Architecting Wealth
Architecting wealth means building a lasting, secure structure to withstand the storms and elements that put your income, net worth, and future growth at risk while empowering you to achieve your goals and to live the life you want to live. Architecting wealth starts with a foundation of education, with pillars of investing, business income, and real estate, tied together with beams of diversification and dollar cost averaging, and protected by a roof of legal protection and optimized taxes.
Education
The foundation of wealth starts with education. Financial education means that your wealth is on solid footing. You don’t have to have all of the education yourself - relying on advisors goes a long way but can also be expensive. You want to balance the cost of the education with the compounding power of starting to build wealth early. This education should also be balanced between book knowledge and applied knowledge through experience. The most important part of this education is the fundamental law of economics - supply and demand. Being able to read when markets have shifts in supply or demand will help you predict what will happen to prices, see which markets to get involved in, and give an understanding of the impacts of fiscal (government) and monetary (Federal Reserve) policy on the economy.
Business
Understanding business will also make you more likely to generate wealth (even if you are an employee) - understanding users/customers, how to solve their problems, marketing, sales, technology, unit economics, analytics, the pros and cons of taking on debt or investment, organizing and leading employees, and good book/record keeping.
In some countries, entrepreneurship is common. In Thailand, for instance, almost every family seems to have a business from real estate development to retail businesses to software development to selling food on the side of the road. In the US, it’s not as common, though the hustle generation is changing that. Starting a business is essentially identifying a good or service that is in demand and that you can find a way to supply. You want to start with a problem that customers have - the best is a problem that sets their hair on fire and that they are trying to solve ever day. Maybe it’s something they want that they can’t find or can’t have or where you can offer a competitive advantage on the price, quality, time, discoverability, or some other competitive advantage. Then, the only way that you know you have a great product or service is by trying to sell it, so you want to minimize the time needed to test selling your product. You can even do this with paper prototypes. Now a good salesman can sell sand in the desert, but it’s a lot easier if you’re selling water, and it can sometimes be a lot more profitable to build a business where you don’t need to spend a lot of money on marketing and sales.
I’ve taken flyers door to door and cold called to sell business to business (B2B) products and consulting services, and I was able to make a living and build a team, even though my products and services were nascent and exploratory. I did this with a great sales process (which can help tremendously if you aren’t someone who can naturally sell a glass of water to a drowning man). This is sales led growth. Now with a good marketing campaigns, I might have been able to close more deals with less time and effort, and potentially relied less skilled/trained sales people. This is marketing led growth. Another model to sell products is through product led growth where using the product is what drives the sale. This usually offers some free value for using a product that you then up-sell users on.
If you are an employee, instead of a business owner, then you are essentially a business with a client of 1 company. You should view your boss and every employee around you as your client. The way to maximize your pay is to build great relationships with your clients (your bosses and employees above, below, and around you), avoid conflict and calm concerns, and create demand and promotion opportunities by bringing leverage to the table. The leverage you have for higher pay is your relationships, competence and capabilities, and outside demand for your services (competing job offers). Great relationships mean your bosses want to keep you happy and take care of you with promotions and pay; if you are competent and capable, they’ll want to do this even more. It’s hard to judge competence and capabilities when you are negotiating an offer for a new job, so you want multiple offers on the table (sometimes you can even start a bidding war). When you feel you are due for a raise or promotion, you want an outside offer to either weigh your options or to ask your boss if they can beat or match the title and compensation.
The paths to higher pay and titles in the corporate world typically mean picking the right industry, the right role, the right location (less important with remote work), picking the right boss to stick with and ride the coat tails of, and/or job hopping. Your resume and portfolio are essentially your product service offering, and your networking, LinkedIn and professional social activity, and resume boards are typically your marketing.
Investments
Investment education includes an understanding of products (stocks, bonds, short term instruments, ETFs, mutual funds, and other products), the historical performance and variance, the associated risks, how many billionaire investors are fundamental investors vs. technical investors, and more.
For those unfamiliar, let’s discuss a few investment products. Historically (over the past 150 years), the stock market has returned on average 10% each year (assuming reinvestment of dividends). When adjusted for inflation, it’s 7% each year. With longer time horizons to invest, stock investments historically have earned higher returns than other products. Bonds are a debt instrument where you’re loaning money at a stated return, but you either give up some liquidity by holding the bond to term or you risk a lower return if you or a bond fund you invest in need to sell bonds before maturity. Short term instruments have terms that are a year or less and thus typically have lower nominal returns than longer term debt instruments. Typically people will invest in funds for these products, but there are times when buying them individually can make more sense. Exchange traded funds (ETFs) and mutual funds are just pools of these types of investments that an investor can invest in. It can make the process simpler. You’ll want to discuss your specific goals and financial situation with a financial advisor. There are other products that are more complex, such as options; these products and others can carry significantly more risk because they create leverage. It’s unnecessary to create leverage when investing in personal investments, and two of the best investors, Warren Buffett and Charlie Munger, frequently discourage people from using leverage (with options or in other ways) to generate returns with personal investments.
