There is a simple wealth equation you must solve unless you want to suffer a similar fate to most retirees. The figures in the U.S. don't make for pretty reading.
Quite clearly, there are problems. You do have options but first, you might be wondering, how in the heck did things get so bad?
What follows is a synopsis, as well as the approach you can take to solve this wealth equation.
The wealth destruction in recent decades was a combination of three things. Most of you reading might find yourself nodding your head in agreement as I discuss each of them.
If so, not to worry, it's never too late to solve the wealth equation.
Post World War II, U.S. employees worked harder but got rewarded for their efforts. Productivity rose almost 97% from 1948 to 1973. Meanwhile, average hourly wages kept pace with a 91% increase.
Since then, things changed for the worse.
Productivity continued its rise from 1973. Advancing over 72% to 2014. You or your parents maintained a work ethos and ethic. But, wages flat lined. Growing only 9% over the same period.
Source: Economic Policy Institute, Wall Street Journal
Add inflation to the mix and picture is even more grim.
Despite working hard over the past 40 years, purchasing power declined. Savings became less meaningful, making it that much challenging to create long-term wealth.
Personal savings plummeted over a 40 year period. During the 1970's the rate was over 12%. By 2005, it was hovering around 2% as credit exploded.
If that wasn't bad enough, the decline occurred the same time borrowing increased. Household debt (relative to disposable income) surged to 130% as the savings rate plunged to 2%.
Post the Great Recession in 2008, the trend has reversed. People are once again saving and paying down debt. Most are now in survival, rather than wealth building, mode.
Investing in the stock market over the long term has proven to be an excellent way to grow long-term wealth. Yet, most people sabotage their investments.
According to Dalbar, the average investor over a 30-year timeframe had returns of only 3.8% p.a. That compares with 11.1% for the S&P500.
So, $100,000 invested by an average investor grew to $294,111. Meanwhile, the market portfolio grew to $2,094,944. An incredible difference of $1,800,834!
Source: Dalbar Journal
The reasons are two-fold.
First, everyday investors are not psychologically equipped to handle market volatility. Second, they do not invest long enough to allow the compounding effect to take hold.
Now, if you can relate to any of the above wealth destroyers, it's time to get back on track. That first step is understanding what the wealth equation is.
I've spent this most recent decade researching the subject of wealth. Developing and refining systems that could put me on a path to financial freedom. It's a never ending journey.
But the most important lesson I've discovered is this. The multi-millionaires are not making the three wealth building mistakes I highlighted above. They understand the wealth equation and they solve it.
Here's the equation:
(I>E) * C = W
I = Income
E = Expenditure
C = Compounding
W = Wealth
Put another way, to build wealth, the ultra-rich…
…Earn more than they Spend. Then, they Invest Wisely.
That's it. That’s the wealth formula used the millionaires. The billionaires of this world. It's that simple and yet, many entrepreneurs I meet with, violate the first part of the equation.
In their pursuit of building a successful business, they leave their job and forego their primary source of income. Unless your significant other is earning enough to cover the family expenses, this is a huge risk.
In fact, in most cases, it proves to be a huge mistake.
Now, I know some of you might be screaming “being an entrepreneur is all about risk”. I hear you, but it's an incomplete statement at best, though.
The wealth savvy knows that becoming a successful entrepreneur is about taking CALCULATED RISKS. Not just taking on blind risk for the sake of it.
Sure, you have all heard about the guy who was down to his last $100 before striking it rich. Or what about the lady who was flat broke, borrowed $10,000 from friends and family who now lives the life of her dreams?
Yes, these are inspiring stories, and sure, such outcomes are possible. If you are like me, these stories even often act as motivational factors to pursue your goals.
As wealth building entrepreneurs with responsibilities, though, you also have to be realistic. For every success story, there are thousands whose lives have been ruined by such reckless decisions.
Financial illiteracy is a scourge of the modern world. This is often true too, of the tunnel visioned entrepreneur too.
We both know that the success rate for entrepreneurs is low.
But, did you ever question why it is so low?
According to a 2014 report released by Statistic Brain, 46% of startups fail due to incompetence. That’s right. Almost one in every two businesses fails because the owner lacked any business or financial acumen.
Success does not boil down to simply having a good idea. It is the execution of the idea from where success is derived. Which brings me right back to first part the formula for solving the wealth equation.
It doesn’t matter if you have to work 10 hours or 100 hours per week, you must somehow earn more than you spend. Only once you achieve this are you in a position to move on to the second part of the wealth equation.
Compounding your wealth through investing.
So, step one is to earn more than you spend. Now, I’m sure most of you have read personal finance sites every now and again. Each one advocating you spend less.
It’s not bad advice, but why focus on spending less when you could earn more?
For the vast majority, having a job is the primary source of income. The education system prepares us for this life. A life that subscribes to the classic “time for money” tradeoff.
There are undoubtedly benefits to employment. But, from a wealth building perspective, it makes the journey a long one. That’s because as an employee, you suffer from the law of diminishing returns.
While you might earn $30 per hour, that rate is typically restricted to 40 hours per week. There might be some scope to work some extra hours. Unless this is at the request of the employer or considered overtime, though, you will not be compensated accordingly. In fact, you probably won’t be compensated at all.
So, as you can see below, the income curve for you as an employee flattens as you reach a certain threshold.
Fig.1: Employed Income Curve
The solution is to seek a pay rise. If you're successful, your income
Fig.2: Employed - Optimised Income Curve
For those employed and looking to boost your income, J.D.Roth wrote an excellent article on the matter. You can read it here - How to Negotiate Your Salary
Of course, having a job is not for everyone. Enter the role of the Self Employed.
Employees have a job. The self-employed own a job. The difference being the latter does not suffer from the law of diminishing returns. For each extra hour worked, you are compensated proportionately as a self-employed worker.
Fig.3: Self Employed Income Curve
Freelancing is a viable option for those interested in the self-employment route. There are two simple steps:
Here is a list of potential skills you might already have, or might be interested in acquiring -
Undecided on which skill to learn?
Check out this article on three of the hottest freelance trends right now.
Next up, you need to put the skill to use.
As mentioned above, Upwork is a marketplace for freelancers to post their services and hone their newly acquired skill. Over time, as you gain experience as a freelancer and build up your reputation, you can increase your hourly rate.
So, your income line shifts outwards. You earn more for the same hours worked.
Fig.4: Self Employed - Optimised Income Curve
The disadvantage for the self-employed freelancer is this. There are only so many hours in a day, so this caps your income potential.
The solution is to go from freelancer to business owner.
Having established your positioning as a freelancer, your final step is to leverage that skill. You do this by operating a business system.
Fig.5: Business - Income Curve
A business system means you remove yourself from the day-to-day activities of the business. So, even though you only put in your regular 40 hour work week, for example, your reward is not capped.
The more effective you become at hiring, leading, delegating and managing, the more successful your business will be. Your business income
You’ll have more savings to invest!
Einstein referred to compounding interest as the 8th wonder of the world. The wealthy are living proof!
Let's look at an example. Assume you start today with $15,000 in savings and you generate returns of 15% per annum. Here is how that would approximately compound:
By the end of year 30, your $15,000 portfolio would have grown to just shy of $1 million. But half of that came in the last five years of the cycle.
So, do you see how over time compounding turns into a wealth building machine?
Now, to compound wealth, there is one skill, in particular, the wealthy have. In fact, according to Forbes, this industry is responsible for creating 151 billionaires worldwide. More than any other industry in the world.
The skill of investing wisely!
If there is just one skill that you should learn to grow your wealth, it is investing. It differentiates those who want to be “rich” versus those who desire to be “wealthy”.
The reason most entrepreneurs I know don’t invest is because they believe it to be confusing. Takes up too much time they lament. Yes, investing can be a time-consuming affair, but only if you let it be.
The “experts” like to make forecasts and predict what will happen in the future. Meanwhile, the media makes it seem like this is critical to investment success. They parade these “experts” on our TV screens.
This is just smoke and mirrors. Trust me, I worked in it for many years to know. I left it because I realized I was wasting time with theoretical nonsense. I should have instead, been busy focusing on risk and building my wealth.
The problem is that those within the industry are overconfident in their abilities. The reality, as Socrates so eloquently put it, is "The only true wisdom is in knowing you know nothing."
Nobody knows what will happen. We can only identify with what is happening. So, to succeed in investing, the key is taking action, maintaining discipline and managing risk. Do not fall into the trap of forecasting.
The other thing that entrepreneurs tell me deters them from investing is that they assume due to their size, they are at a disadvantage to institutional investors.
The solution they conclude is to replicate their investments. After all, they representative the "smart money". Boy oh boy, is that a mistake. In his book “David and Goliath” Malcolm Gladwell proclaimed:
When it comes to investing, you have a couple of advantages over the institutional investors.
First of all, you are small, and you are more flexible. This opens the door to a far greater range of opportunities to invest. Second, you have no conflicts of interest. You are playing the game of investing to win. To compound your wealth.
Many institutional investors play the game not to lose. It's because their primary income driver is not investment returns. Rather, it is the performance and management fees they charge clients.
Provided they don’t blow up the portfolio or lag too much behind peers, clients will have little reason to switch away from them.
So, whatever reservations you held about your ability to invest, it's time to shake them off. As a responsible wealth builder, you should understand the basics of investing. From the stock market to bonds, real estate and commodities.
It’s not going to happen overnight. Nor does it need to. But over time, add this knowledge to your arsenal and you’ll be a more efficient wealth builder.
"Earn more than you Spend. Then invest wisely". The wealth equation comes down to that single phrase.
Most people focus on trying to save more and spend less to acquire wealth. It's a viable approach, but it's a long drawn out one and it's therefore not preferable. Instead, switch your mindset to that of earning more and compounding these proceeds.
Many of you might be thinking "yeah, easier said than done". You're right. Creating wealth is not easy. It's a challenge I face every day to reach my goal of financial freedom so I can live life fully on my terms.
However, after many years of diligent research and testing, I settled on a 3-pronged approach to building wealth. I refer to it as the A.B.P Wealth Pillars approach. A powerful approach anyone can use to get started in solving the wealth equation.
So, if you are frustrated with searching. Or, dejected by your lack of progress, then check out my free report, Solving the Wealth Equation.
From establishing your authority positioning to starting/ growing your business and building your investment portfolio, the report has you covered.
If you haven't yet claimed your free report, you can do so by clicking here. Just my way of showing you how I'm enhancing my long-term wealth, and how you can too.
James is a digital marketing consultant and online business strategist. He helps coaches, consultants, and solo professionals market their business online so they establish authority positioning and predictably generate 5-20 high-ticket, new clients every month.