Would you rather be rich, or wealthy?
Is there even a difference and does it matter?
There are many definitions of being rich. The US government considers someone as rich by having a net worth amount over $1m USD or making over $200k USD/yr. Credit Suisse (a Swiss bank) considers someone as a high net worth individual (HNWI) as someone who also has a net worth over $1m USD, and a ultra high net worth individual (UHNW) as someone who has a net worth over $50m. The economic policy institute places earners over $173k/yr in the top 10 percentile of earners inside the US. If you meet these requirements, you are rich. Congratulations.
When you think of a rich person, you might think of Scrooge McDuck diving into a pool of gold coins, someone who won the lottery, celebrities or athletes who are paid large sums. These are all people who could be defined as rich, but they are not yet wealthy. The wealthy are people who ask how long will my assets last, and how will it grow to give me more time away from working. The rich have a pile of money, where truly wealthy individuals have assets: things that pay them to own them. A pile of money can be spent or its value could be inflated away. Assets will keep producing fruit, year after year, hopefully forever. A rich person could squander all their riches. A wealthy person would have new income year after year after year, never running out. Many rich people become poor because they never implement this concept of the wealthy, accumulating assets with their riches. This is also the reason why you cannot save your way to wealth or why the average person trying to retire feels uneasy if they only have currency in a bank account. The goal of trading time for money, is to accumulate assets so that trading time for money becomes optional due to the generation of cash.
I had to change my mindset from saving large piles of money for retirement, to creating streams of income to build wealth.
-Matt Theriault
Host of the Epic Real Estate Podcast
Speculator v Investor
How do you know if you are buying an asset?
When people put their hard earned dollars to work for them, they might go buy stocks, bonds, real estate, crypto, gold from a hot tip they heard from a friend, or someone on TV. They may get into large amounts of debt to purchase a home or a car. They may see a chart and see that the price is going up, and want in, hoping to sell at a higher price. What they thought was investing, was really speculating. The difference is that this will not produce wealth because this person might lose everything, or they will have to keep finding new speculations to keep growing. At the end of the day, they owned liabilities, which do not pay you to own them, or worse, you pay to own them out of your own pocket, like a house or car. They are not buying assets. Assets are things that pay them to own them like a cash generative business, rental real estate, oil well or a farm. When you play the game monopoly, it becomes real clear if you own an asset or have liabilities each time you roll the dice.
The best investor in the world, Warren Buffett (92), has been compounding his wealth since the 1940s. He grew his own personal wealth from nothing to $100B by investing in companies via the stock market. When he invests, he looks for a great business that produces cashflow, not a company that just grows its its top line revenue, start ups that don’t even have a top line (any cash coming in), or speculations. Warren wants to know, if the stock market shut down for 10 years, would his invested money keep growing in value from the business efforts of the company and by great capital allocation from it’s managers. Warren looks for something that will produce fruit, year after year after year. Due to compounding at over 18% per year, it would be impossible now for him to squander the wealth of his estate.
Most people have a hard time with this concept because it requires due diligence, and patience. They may see a good company, but its overall value if you were to buy the entire company is far to high compared to the cash it generates, but since it is doing something trendy, they skip looking at the business and it becomes a speculation, just hoping the price goes up to sell to another who thinks its price will also go up. People can make large sums of money speculating on companies, crypto, real estate, etc. I am not going to focus on this much in this blog because it becomes a casino of bets, and allocate a very small portion of my overall portfolio to this. In general, a persons portfolio should have assets that pay them to own them, and not speculations. Most people who go into casinos over time lose unless they have an edge, and should stay away. Most people do not have the self control to buy low and sell high.
How do we build wealth?
Warren Buffet suggests most people on earth should grow their wealth buying the S&P 500, a basket of about 500 top companies in the United States. This spreads risk to 500 large companies. Why does he suggest this? Warren Buffett has had a long running bet with hedge fund managers across the globe to see if they could outperform this index in portfolio returns, and found that the overwhelming majority of fund managers who invest client’s money under perform this passive index. They could have had better returns in a more passive investment. Most of this under performance comes from bad investment picks, and emotional errors when deciding when to buy or sell. As a result, Warren Buffett’s company Berkshire Hathaway has been able to outperform the S&P 500’s returns by almost double since its inception in the 60’s, and why he was the wealthiest man on earth for decades.
If you are going to deviate from Warren Buffets advice, proceed with caution. I will go further down the rabbit hole of investments, but most should just stop here and buy the index. Most people putting money into a retirement account are only allowed to buy index funds anyway and are unable to individually allocate funds to individual stocks, real estate, or alternative positions like gold, and agriculture. Based on the Trinity study, an investor can pull up to 4% per year for retirement from this S&P 500 portfolio and have low risk of running out of funds. If you wanted to be conservative, you could drop this number to 3%.
The first rule of investing is don’t lose money, and the second rule is not to forget rule number one.
– Warren Buffett
The 10 Levels to Financial Independence
Level 0 – Financial Dependency
Level 1 – Financial Solvency
Level 2 – Financial Stability
Level 3 – Debt Freedom
Level 4 – Coasting FI
Level 5 – Financial Security
Level 6 – Financial Flexibility
Level 7 – Financial Independence
Level 8 – Financial Freedom
Level 9 – Financial Abundance
Level 10 – Tiger FI
Level 0 – Financial Dependency
You have debt payments, and your needs are greater than your income. You are dependent on others to survive. Dependency Examples: Credit Cards, Loans, Parents, Government, Church. We all start here. Sometimes we boomerang back. Make a budget, and a list of all debts owed. If you do not have a job or have one job, you may have to work more, and get a second job to have money left over once all bills are paid each month. This will get you out of a dependent state.
