Ever since I disclosed my net worth broke eight figures strange emails have been coming in. Another milestone was passed without fanfare. Past experience had me used to the lack of excitement financial milestones caused.
A theme among many emails revolved around my rate of return. I never really thought of it that way. It was just a thing that happened because I saved a large percentage of my income and invested the bulk of my excess money in index funds. One commenter said he was impressed because my rate of return over the last 20 years was 11% while the S&P rose only 8.5% per year on average. I don’t know if it’s true; I never broke the numbers down that way. All I care is that it grew to a lot.
What the emails and comments forget when they calculate my rate of return is that I added funds over the last 20 years. If I reached my million dollar goal when I was 32 and never dropped another dime in the kitty my internal rate of return would be impressive. Instead, I added excess funds every year. If I analyzed my real return including the additional invested fund my internal rate of return would be less impressive.
There is something else strange about my net worth everyone forgets. I own a business and business ownership has a strange way of building net worth fast. The first million arrived a lot sooner for this broke farm boy than expected. Sure, liquid equity investments were a large part of the seven figure net worth 20 years ago. But I owned real estate and a business too.
Real estate had subpar returns for me. The money was okay, but not great, especially when you consider risks and the time and work involved. The mutual funds did well, as expected. The late 90s were great years for the market and I don’t need to remind you the market has been running higher for eight or so years now. The real surprise, the real sleeper, was the business. It wasn’t planned at first, but once I understood how powerful a business can be at increasing net worth I used all my accounting skills to make good use of the advantage.
Warren Buffett Enters the Room . . . Again
I have followed Mr. Buffett for a long time. One thing that always amused me was his knowledge of the tax code. His stellar growth at Berkshire Hathaway is only amazing because people don’t see how he did it. His stock picks have been solid, no doubt. But it doesn’t completely explain his massive outperformance.
Early in Buffett’s career there were many significantly undervalued stocks. That environment does not exist today. Try to find a listed stock with more cash and equivalents than the price of the common stock itself. Doesn’t exist today.
When the market rallied and kept rallying the awesome deals disappeared. Guys like Buffett don’t sit back and sip Mai Tais all day when the well runs dry; they look for more opportunities. Buffett’s massive knowledge of investing and accounting allowed him to do something few are capable of.
Here is Buffett’s secret. When a corporation, Berkshire Hathaway perhaps, buys enough shares (a large enough percentage) of another corporation, the buying corporation includes their percentage ownership of the profits into their own reported profits. The thought is if the buying corporation owns that much of an interest they will effectively gain their portion of the profits even if the profits are not distributed as dividends.
When Buffett buys a stock he buys a lot of it. Now you know why. He wants to hit a magical percentage of ownership so he can include those profits into his own even if there is no current distribution. Later he gets to claim the capital gain, too. The companies he wants to buy must be good deals. He must also consider the ramification on the book value of Berkshire Hathaway.
Increase Your Net Worth $2 for Every $1 You Earn
The little trick Warren Buffett uses to increase the book value of his company is educational. There is a magnifying effect in play. You get extra zing if you do it right. The small guy has it easier if he knows what he is doing.
Going back to my disclosed net worth, the real question or comment should not have been about growing my net worth from ~$1.2 million to ~$12.6 million in 20 years. The real questions should have involved issues of getting to the first $1.2 million. How did a broke farm boy from the backwater of nowhere tuck away a million dollar net worth in 14 years? Since nobody asked, I’ll answer the question.
To start, the family farm finalized the bankruptcy a few months after I graduated from high school. I didn’t go bankrupt. My life savings was meager, but there were a few dollars rolling around my bank account. Remember, in 1982 bank deposits paid double digit interest rates (and a free toaster if you opened an account with $100, or was it $1,000; I always forget).
Even so, I did not have a head start on my way to a seven figure net worth. I started working in my dad’s business for peanuts. Spending was as close to zero as you can get without being zero. (You in the back, sit down! I know that comes to one cent.)
Saving all my income and investing it in bank deposits paying 12% and dropping some in growth & income mutual funds for the rest started the nest egg growing. A side gig preparing taxes which paid more than my real job sparked the early growth stages of my stash.
Things still weren’t awesome. I took a few years off to read nonstop. Then I met Mrs. Accountant and my hyper frugal ways (did someone say dumpster diving? —we called them McDonald’s runs back then) would no longer work. I had a one-year stint as a custodian at a parochial school before my real big break. I didn’t know it at the time, but quitting my day job after a full career of somewhere around 14 months was the best thing that ever happened to me. And my net worth.
