Building wealth the sound way is done by recognizing some of the factors that makes the most impact to wealth building.
In my previous article on my formula to wealth building, I highlighted 2 key factors that are within a family or a person’s control and make the most impact to wealth building:
- Putting money early to wealth building versus late allows you to build wealth with less funds
- Putting more of your take home income to wealth building versus less allows you to hit your financial independence goals drastically faster, and possibly needing a lower rate of return
A third factor that makes a lot of impact to your wealth is whether putting more to your wealth building, or chasing a higher rate of return.
If we break up a family or person’s wealth building into 2 sections:
- Before a substantial amount of Wealth is built up
- After substantial amount of Wealth is built up
We can understand funding more to wealth building or chasing a higher rate of return is more meaningful.
Before a substantial amount of Wealth is built up
Suppose there are 2 person both earning $45,000 a year. The first person channels 10% of his salary or $4,500 to wealth building, while the second person channels 20% of his salary or $9,000 to wealth building.
The first guy, being more diligent, studious and adventurous, pushes his wealth building hard, average a rate of return of 15% per year, while the second person was gullible, was talked into purchasing an investment linked insurance, which average only 2% rate of return per year.
Over the next 10 years, the person with the 15% rate of return should be trouncing the person with 2% rate of return. As the result show, they are roughly similar at the end of 10 years with $109k. It turns out that channelling more to wealth building matters more when your wealth fund is small.
Channeling 100% more to building wealth is like making a 100% return on capital by itself.
After a substantial amount of Wealth is built up
The 2 person in the first part eventually build up $300,000 in their wealth fund. They hypothetically still earns $45,000 a year.
Person A can still add $4,500 per year to his $300k and Person B can still add $9,000 per year to his $300k but their yearly wealth funding will hardly make a dent to their wealth fund.
Doing this will result in a 1.5% and 3% increase in net worth respectively.
Rather, their skills in building wealth matters more here.
If a person does not have a fundamentally sound wealth building method, falling prey to some investment scams, he could see his net worth take a 55% draw down.
His $300,000 may become $135,000.
It will take many years of $4,500 or $9,000 to make up for not having adequate competency in wealth building.
In contrast, if a person have taken effort and build up fundamentally sound wealth building abilities, the impact of a 10%, 30% or 55% growth in his net worth would make a much bigger impact than his annual funding to wealth building.
Importance in understanding this factor
A person needs to understand that when the net worth or portfolio is small, funding more to wealth building makes a bigger impact than chasing great returns.
When the net worth or portfolio is substantial, sharpening wealth building competency or ensuring wealth building method is fundamentally sound matters more than funding wealth.
While having both is the best situation to be in, the common problem is that most expect that when they have $5,000 or $10,000 in spare cash , they think that putting the money in some stocks can turn this amount into a substantial net worth.
That scenario is possible, but chances of more hurt and pain is likely. It also shows that by not building up wealth building competency, they overrate what unit trust, ETF and individual stock investing can achieve.
Much higher success can be achieved by optimizing their spending, putting in effort to earn more, and channeling more to wealth building.
Importance of getting ready for a substantial net worth
And when we start building our wealth fund or portfolio, we may seldom think that we will eventually managed $200,000 to $1 million.
A person needs experience, competency and temperament to make sure he or she grows this substantial sum prudently using fundamentally sound methods.
Often, the person realizes overnight that they do not have adequate or ANY wealth building competency, so they delegate to insurance agents, financial planners, wealth managers that costs a bomb, whom they thought have their best interest at heart.
Else they start listening to hearsay or prevailing wealth building fads to build wealth themselves.
This is perhaps why investment courses are so popular as folks have accumulated enough and find that it is time they manage and grow their substantial wealth well.
Experience, competency and temperament don’t get equipped overnight. They take place through much practice, reflections and fine tuning.
Wealth building skills have to be built up, often when you have very little and when you think you least needed it.
The simplest form is reading some fundamentally sound personal finance and investing books.
I hope I have highlighted well funding substantially when your net worth is small matters more and it is crucial to have a good skillset in wealth building when your wealth fund is substantial.
Even though you may find that you are contributing $100 per month to wealth building, not enough to purchase higher yielding and more risky assets, you have to spare some effort to improve your wealth building. Keep reading and keep learning. Waiting for when you need the skillset may be too late.