So why would someone want to invest in these personal investments? You know what Einstein called the most powerful force in the universe? Compounding interest (there is no record of him actually saying this but it gives a dramatic effect). If you contribute $292 into an investment account each month for 30 years, and your investments return an annual return of 7%, then you’ll end up with over $1 Million. If you had saved $292 in a savings account each month over the same time period, you would end up with $157,680. This shows the power compounding interest can have over the long term.
Meanwhile, if you contribute $883 into an investment account each month for 30 years, and your investments return an annual return of 7%, then you’ll end up with the same $1 Million. This is $317,880 in total contributions. This shows that by waiting 15 years, you would need double the total money to generate the same level of return, but it’s 3 times the monthly contribution.
You can invest in funds that target a specific goal for you (like target date funds for retirement), have portfolio managers help guide and review your investments (usually there is a minimum balance) or you can have professional investors manage your investments for you with a managed account. In all of these scenarios you’ll want to keep an eye on fees, as they can lower your returns (even a 1% yearly fee can lower your returns significantly over the long term). I’ll discuss more about investments and strategies below.
Real Estate
Real estate education means learning to find a great deal (i.e. using the 1% rule, investing for appreciation), which loans to use and how to qualify, how to add value to properties, construction costs and processes, property management, how to maintain properties and plan for unexpected expenses, and the power (for good and bad) of leverage.
Real Estate investing in the US usually uses debt financing and thus most real estate investors are leveraged. This can supercharge your gains and losses. If you buy a home with a down payment of $12,500, and it gains $50,000 in value in a year, then you’ve generated a 300% return in one year on your money. But the opposite is also true. If instead the home had declined $50,000 in value, then you would have had a -300% return in one year. So why do real estate investors use financing, which creates leverage, if Warren Buffett and Charlie Munger discourage leverage in personal investments? Typically the real estate market moves slower than the stock market, and it’s a hard asset that you can rent out and generate cashflow with. So if you hold your real estate long term, and you generate cashflow by renting it out (or part of it out), then you can lower some of the risk. McKinsey did a study and found that the average lifespan of an S&P 500 company in 1958 was 61 years while today it’s less than 18 years (1). The value of a single family home, on the other hand, is historically much less volatile than with stocks. Still, all investments involve risk, leverage supercharges that risk, and holding investments long term and generating cashflow from them help to lower some (but not all) of that risk.
Some real estate investors might choose to start out by using debt financing when they don’t have the capital to otherwise get started, and then pay off the loans with cashflow over time. Mortgages can have a variety of terms including 15 and 30 years, so if you make all of the payments, you own the full value of the investment at the end of the term.
Diversification
A few last important principles to learn are diversification and the safety it provides, dollar cost averaging vs. market timing, legal structures to protect yourself, and ways of optimizing your tax liabilities. Architecting this correctly means your business income, investments, and real estate will have a higher likelihood of producing wealth.
When you look at the two sides of diversification, you see financial advisors on one side telling their clients not to put all of their eggs in one basket and on the other side Warren Buffett taking big positions in stocks. Financial advisors will show studies that say that 90% of the benefits of diversification are achieved with 12 - 18 stocks or suggest 20 - 30 stocks or 60 - 80 stocks. Some will suggest investing globally and ensuring you are not weighted too heavy in any one industry. Warren Buffett takes a different approach. Though he might invest in 48 companies, 1 stock might make up almost half of his portfolio’s allocation). Target date funds and managed accounts might invest in a diversified group of funds that are each themselves diversified. A common benchmark for fund and portfolio managers is the S&P 500. It is an index of the largest 500 companies listed on stock exchanges in the United States. If you just want to invest in these companies, there are ETFs and mutual funds that track the S&P 500 with relatively low management fees. If you want to invest like Warren Buffett, you don’t have to do all of the research that he does nor track his filings. You can just invest in his corporation.
