When you first graduate from school, you may have a desire to make six-figures a year. Then once you make six-figures and get taxed out the wazoo, you start wondering how to create next-level wealth.
Next-level wealth is based on net worth, not income. Earning a top one percent income is nice, but paying over a 40% marginal federal + state tax rate isn’t.
If you want to create next-level wealth, your goal should be to create as much equity as possible that is never sold.
You can build as much wealth as Jeff Bezos so you can laugh at all of us peasants trying to make ends meet during a global pandemic! You and the next 100 generations of Bezoses would become untouchable.
The Desire To Create Next-Level Wealth
Ever since I was a kid, I’ve wanted to become rich. I saw so much poverty growing up throughout Asia that it made me scared to be poor.
In Malaysia, when I was in middle school, my poor friends lived in a studio with their parents and siblings. They subsisted on one or two simple meals a day as their parents worked multiple jobs to make ends meet. My rich friends lived in mansions in the hills with chauffeurs. Their parents were all business people. It was such a different world.
One of the luckiest things I’ve ever done was not sell any major assets during the downturn between 2008 – 2009. It’s understandable to panic sell when things are crashing and burning.
It’s also easy to sell in a down market when you have a major life event e.g. losing your job, having a baby, etc. But fortunately, many of my investments were either illiquid (real estate) or were locked up with long vesting periods (private funds). Even if I had wanted to sell, I couldn’t have!
Just like how the 2008-2009 downturn jolted me into trying to build more wealth, the current 2020-2021 downturn is doing the exact same thing. These painful periods are often the most motivating to build next-level wealth.
Hang On For As Long As Possible
There was a period of time during the 2008 – 2009 bear market when several personal finance sites sold for between $1 – $4 million. Although $1 – $4 million is a lot of money in absolute terms, based on the cash flow, the acquisition prices were all absolute steals.
For example, one guy with an operating profit of about $700,000 a year sold his site for only $2,500,000. You’re not even a real millionaire at $2,500,000 thanks to inflation. If you have a partner, then you’re definitely not a millionaire because you’ve got to divide the after-tax proceeds by two.
To generate $700,000 a year at a 8% rate of return requires $8,750,000 in capital. At a more conservative 4% rate of return, you’d need a whopping $17,500,000 in capital to generate $700,000 a year!
It’s hard to say someone making $2,500,000 got robbed, but robbed he was. If he had held on for just 3.6 more years, not only would he have made a total of $2,500,000 in operating profits, but he would still own a site making $700,000 a year or more for the foreseeable future.
To build next-level wealth, you’ve got to hold onto your equity for as long as possible.
Think About Your PayBack Period
The payback period is the length of time required to recover the cost of an investment. In the site sale example above, if the buyer can maintain his operating profit level, he’d recover his full $2,500,000 investment in just 3.6 years. 3.6 years is his payback period.
All money earned after the payback period is 28% a year gravy. Earning 28% a year for a decade will make you rich.
Let’s say the buyer has some hustle and expertise. He could conceivably grow operating profits from $700,000 in year one to $850,000 in year two and $1,000,000 in year three.
In this scenario, the buyer lowers his payback period to 2.9 years AND could sell the site for $3,600,000 (44% more) based on the same pitifully low multiple of 3.6X operating profits ($1,000,000 operating profits X 3.6 multiple).
But since 2009, something magical has happened. Valuations for media companies and the entire S&P 500 expanded by ~100%. See the chart below.
When the site owner sold his site in 2010, the S&P 500 was trading at 15X Cyclically Adjusted Price to Earnings (CAPE). Now valuations are at around 30.5X.
A 100% increase on a 3.6 multiple equals 7.2X. Let’s do some math and find out how much the person who spent $2,500,000 on a site back in 2010 has made so far!
This is a perfect example of how one person can create next-level wealth through equity.
