the dividend stock. By doing this, I can leverage the power of compounded earnings to increase the cash flow capacity of my stock portfolio.

As a general rule of thumb when it comes to investing in dividend stock is to invest in well run companies that have a long history of paying dividends. You want to also see dividend growth every year. These stocks are called the ‘Aristocrats’. One noteworthy point, too high of a dividend (over 5%) may not be good. This may be a sign that the company is trying to lure new investors in before they drop the dividend earnings. A good website to use is SeekingAlpha.com to check the dividend history of a company.

As far as taxes, dividends are only taxed as capital gains which are between 15-20% which is a lot better than your normal tax rate.

Dividend stock can be purchased individually or in an index fund. Billionaire investor, Warren Buffett, likes index funds so much that he has gone so far as to have advised investors to put as much as 90% of their stock investments into index funds. Check out Vanguard, Fidelity or Schwab for these.

Lending

Peer-to-Peer lending allows individuals and businesses to bypass banks and go directly to investors for loans. So now you become the banker. Your return may be higher but it may come with a risk. Loans given to individuals and businesses are generally unsecured, which means the main risks to investors come in the form of borrower defaulting. You can check these sites for further information: streetshares.com, lendingclub.com, proper.com, or upstart.com

Real Estate

Real estate has been a lucrative investment for many investors. Whether you buy an individual unit, multi-family, commercial, senior housing or storage units it has many benefits. You can invest in real estate with stocks, REITS, or a direct purchase.

When you buy directly you can leverage the tax benefits of depreciation to reduce or potentially eliminate any taxes that would otherwise might be due on the flow that you receive from rent.

The downside to owning real estate outright is that you either have to manage it yourself or hire someone to manage it for you.

With REITS and stock you won’t have to manage it but your proceeds will probably be less.

(Stay tuned for Part 4 for more income producing assets….)