Diversification also reduces risk with business income and real estate investing. When you have multiple streams of income, losing one is less catastrophic or to your financial health and financial goals. Layoffs are a cyclical event in even the healthiest companies and valuable, well liked, and loyal employees are not immune. Businesses are not only at risk from business cycles, they also face many other risks such as competition, regulatory risk, litigation, shifts in demand, quality problems, and numerous other risks. The landscape is always changing and technological innovation can accelerate the changes.
Dollar Cost Averaging
The benefits of Dollar cost averaging over market timing are important to understand. When the markets crashed in 2008 and stocks indexes lost more than half of their value , it was easy for many professional investors to recommend investing and going overweight in stocks. The thinking was ‘what do you have to lose? If it all crashes to 0, then we’re going to have bigger problems anyways.’ Still, many others warned against investing at what would be one of the best times to invest in a business cycle (so long as the stocks you picked didn’t go bankrupt or so long as you diversified into index funds). When there’s blood in the streets, that’s when you can find deals. Warren Buffett says “be fearful when others are greedy and greedy when others are fearful.” The problem, though, is you don’t often know how low investments can go, whether individual stocks will go out of business, and you don’t want to need cash waiting for the market to turn around. This is why long term investors caution against “catching a falling knife” and will frequently say that “markets can remain irrational longer than you can remain solvent” (a quote often attributed to John Maynard Keynes). Some then resolve to a strategy of “buy the dip”. The problem is knowing what is a dip and what is a crash. Many stock market crashes also have what’s known as a “sucker rally” or a “bull trap” where all indications seem to show that the market is bottoming out and turning towards the upside; this happens right before the next crash. Some investors will resolve this problem with the strategy of “don’t fight the Fed.” This means that when the Federal Reserve is being hawkish and combating inflation to reach their mandated target of 2%, they will raise interest rates which will increase the cost of borrowing for businesses and lower the price of bonds. Why would I pay the par/face value of a bond at 2% when the Fed is raising interest rates and I can get a higher rate on a “risk free” 10 year treasury note (risk free is in quotations because it is commonly considered an instrument for a risk free rate of return though all investments carry risk)? Stocks can suffer, too, from a hawkish Fed. Some stocks might go out of business if their business is interest rate sensitive (lending companies that rely on refinancing for their business) and more investment dollars may be pulled out of riskier stocks (lowering the price) and put towards less risky bonds (note that there are bonds of all risk levels but US treasuries are considered less risky than stocks in general and AAA rated corporate bonds are often considered less risky than their stock counterparts). The main reason for market timing leading to worse outcomes than dollar cost averaging, though, is psychological. Investors stay too conservative for too long waiting for the right time to buy and wait too long for the right time to sell. It’s not enough to buy at the right time when market timing, you also have to be right a second time when selling unless you hold your investments long term. It should be noted that Fidelity Investments did a study and found that people who forgot about their 401k performed better than those who actively managed it. Warren Buffett also frequently points out that professional investment managers perform worse than a coin flip when comparing their returns minus fees against the S&P 500. He even once said that he had instructed his wife to put all of her money into the S&P 500 in the event of his death.
Dollar cost averaging, on the other hand is a way of circumventing the risks and dangers of market timing. Instead of trying to buy or sell at the right time, you buy (or sell) regularly. The most common implementation of this strategy is investing a set amount each pay period into a 401k, retirement, or brokerage account. By investing regularly, you buy more shares of investments when prices are low and less shares of investments when prices are high. This lowers the average price you pay for your investments compared to what the average price of those same investments were over the same time period. While the difference in price may seem small, given enough time, the returns compound.
Home Cost Averaging
This concept can be applied to other markets. A common refrain from successful real estate investors is that they are always buying real estate - whether real estate is cheap or expensive. Barbara Corcoran has frequently said that she overpays for real estate all the time. This common strategy among successful real estate investors is something I like to call “home cost averaging.” When real estate is cheap (such as when the housing market was bottoming in 2012 after the 2008 housing crisis) you can buy more investment properties. When real estate is expensive (more recently), it’s harder to find a deal where the cashflow numbers work so you end up buying less real estate. Given that US housing is currently undersupplied, population is expected to continue to grow, lumber and sand supplies needed for framing, concrete, and other construction materials are expected to become more scarce, and given historical inflation and the Fed’s target rate of 2% inflation, most real estate investors expect the price of homes to be more expensive in the long term (say 30 years from now) and thus are willing to always buy real estate now to generate long term returns and wealth. It should be said, though, that it is not a given that real estate will always appreciate in real or even nominal terms, when homes become unaffordable for the local people who want to live there, demand (and thus prices) can decline, and that the old adage is usually true that real estate is local - it is usually tied to fundamentals of jobs and wages in the local economy (remote work can disrupt some but not all of those fundamentals). The most important parts of investing in real estate is whether the local population is growing, whether local jobs are expected to grow, and buying at a great price. Investors who buy the wrong deals can go bankrupt, especially if they over-leverage themselves.