Investment Returns Scenario For Next-Level Wealth
2010 Investment: $2,500,000
Business Operating Profit: $700,000
Estimated Payback Period: 3.6 years
Forecast Operating Profits
Year 1 Operating Profit: $700,000
Year 2 Operating Profit: $850,000
Year 3 Operating Profit: $1,000,000 – Everything paid back in 3 years
Year 4 Operating Profit: $1,000,000
Year 5 Operating Profit: $1,000,000 – Keeping OP flat to stay conservative
Year 6 Operating Profit: $1,000,000
Year 7 Operating Profit: $1,000,000
Year 8 Operating Profit: $1,000,000
Year 9 Operating Profit: $1,000,000
Year 10 Operating Profit: $1,000,000
Total Operating Profit Over 10 Years: $10,000,000
Percentage Return If Not Sold: 400% ($10,000,000 / $2,500,000 investment). Not bad! The owner will continue to make $1,000,000+ a year in cash flow.
But because valuations for online media properties have increased by 100% since 2010, the buyer can now turn around and sell his $1,000,000 a year operating profit business for $7,200,000 based on a 7.2X multiple instead of a 3.6 multiple.
Total Return After Sale: 680%. $10,000,000 operating profits + $7,200,000 sale price = $17,000,000 divided by $2,500,000 purchase price = 680%.
Now imagine if the business grew operating profits to $2,000,000 before selling, instead of keeping operating profits flat for all 10 years. We’re talking a total return of over $30,000,000 from a nice little lifestyle business.
Compared to the measly $2,500,000, having $30,000,0000 is some REAL F YOU money. Compared to the returns of the S&P 500, there is really no comparison.
You can either buy a business or build your own. Why not do both?
Don’t Be Tempted By Short-Term Gains
To create next-level wealth, you must have patience.
Now obviously an investor might be stupid enough to drive a newly acquired business into the ground. But most people who spend $2,500,000 have enough smarts to make sure they hold operating profits at least flat to reach their base case payback period.
Large absolute dollar amounts are enticing to business owners. But they are dangled in front of you because you have something even more enticing for the buyer! Never forget the rationalness of finance. In our permanently low interest rate environment, please do not sell your cash cows.
If you can buy a cash generating business with a payback period of less than five years, you should get excited. Your investment essentially becomes risk free after five years. It will then make a 20% return into perpetuity. A 20% return is a home run compared to a historical average 8% – 9% S&P 500 return.
If you believe you can increase operating profits after acquisition, then you should get pumped. Finally, if you believe there will be valuation expansion on top of business growth, you should go all-in.
Creating Next-Level Wealth In Real Estate And Products
Two of my favorite ways to build passive income is through real estate and creating your own products.
Below is a chart showing how much capital you need to have to generate $55,000 in net rental income and $20,000 in revenue with a product at various interest / return rates.
Notice how the lower interest rates go, the more valuable the real estate and product becomes. With the 10-year bond yield below 0.7%, the value of these two types of cash cows have gone way up in the new decade!
Is there any wonder why the demand for real estate is so strong? When you can create your own products with minimal up front costs, it must be done if you want to build more wealth. I’m personally going to create a new book to be published next year.
Profits + Equity = Next-Level Wealth
There’s a reason why so many of today’s wealthiest people are entrepreneurs. Not only do they create businesses that generate revenue, they also own equity that can be sold for multiples of annual revenue or earnings.
Most day jobs don’t build equity. When it’s time to go, workers are left with nothing because they are no longer contributing their time. There is no leverage in only being a laborer.
Of course, sometimes you do get equity and your equity doesn’t go anywhere. For example, you may have joined Uber in 2015 when the company was valued at $51 billion.
Today, Uber is still valued at about $51 billion. This is despite employees accepting a lower salary for all these years. But at least you have a chance to create next-level wealth through equity ownership.
Best Ways To Create Next-Level Wealth
1) Build a business
I encourage everybody to build a business that also grows a strong brand. I’m talking about many types of businesses, not just a website business. With a strong brand, you can pivot more easily as the world changes. With a strong brand, you can command higher prices and take more marketshare.