Skyrocketing Net Worth
Do you like games? I do. Let’s play.
Thought experiment: Assume you start your own business, a season tax preparation business, perhaps. You visit the local apartment association and speak a time or two to build your client list. Just for argument’s sake let’s say you bring in 200 clients (don’t want to work too hard) and each client on average pays you $500. (They have rentals so the returns are not the cheapest.) Your revenue for the year is $100,000.
Tax preparation firms have 40% – 50% net margins if they manage properly. Just to make our game easy enough to figure in our head we will say our business owner has a 50% net profit margin. As a result $50,000 ends up in his pocket as profit.
First question: What is the net worth of our hero if she has nothing else to her name? $50,000? Hold that thought.
Our business owner is frugal, but wants to supercharge her net worth so she adds another 200 clients at an average fee of $500. She now has $200,000 in revenue and because she manages her company so well 50% of revenues end up in her pocket. Her income increased $50,000.
Next question: How much is she worth now?
Most people would say if she spent absolutely nothing on herself she would have a $150,000 net worth—a $50,000 profit from year one and $100,000 profit from year two. If you said that you are wrong. Her net worth is $350,000 to $450,000!
The Numbers Game
Okay WA, you lost your mind now. She has a business for two years, earns a combined profit of $150,000, spent absolutely zero of the profit investing it all and has a net worth of $350,000 or more? That doesn’t make sense! What’s the punch line? Stock market tripled in a year? She played options? Won the lottery?
None of the above. She played the safest game in town.
I’ll give you a hint. The first year her net worth was already $150,000! Still blows your mind our business owner starts a business, does a hundred grand in sales and has a net worth more than her revenue!
[Stop teasing me! There are other blogs I can read you know.
Okay, okay. I’ll spill the beans.]
Every business is worth something on the open market. In this case we have a tax preparation firm. Tax firms generally sell for 1 – 1.5 times revenue. Therefore, our business owner generated $100,000 of new revenues in year one. The value of the new revenues is 1 – 1.5 if sold on the open market, plus the profit she got to keep from owning the company the first year.
In year two she doubled sales, hence the value of the firm. Of course I am assuming a conservative value by using the lower end of the range.
When I was 32 my small tax prep business did around $300,000 in revenues. Real estate added ~ another $200,000. Without the business and real estate investment values added to my net worth I would have had to wait a bit longer to hit the seven figure mark. Maybe I would have enjoyed it more if only the cash was counted. Doubtfully.
The Power of Knowledge
In my life business ideas revolve around my firm. Over the years I have sold off pieces of my company only to engage a new idea, expanding the business in a different direction. I never failed to attract at least 1.0 times the revenue of the piece sold.
Armed with this knowledge I am able to increase my net worth with a multiplier effect. I never consider a client worth only what they pay me or the profit on the account. If a new client comes in with $10,000 of work I know I will generate $4,000 to $5,000 of profit for my favorite human AND increase the value of my company by $10,000 or more. In my mind I have a massive annuity and a nice check at the end if I sell.
This why my net worth grew so fast and why I said real estate underperformed. This doesn’t happen with investment properties. If you raise rent $10 a month the value of the property may increase, but it will be negligible. Real estate is worth what the market says it is. Businesses are worth a multiple of revenues, profits, assets or a combination.
This is why it is not that hard to be wealthy. This is why it is not hard to build a million dollar net worth. Starting from zero today and knowing what I know I could reach seven figures in five years tops. That isn’t bragging either; it’s a simple fact.
And now that you know the facts you can do the same.
The best way to learn is by studying the best. Experience has value as long as it also has a foundation in knowledge. Reinventing the wheel again and again is a fool’s errand and not conducive to personal development.
Studying the best takes many forms. Working for someone at the top of their game is the best way to learn, but the opportunities to do so are limited. Formalized education communicates facts without always presenting the best in your selected field. The number one way to learn from the masters is to study them through intense research of their work. The greatest minds are available like never before. YouTube videos of their speeches and books and news articles on their practices give us massive quantities of material to learn from.
Today we will focus on a simple story shared by Charlie Munger, Warren Buffett’s friend and right-hand man at Berkshire Hathaway.