Level 1 – Financial Solvency
At this level, you are current on all debt payments, and can meet the basic cost of needs like food, water, shelter, clothes, without others to depend on. Focus on maximizing income as much as possible. Maximize income from 1st job, and obtain a 2nd job to increase income if you have maximized the earning potential of the 1st. Be aware of lifestyle creep, the phenomenon of spending more money once making more money. Keep your budget tight and do not expand your lifestyle if you want to accumulate wealth and move onto the next stage.
Level 2 – Debt Freedom
Start thinking in terms of interest rates & compounding. Become completely debt free of high interest payments greater than 7% first. Become the John Wick of debt, taking out each target one-by-one, lowest debt to highest debt. Rid yourself from debt slavery, then begin moving toward a +10% savings rate. Have a fully funded emergency fund usually 3 months annual salary (in cash only).
Ex. Income is $40k/yr, so you should have a $12k Cash Emergency Fund (uninvested). Keep <$10k in hidden, untouchable, physical cash, the rest with a credit union. The base of your financial pyramid. Negative interest is why people stay in debt.
Level 3 – Financial Stability + Investor
Work on becoming a Henry (High Income, Not Retired Yet). You should begin funding accounts, and buying assets to accumulate wealth once you are financially stable, and have no debt. Begin at saving at least 20% into a separate investment account, with the goal of saving 50% of your hard earned income. Pay yourself into this untouchable account very first once you get paid. Invest in high ROI (>15%) only investments. Realize low compounding is the reason why no one can get out of the rat race or retire. It is also the reason why high interest debt or currency debasement keeps people enslaved. Master of compounding to move onto the next stage.
Ex. You make $60k/yr, with a 20% savings rate which is $12k/yr. At 20% ROI = you would make $14.4 y1, 17.2k y2, 20.7k y3, 24.8k y4. By yr5 you’d have $118k. Imagine a 40% ($242k) or 50%($296k) savings rate.
Level 4 – Coasting Fi (Barista FI/Remote FI)
Freedom from your Employer. Barista freedom, you could go pursue your passions and work part time as a barista to cover some basic expenses. You have agency. You have been frugal early, and started investing. You can coast to retirement on the pace you’re going due to your assets compounding at a high rate of return. You can leave your job, and do any job you want, but still need to work to make ends meet to get to retirement. You have enough in investments that you can just coast with a job to the finish line, with that sum compounding to your retirement.
Ex. Barista Part time job = $1800/mo for current monthly expenses, while your net worth keeps compounding at 7-20%/yr to your 30x yearly expenses goal of retirement. At this point your coast/Barista job + compounding assets = retirement.
Level 5 – Financial Security (Skinny FI)
When cashflow from investments can pay for survival expenses (food, water, shelter, clothes). You do not need your barista job anymore but this does not include wants like Netflix, or nice cars. Just enough for the bare essentials. You’d be ok if you lost your job. You’re secure. You have roughly 6x annual expenses. These multiples are estimated ranges, but realize the monthly CF from these investments is what matters. This is the level where you focus on lowering your tax rate. Just remember, if you live on less than you make, you’re rich, and if you live on more than you make, you’re poor.
Ex. $500k Net Worth = $20k/yr = $1,600/mo lifestyle (4% rule). Basic expenses met.
Level 6 – Financial Flexibility (Flex FI)
Similar to level 5. You have enough cashflow to pay for survival expenses, plus basic wants (ie Netflix, basic vacations, basic car). This is roughly 15x annual expenses or half financial independence. You are secure and flexible.
Ex. $750k Net Worth = $30k/yr = $2,500/mo lifestyle (4% rule). Expenses met.
Level 7 – Financial Independence
This is twice level 6, and based off the 4% rule. You must have 30x annual expenses. You can retire, stop here, and exit the rat race. This is the level where you begin estate planning.
Ex. $1.5M Net Worth = $60k/yr = $5k/mo lifestyle (4% rule). Expenses met plus.
Level 8 – Financial Freedom
This is roughly 2x financial independence. This is financial independence with dreams factored in. You can live where ever you want. Travel where ever you want. Live life as you please. You can retire comfortably. You might lease cheaper yacht for a winter in the Caribbean.
Ex. $3M Net Worth = $120k/yr = $10k/mo lifestyle (4% rule). Boss expenses met.
Level 9 – Financial Abundance (Fat FI)
Roughly 3x financial freedom = 6x Financial independence = 180x annual expenses. More than you are ever going to need. If a horrible bear market happens of a 50% or greater draw down, you still have 1.5x Financial Freedom and will not phase you at all. You’re untouchable. The waves come, and it doesn’t phase you at all. You’re a legend. You might own a nicer yacht in the Caribbean.
Ex. $12M Net Worth = $360k/yr= $30k/mo lifestyle (4% rule). Baller expenses met.
Level 10 – TIGER 21 FI
+$20 Million Net Worth. Set aside 7 Yrs of cash expenses for any Black Swan event. You can live on cash alone during a full market cycle. You are not just untouchable; you are in the top 0.1% of American families. The Elite. You’ve won the financial game. Increase protective legacy assets at this point (gold, land, timber, art, etc). With a $50k/mo lifestyle, you made the average yearly salary just in a single month. Better yet, your interest on interest return makes you $2k/mo alone. You might sail around the earth in an expensive yacht, wearing a monocle, then drive a Bugatti through Eurasia to go climb Everest.
Looking at your bank statements, you could be mistaken for a Rothschild.