Making money from your day job is fine, but you’re slaving away making someone else who owns all the equity rich. Even if you are at a startup with equity, just know that for every $1 you make, you’re literally making someone else more senior 20 – 10,000X richer. Instead, get in the mindset of making yourself rich by growing your own equity.
If you own a business, please be patient and do away with short term thinking. I still remember people mocking the founders of Snapchat for rejecting a $3 billion offer from Facebook in 2013. But unlike the peanut gallery, the founders knew that if they just sat in their seats and continued to execute, their business would be worth much more over time. Today, no matter how ridiculous the value proposition, Snapchat is worth ~$32 billion.
Yes, growing a business is not easy. But at least starting one today is. Most people never try, which is why most people will never come close to creating next-level wealth.
There are endless examples of people who’ve created something from nothing and sold it for mega millions in a relatively short amount of time.
2) Take a gamble and join a startup
Joining a startup will likely make you poorer rather than richer. Startups pay below-market salaries in exchange for equity that could be worth a fortune. But most of the time, startup equity will be worth a ho-hum amount or nothing due to startup failure. If you plan to join a startup, please sleep with one eye open.
It’s very hard to win the lottery. So long as you remember this, you are free to join a startup to seek your fortune. The earlier you join a successful startup, the more equity you will build. However, the earliest startup employees have the highest amount of risk. Therefore, please negotiate a solid equity package.
3) Become an angel investor
I also don’t recommend anybody angel invest with money they cannot afford to lose. Hitting it big with angel investing is even harder than hitting it big with a startup. You have no edge. Further, you need to invest a decent sum of money to have a large return.
For example, let’s say you invested $25,000 in a startup that returned 100X. The gross amount of your $25,000 is now worth $2,500,000. However, you need to cut the amount in half due to dilution from subsequent funding rounds. Then you’ve got to pay taxes. You may end up walking away with only $800,000. Not bad, but not next-level wealth.
4) Join a tech monopoly
You might not create next-level wealth quickly if you join a tech monopoly like Google, Facebook, and Apple. However, you will get paid way more than the average employee and receive extremely generous equity packages.
For example, Google pays 23-year-old software engineers with one year of experience around $200,000 a year. By the time these employees turn 30, they will have a median total compensation of $350,000. If you are in the top 15%, your total compensation package is around $400,000.
The Easiest Way To Build Wealth
Obviously, joining a hot startup or a tech monopoly is difficult. The competition for these jobs is fierce. Meanwhile, investing a large enough sum as an angel investor also takes guts or already having a decent amount of money.
Therefore, the easiest way to build next-level wealth is by starting your own business on the side. Work your day job and then spend your remaining hours building your side business. If you want to build next-level wealth, you must put in the extra time.
The great thing about building your own business is that it’s permission-less. You don’t need a fancy college degree. You don’t need a lot of capital. Nor do you need to be invited. All you’ve got to do is start.
If you want to build next-level wealth, you need to own equity that grows. You could get lucky by joining a Google in its nascent period. However, you don’t only want to rely on luck if you want to get really rich. Ride your company’s growth and try and increase your own luck by taking further action.
Tool To Build Next-Level Wealth
To create wealth, you must diligently track your wealth. Sign up for Personal Capital, the web’s #1 free wealth management tool to get a better handle on your finances.
In addition to better money oversight, run your investments through their award-winning Investment Checkup tool. I will show you exactly how much you are paying in fees. I was paying $1,700 a year in fees I had no idea I was paying.
After you link all your accounts, use their Retirement Planning calculator. It pulls your real data to give you as pure an estimation of your financial future as possible using Monte Carlo simulation algorithms. Definitely run your numbers to see how you’re doing.
I’ve been using Personal Capital since 2012. In this time, I have seen my net worth skyrocket thanks to better money management.
Originally posted at https://www.financialsamurai.com/how-to-create-next-level-wealth/