Tell Me a Story
Munger gave a talk to the USC Business School in 1994 where he shared a story Buffett told when lecturing at business schools. Here are the exact words Munger used:
When Warren lectures at business schools, he says, “I could improve your ultimate financial welfare by giving you a ticket with only 20 slots in it so that you had 20 punches—representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all.”
He says, “Under those rules, you’d really think carefully about what you did and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”
Buffett’s story is about more than investing; it’s about life. People buzz around trying to do everything and end up doing poorly in each endeavor. Investors trade stocks like baseball cards; people buy home after home believing they are moving up with each new personal residence; employees keep moving from job to job looking for more . . . ; business owners search for new clients endlessly.
Around here we encourage index fund investing. It’s a perfect way to set it and forget. That counts as one punch on the 20-slot card. I have a mad money account where I invest a small portion of my liquid net worth. The account only has a handful of stocks. By limiting how many companies I own I spend more time researching those companies and evaluating their prospects.
I also make incredibly stupid mistakes and pay the inevitable price for such mental lapses. In the late 80s and 90s I was in a partnership with my dad and brother. We bought real estate. A lot of real estate. By the time we were done we had 176 properties to consume our lives. Actually, my dad and brother were not involved so “I” had 176 properties to consume “my” life. I punched my 20-slot card 176 times!
Lack of focus hurt results. I had properties spread out over a 200 mile radius. Multiple property managers were involved. We had the money so we kept on buying. And selling.
Eventually I experienced burnout. The fun, even the desire for profit on it, was gone. The buying stopped and the selling accelerated until there were no more properties. The partnership was done. Countless hours yielded a good, but not great, return. The lust for more for more’s sake cost dearly. Lesson learned. Kind of.
What could I have done better? The money was there and so were the opportunities. Burnout could have been avoided. If I would have heard Buffett’s advice back then it would have saved me from plenty of pain.
The 20-slot rule applies to more than stock investing. Rather than buy so many single-family homes I should have bought fewer multi-unit properties. I toyed with the idea at the time. I reviewed a serious number of apartment complexes and commercial properties. The numbers were compelling. In many cases the profit potential was higher than anything I could earn with my current mix of investment properties. The reason why I decided to pass on multi-unit buildings was because it would be harder to sell such properties and would likely take longer as well since fewer buyers were in the multi-unit market.
If Munger were standing beside me he would have smacked me up behind the head. I can hear him say, “Idiot. Think like an accountant!”
Warren Buffet says you should buy a stock as if the stock market will be closed for five years. The point again is to focus on the investment and invest for the long haul. I didn’t buy fewer large value buildings because it would be harder to sell them. I acted like real estate should be day-traded. SMACK!
The missed opportunities are only talked about now. My choices when I ran LuK Enterprises cannot be changed. It’s in the history books. At least I learned my lesson. Right?
Thinking like an Accountant
This blog is about teaching people to think like an accountant. You would think an accountant with decades of experience could communicate such a message with clarity. You would also think said accountant would walk the talk. Welcome to my fantasy world.
I share my failures in business (and sometimes in life) because that is where the opportunities to learn exist. Plenty of successes brought me to this place. Bragging about the times I knocked it out of the park would waste both our times.
Sometimes a 20-slot card is too many slots and other times too few. For example: In my practice I have more than 20 clients. Most businesses require more than 20 clients to be viable and to reduce risk. One client should not determine the success of a company.
As my business has grown over the years and with this blog, I find myself saying “no” to new clients more often. My practice is small for a reason. I enjoy the work. Expanding to additional locations would not make me happier. Quite the opposite. More locations and more clients would reduce the relationships I have with my current clients. A thousand clients is too many at times already.
My 20-slot card has only one slot when it comes to marriage. Two slots would be too many for me. Even my dating card had fewer than 20-slots. I dated fewer than five women in my life. Two received more than one date and only one became my wife.
I never understood the idea of dating a large number of people to find Mr. or Mrs. Right. The answer is obvious when speaking with a potential mate before it ever gets to the first date. If the answer is obvious, why invest the time? You are not dating to see if this person is right for you; you are dating for the opportunity for a piece of ass. Be honest. You know it’s true.
There is no guarantee a mate will work out. Divorce happens for a variety of reasons. If a young lady doesn’t fit my vision of a life mate we can still talk and be friends. All the emotional baggage is eliminated before it is ever created.
Most people take whatever comes their way in interpersonal relationships. I am no fan of luck. I actively sought out Mrs. Accountant. I would come to the table with a one-slot card and was darn careful about punching that slot.
None of this guarantees success. