The Secret Power of Investing

Have you ever wondered how it is that the rich keep getting richer while the poor tend to get stuck grinding in the rat race? The secret is investing, but this isn’t Beanie Baby’s or a dusty box of baseball cards kind of investing. No, the rich invest in something else entirely.

What the rich invest in are assets, while the poor invest in liabilities.

Assets vs Liabilities

If you are wondering what exactly those two terms mean, financially speaking, assets are anything that generate wealth or income while liabilities are the exact opposite, things the subtract from your wealth or income. Typical assets include stocks, bonds, real estate, certificate of deposit (CD’s) treasury bills (gov bonds) land and of course cold, hard, cash.

A car loses 50% of it’s value as soon as you drive it off the lot of the dealership, with an additional 15-20% per year afterwards. Courtesy of AAA Insurance

It should be noted that with some rare exceptions, your house and car are not assets. Typically, you make payments on your house or car and they do not directly generate income for you, even though your car gets you to and from work. Because you have to make these payments, plus cars typically decrease in value year over year, in what is called depreciation, they fall under the liability’s category.

However, these liabilities could easily become assets if you were to rent them out, say you got roommates or lent out your car over the weekend and got paid for it. Your car could also be considered an asset if you use it as a rideshare with Uber, Lyft or other services.

Net Worth vs Income

How much stuff do you have that is worth something of value? Do you own any jewelry or precious gems/metals? Do you own a house, TV, appliances or literally anything that could be sold, including the phone or computer you are reading this on? Then the realistic value of those objects could be tallied towards your net worth.

Net Worth is equal to the value of your assets minus your liabilities. Courtesy of experian.

Your net worth is the sum total of your assets minus your liabilities (Net worth = Assets – Liabilities) For example, if you own a home instead of renting you could add the market value of the house to your assets, but you would still have to subtract what you owe on the mortgage. Same thing with a car, which typically are net losses on your net worth as they typically decrease in value quicker than you can pay them off.

As mentioned above you can add up things like appliances and electronics to your net worth, but these are typically of such minor value as to not be included in most major forms of net worth calculations with the exception of jewelry.

If you have a 401k, a retirement account or investment accounts then you can also add those to your net worth.

Your income on the other hand, is determine by things the provide you with cash month to month. For most people this comes in the form of a job. Other’s and especially the rich make sure to have multiple forms of income (called income streams) which usually come in the form of rent from real estate, dividends from stock and/or bonds, and of course businesses.

It is no accident that the rich have multiple streams of income while the poor tend to only have one or two. The rich take the income from their multiple streams in order to purchase things that will generate more income for them.

The Secret Power of the Rich

The rich have a not to secret superpower. They have the ability to turn their money into more money. No, the don’t print money or use other illegal means to do so (usually). They simply use the power of interest. If you don’t know what I’m talking about think about a car loan. How does the dealership make money? They give you the car and you make payments on it, and with those payments a portion of the money goes to paying the car off and another goes directly to the dealerships account. That is exactly how rich people get richer too. They purchase large quantities of stock or bonds and those investments then pay dividends. The rich then take those dividends and use them to purchase more investments.

This will be easier to explain with some numbers: Let’s say a rich investor decides he wants to purchase some stock, each share of stock costs him $10, and he buys 10 shares for a total of $100. Let’s then say, over the course of a year that each share he purchased gives him $1. By the end of the year he would have earned $10 in dividends. Assuming the stock price hasn’t changed this would mean that he could purchase another share, essentially for free, and by the second year he would have 11 shares, which would pay him $11 and thus he would be able to purchase another share of stock, and have $1 left over. Repeat the process a few more times and you could see how this would begin to add up.

Graph shows different projected account values for investing $125 per month, with the dashed line and the box at the top representing 5 years of investment. Courtesy of DallasFed.org

(In fact, I did the math, and though it takes a long time at the rate of return mentioned after 26 years of investing you would earn more per year than invested in the initial year, and by 50 years you would be earning 10x in one year than the initial investment, all assuming you invested the $100 and never added any more of  your own money into it.)

So while a 10% return is absurdly high for a dividend, where the average may be around 2-4%, I used 10% for easy round numbers. Of course, if you were to use a lower yield of 4%, but also put in $100 a year you would be earning a yearly dividend greater than your yearly input after 17 years.

Now obviously putting away $100 will not suddenly make you rich, but if you were to somehow manage to put away something crazy like $500 a month or more, then you could see some really powerful investment returns, and that is one of the ways that the rich are able to earn their millions.

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