The secret formula for wealth

Facebook has made us immune to so-called clickbait headlines, but there’s no field more ripe for clickbait than personal finance.

Where’s there’s money, there’s greed. Where’s greed, there’s clickbait.

But, just because the headline is suss, it doesn’t mean it’s not true …

… you see, there is a ‘secret’ formula for wealth.

It’s simple, it’s intuitive, and it’s here:

This part of the formula (there’s more, the most important part, below) simply says that Wealth is a function of Capital (how much money you can save to invest rather than earn to spend) and Time (to allow the magic of compounding, assuming that you reinvest all your gains).

But, that clearly doesn’t explain why you’re (relatively) poor and Zuck is (obscenely) rich.

That’s why I added the X Factor (the ‘X’ in the middle of the formula).

With the X Factor set very low (call it 1 on a scale of 1 to 10), you can save and pump up your retirement fund all you like, but you’ll still find it very difficult to retire early or well.

Generally, if you’re relying solely on savings and ordinary investment returns (e.g. the stock market), you get to choose ONE: retire early … or … well *

But, if you want to retire early and well, then you’ll definitely need to take some affirmative action to rapidly and dramatically increase your X Factor.

Here’s how …

[this is the ‘secret’ part of this article’s clickbait headline]

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The first part of the ‘formula’ (I’m not promising that this makes strict mathematical sense) expresses the classic Risk (Ri) versus Reward (Re) tradeoff:

The more Risk you are prepared to take, the greater your expected Reward.

This also explains why your finances are probably in the pack, i.e. roughly the same as your peer group:

You all roughly take the same risks, so you can all expect roughly the same rewards.

If your friends still work, and have not built up significant wealth, then — if you also invest how they invest (e.g. stock market, your house, a little crypto, and so on) — then you can expect similar results.

Of course, you could always take an extreme risk and win the lottery (nobody said ‘big risk’ has to equal ‘big bet’) … but, that’s a little unlikely, so here you are.

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The second part of the formula expresses a new concept; one that I call the Leverage (L) versus Drag (D) tug-of-war:

Leverage is simply any method that you can use to multiply your money or your efforts:

• It could be borrowing money (which is what makes real-estate such an attractive long-term wealth-building investment: banks will lend you their money without any claim to your upside … sweeeeet deal).
• The leverage is easy enough to understand: if your cost of money (e.g. interest) is less than what you earn on that money, well, you are positively leveraged … and, congratulations, you just made money out of thin air!
• But, you could also leverage your efforts by learning a skill that helps you earn more money (e.g. getting a new qualification, which leads to a better, higher-paying career) or one that helps you invest your money better (e.g. by reading the right books, and … the right articles … about, well, investing).

Drag, on the other hand, is anything that holds you back, physically, mentally, emotionally, or financially:

• Borrowing money, whilst attractive if the interest rate is low and what you invest it in appreciates enough (e.g. real-estate), can equally drag your finances backwards if the interest rate is high &/or you use it to buy ‘stuff’ that doesn’t increase in value over time (e.g. your car, furniture, clothes, etc.).
• The drag is also easy enough to understand: if your cost of money (e.g. interest) is more than what you earn on that money, you are negatively leveraged … you just made your money go poof!
• Your state of mind can be a drag, too: for example, it could be that you aren’t in a good headspace (fix that before you try and fix your finances; paying off a little debt here may make you feel good … and can’t really hurt, as long as you don’t overdo it).
• But, I’ve found that the greatest drag on your future wealth is your current belief system around money. Just keep learning, and implementing; take many small steps, rather than a few big ones. It took me a long time to come around to my current way of thinking, too.

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For the mathematically astute, you’ll see that Risk/Reward and Leverage/Drag are interrelated:

Take a Risk that goes bad (naturally, some will) and it will put a Drag on your finances. But, what goes down, must go up, and Reward, when Leveraged - and, luck is on your side - is what really builds your Wealth.

So, when the stock market crashes, keep your money in and buy more **

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So, how do you take advantage of this formula to build up your X Factor to Zuck’s 10 out of 10?

Well, you don’t …

But, you can certainly look to build up a little war chest using your savings (by applying saved Capital over Time), and think about how you can take a little more calculated Risk, by applying Leverage.

And, that sounds a little like starting a side-hustle to me.

After that?

Well, comment or reach out (adrian@smalltimevc.com), and I’ll give you some ideas … or, just hit ‘clap’ a few times and maybe I’ll keep writing.

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UPDATE: * after I published this tweet, I reran the numbers and found an error:

Here’s the spreadsheet that I used: https://docs.google.com/spreadsheets/d/1T5HmHig76mTCZ_UsASc48F9-lxTrCkee9J2GK03K1pE/edit?usp=sharing

** this is not investment advice; it’s just illustrating the principle of leverage.