How To Build Wealth

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Peter Da Vanzo

Jun 10, 2022

5 MIN

How To Build Wealth 

 

What is wealth?

 

It really depends on who you ask. For some, being wealthy means having good health and friendships. For others, it means liberty and freedom. 

 

However, let's look at building wealth through an investor lens. For investors, wealth building means investing in appreciating assets over time. These can be physical assets like property, and precious metals or financial assets like equities and bonds.

 

In this three-part blog series, we'll look at strategies to build wealth over time. We'll look at the different wealth-building approaches, the 95/5 method, and why a person in their 20s needs to think about wealth building differently from someone in their 50s. 

 

But first.

 

"History doesn't repeat, but it often rhymes" – Mark Twain. 

 

Investors would love to know what happens in the future. It would make asset-buying decisions easy! 

 

Sadly, none of us can predict the future. But what we can do is consider human nature - that doesn't change. Ergo if human nature doesn't change, then what has happened in the past is highly likely to happen again. 

 

People have always attempted to store wealth. Saving and building for the future rather than consuming everything in the present led to significant benefits for both individuals and society.  

 

People first built and stored their wealth with physical assets like property, animals and precious metals. They maintained herds of animals kept for their milk, fleece, shells and meat, and they staked out and defended productive land. Once permanent settlements became established, real estate and personal property also became a store of wealth. 

 

Developed civilisations required a medium of exchange to simplify trade between individuals — money, in other words. Precious metals were often used, specifically gold and silver. The industrial revolution that began in England added the development and acquisition of capital infrastructure to the wealth equation - manufacturers, people who controlled raw materials, and ship owners became the new rich.

 

Yes, disasters happen. Significant events – crises like the '87 crash and September 11 - slam markets into reverse. Then booms happen. Waves of technological change, like the internet, produce massive wealth and make early investors rich. 

 

Economies move through cycles of expansion and contraction. People often overreact to such changes. They become overly negative during economic downturns as quickly as irrationally euphoric when the economy booms. That is the historical pattern. 

 

The big takeaway from history is that ways to build and store wealth are essential to prosperity and security - and the means of doing so are constantly evolving. Technological change provides massive opportunities to early investors as a new value is created, and new asset classes emerge. Economies move in boom and bust cycles, but the long term wealth investor isn't overly concerned by short term movements. They focus on distant horizons. 

 

 A Wealth Builder Mindset

 

Psychologists refer to this ability to defer gratification as having a 'low time preference.' A good analogy is the forestry industry, where seedlings are planted, and their value isn't realised until the trees are chopped down 25 or more years later. 

 

Successful wealth builders share the same long term perspective.

 

In recent times, we have been seeing high inflation. Inflation results from Covid responses, war, quantitative easing and international supply chain issues. Do these bother the long term investor? 

 

Not really. 

 

Did you know that the S&P 500 index has returned a historic annualised average return of around 10.5% since its 1957 inception through 2021? The average stock market return has been about 10% per year for nearly the last century. That has included times of world wars, financial crashes, plagues, threats of nuclear armageddon and every challenge imaginable. Those who focused on the long term rode out temporary setbacks. 

 

Yet, the return, on average, remained 10% per year. 

 

Compounding Interest

 

If 10% doesn't sound a lot, consider compounding interest. 

 

$10,000 invested in the stock market 50 years ago would be worth $1,606,866 today. Each year, the interest compounds. For example, in year one, an investor had $10,000. In year two, $11000. In year three, they'd enjoy 10% on 11,000, not just on the initial 10,000. That's the miracle of compounding interest. Money makes money. 

 

This calculation is an oversimplification because the market will not return 10% in any one year, but the principle is clear. Over the long term, wealth builds upon wealth. 

 

Patience is undoubtedly well rewarded! It doesn't matter to the long term investor if there is high inflation now. There won't always be high inflation, and investment opportunities will always arise. 

 

But what if you don't want to wait 50 years?

 

How To Build Wealth In Your 20s

 

It's always a very good idea to talk to an experienced investment advisor before making any plans. However, the general principles to consider are: 

 

The lesson of compounding interest is that the earlier you start, the more you'll likely have in future due to interest building on interest. 

 

The young can take a higher risk than older people who might be nearing retirement as they have more years of work and savings ahead of them. They don't need to touch their savings for retirement anytime soon. High risk means higher returns over time, but potentially more significant losses during downtimes. An older person may need access to money sooner, so she is less likely to take the risk of more significant swings in value. 

 

Pay down debt, live within your means and try to invest what is left over. Debt robs you of your potential to make money and hides the actual cost of purchases. $10,000 spent on a luxury good could return many times this amount if invested in appreciating assets over the long term. 

 

How To Build Wealth In Your 50s

 

Again, it's good to talk to an investment advisor before making plans. However, the general principles to consider are much the same as for people in their 20s, but due to the shorter time to retirement, people in their 50s need to keep an eye on risk. They don't want the value of their investment to be down when they may need to liquidate funds in retirement. 

 

Those in their 50s can still enjoy the benefits of compounding interest and should still pay down debt and live within their means, but they may need a slightly different approach to build wealth quickly. 

 

The 95/5 approach. 

 

With this investing strategy 95% of wealth is kept in predictable assets such as property, cash, stocks and bonds. People in this age group typically pick conservative or balanced approaches, mixing these asset classes. The aim is to mitigate risk. 

 

The remaining 5% can be used for higher-risk asset classes. These may include tech stocks, innovation stocks and crypto-assets. The investor expects this 5% to significantly outperform the market in return for the risk. If the 5% dips or they lose it entirely, it doesn't significantly affect their financial position. Most of their wealth is still accessible due to their 95% holding in more conservative investments. 

 

There are, of course, no guarantees. Still, it pays to keep in mind the stellar performance of tech stocks since the late 1990s - every $10,000 invested at Amazon's IPO in 1997 would today be worth $4.8 million today - and every $100 invested in Bitcoin in 2010 would be worth $48 million, as of last year. 

 

Crypto: From $10K To $48M

 

There's one asset class that few financial advisors mention, yet it's an asset class that has outperformed most others. 

 

That asset class in cryptocurrencies. 

 

As we've seen above, if you'd invested $10,000 in Bitcoin around October 2010. If you invested $300-400, you'd have been able to buy about 1,000 bitcoins. Those 1,000 bitcoins would've been worth more than $48 million at its all-time high last year. 

 

Someone who invested in the 95/5 approach using crypto in 2010 would be a very wealthy retiree today. The beauty of it is that most of their existing wealth remained in relatively conservative and accessible investments. 

 

Is the return guaranteed? 

 

No, no one knows the future. However, the potential of crypto is enormous. Crypto could go up, down or sideways. Given the volatile nature of crypto, that could happen in one week! 

 

In part two, we'll explore the future of crypto as an asset class.