How To Become Wealthy In America
Austrian Economists Pirmin Fessler and Martin Schürz released a new study measuring how wealth is generated in across Europe and in the United States. If you are into economic papers, it’s an interesting 45-page read. If you’re not into reading economic papers I’ll provide you with a quick summary of their findings.
They split households into four categories.
- Business Owners
The results for the United States are not surprising:
- Renters have the least wealth
- Homeowners have slightly more wealth than renters
- Business owners & landlords have MUCH more wealth than everybody else.
In the United States, business owners & landlords have 5X more wealth than the national average, that is the wealth gap of any country included in the study.
So to answer the question, how do you build wealth in America? You own a business or you own property that other people pay to live in. I’m going to add a third category that is not included in the study which is you own stocks.
I don’t know if stock ownership was included in the study but there is no question ownership of any significant amount of stocks has a very high correlation with wealth. If you doubt that consider the fact that the top 1% wealthiest households in American own more than 40% of all stocks.
Owning A Business
One of the classic examples of inequality is the disparity in wealth between business owners and workers. Owning a profitable business is the number one way to build wealth. As a business owner you have access to a lot of preferential tax treatment, if you’re incorporated you can choose to pay yourself a salary or pay yourself with dividends when it suits your needs.
The greatest benefit of being a business owner is you can pay other people to run the day to day operations of your business (again emphasizing that your business is successful) allowing you to sit back and collect passive income.
While successful business owners tend to build the most wealth of any other group in society, it is by no means a slam dunk. Don’t forget that two-thirds of all businesses fail. It is without question a “high risk, high reward” avenue for building wealth.
If you want to dip your toes into the waters of entrepreneurship without leaving the safety of your full-time job, start a side hustle. When I say a side hustle, I don’t mean driving for Uber. I mean starting a side business.
A side business like blogging or setting up an online store is something that you can do in your spare time. This allows you to keep the security and benefits of your full time job while exploring other avenues to increase your income. If you can increase your income while maintaining your current living expenses, you could have plenty of disposable income that you can invest and begin to grow your wealth.
Starting a side business has three primary benefits.
- It helps you understand if you are cut out to be a business owner
- It provides unlimited upside to your income and ability to generate wealth
- If you are successful (and lucky) it could turn into a full time “real business”
Becoming a Landlord
Real Estate provides three methods of building wealth.
- Attractive monthly cash flow
- Asset appreciation and;
- Debt repayment
Wealth Builder #1: Cash Flow
The monthly cash flow is the difference in the rent you receive and the operating expenses of your rental property. A solid Real Estate investment should be producing positive monthly cash flow from day one. If it is not, you are not investing, you are speculating.
A savvy Real Estate investor does their homework before they buy a property. They will ask questions like;
- How much annual rent is the property currently generating?
- How does that compare to similar properties in the neighborhood?
- How much annual operating costs are associated with the property?
- What is the vacancy rate in the neighborhood?
A handy rule of thumb to help determine if a property is likely to cash flow is the “1% rule”. Which states that monthly rent from a property must be at least 1% of the purchase price.
If you bought a property for $100,000 it would need to generate $1,000 per month in rent to achieve the 1% rule. While useful, you can’t simply rely on the 1% rule to determine if the property will cash flow. It’s important if you are thinking of investing in real estate to learn how to value a potential investment.
Part of the reason Real Estate has attractive cash flow is that it has numerous tax benefits including:
- Deprecation on the property
- Deduction of mortgage interest
- Deduction of property taxes
- Deduction of insurance and other operating costs
- Deduction of utilities
- Deduction of Homeowners Association Fees
- Deduction of repair expenses
- And in some cases deduction of travel expenses
Wealth Builder #2: Asset Appreciation
The second way Real Estate helps build wealth is through asset appreciation. If the value of the house goes up, you’ve become wealthier. There is no guarantee your property will appreciate in value but if it does it will help accelerate your wealth.
Wealth Builder #3: Debt repayment
Since most Real Estate investments are leveraged, meaning you used a mortgage to buy the property, Real Estate provides a third way to build wealth, paying down debt. Each month when you collect rent and make your mortgage payment your equity in the property and your wealth increases.
Let’s say you buy a rental property for $500,000 and have a mortgage of $400,000. On day one you have $100,000 in equity. After 20 years you have used the monthly rent to pay off your mortgage but the value has not changed, it’s still worth $500,000. But since you no longer have a mortgage you own that $500,000 free and clear and created an additional $400,000 in wealth.
If someone else (your tenants) is paying your mortgage, you do not even need the property to increase in value to create wealth.
Add up the benefits of the monthly cash flow, potential asset appreciation, and debt repayment and you have a nice trifecta of wealth creation.
Owning stocks does not typically provide the same opportunities for extreme wealth generation that owning a business or a rental property can provide, but it has one massive advantage. It is the most accessible way for middle-class households to build passive income.
What do I mean by accessible? It’s never been easier to invest small amounts of money in the stock market. You can open up an online brokerage account and start investing with as little as $10. Owning a rental property or running a business typically requires a lot of money to get started.
What do I mean by passive income? Once I invest in the stock market, I begin collecting dividends without lifting a finger. Owning a business or a rental property potentially requires a ton of work. Owning stocks requires no work.
The downside of investing in the stock market is that it can be extremely volatile and the results are outside of your control. Everyone’s worst fear with the stock market is that you will put all your money in one day and the next day the stock market will crash.
The risks of the stock market are well documented, but I want to take a moment and focus on the rewards as it pertains to building wealth.
When the stock market crashed in 2008–2009 I was in my third year of University, well on my way to graduating with $50,000 in student loan debt. Since I seem to like beating myself up, I often think what if I had invested that $50,000 in the stock market rather than in my education? How much money would I have today?
Don’t get me wrong, my education has helped me land a career that has opened up wealth building opportunities. I don’t regret investing in my education. But, a quarter million bucks would be nice!
Personally, I am attempting to build wealth through all three methods outlined in this article.
- I currently own two houses
- I am investing in the stock market through low-cost Index funds
- I am engaging in a side business through my writing on Making of a Millionaire.
I am interested in what you think.
- Would you classify yourself as a renter, homeowner, landlord or business owner (or some combination of those)
- Do you own a business, rental properties or stocks?
- Is there another major path to wealth creation that was not discussed?
This article is for informational purposes only, it should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.