Legal
Legal structures can protect your wealth, usually by limiting your liability. So long as you don’t “pierce the veil” of the company by co-mingling funds or activities of your business with your personal life, then a limited liability company (LLC) is a common legal entity that you can set up online in sometimes as little as 15 minutes that will protect your personal assets in the event of being sued. Some people will hold their real estate investments in an LLC for this reason. Some investors will hold every property in its own LLC, though this increases the work you will need to do when filing taxes.
Legal structures can also provide the framework to leverage your business income if you take on investment or debt financing with the purpose of growing. Investors or debt financiers want to clearly and easily understand the legal structure of your business so that they understand the risk they are taking on by investing in or lending to you.
There are many different legal structures one can use to protect their current and future wealth and you will want to do your own research and speak with a lawyer for legal advice. The accessibility of this information is abundant on the internet, and their are online automated services that can help you, but for legal advice tailored to your goals, finances, and life circumstances, you can always speak with a great lawyer, though the price might be higher.
Tax
The legal structures of how you invest and receive income also play a vital role in how much you pay in taxes. Taxes are a cost that with planning can be legally reduced. The IRS’s website describes the difference between tax avoidance vs tax evasion. Tax avoidance is legal and simply means using legal means to lessen your tax liability and increase your after-tax income. Tax evasion, on the other hand, is illegal and is the failure to pay or a deliberate underpayment of taxes (3). Some people may also discourage tax avoidance, even though it is legal, on ethical grounds since the common areas, goods, and services that we use publicly are funded through taxes. Some people may prefer to call tax avoidance a different name as well, since it doesn’t sound palatable. They may call it tax planning, tax strategy, or tax efficient ways of managing, deferring, and reducing taxes. Some may also avoid the term “tax avoidance” due to not wanting to be seen as giving tax advice and distinctions they may draw between practices that are common vs. practices that are uncommon, considered a loophole that might be closed, or practices that are in a legally or ethically gray area that could damage reputations or introduce risk.
The common ways of reducing business income taxes are through using an S-corp or an LLC taxed as an S-corp to pass through income to your personal tax returns. Some of the most common ways of managing, deferring, and reducing taxes with investments are through 401k type retirement plans, traditional or roth retirement accounts, other tax advantaged accounts, and tax loss harvesting. Real estate investors also have tax benefits. Depreciation of real estate is one of the most discussed mechanisms of reducing tax liability, but there are many others. There are various other tax laws that provide benefits and tax credits and incentives that exist that can reduce liability. You will want to do your own research and/or speak with a tax professional.
Something to also consider with taxes is your estate planning and the tax consequences when you pass away. This is an important element of creating what’s known as “generational wealth.” Again, you will want to do your own research and/or speak with a tax professional.
Lasting Structure of Security
Building wealth is like building a structure to withstand the weather and elements in order to create security. Architecting wealth starts with a foundation of education, with pillars of investing, business income, and real estate, tied together with beams of diversification and dollar cost averaging, and protected by a roof of legal protection and optimized taxes.
About the Author
Cash LeBrun has worked for fintech companies and financial firms for over 13 years of his career in technology and financial services. He received a B.A. in Economics from the University of New Mexico.
Sources Cited
1) https://www.imd.org/research-knowledge/disruption/articles/why-you-will-probably-live-longer-than-most-big-companies/#:~:text=A%20recent%20study%20by%20McKinsey,S%26P%20500%20will%20have%20disappeared.
2) https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator
3) https://apps.irs.gov/app/understandingTaxes/whys/thm01/les03/media/ws_ans_thm01_les03.pdf
Disclaimer
I am not a financial advisor, attorney, or accountant nor am I holding myself out to be. The contents on this website are for educational purposes only and represent my personal opinions. The information contained on this website is not a substitute for financial advice from a professional who is aware of the facts and circumstances of your individual situation. To make the best financial decision for your needs, you must conduct your own research and seek the advice of a professional with the appropriate licenses if necessary. All investments involve some form of risk and there is no guarantee that you will be successful in making, saving, or investing money; nor is there any guarantee that you won't experience any loss when investing. It is also important to note that past performance does not predict future performance, and any historical analysis does not predict what will happen in the future.
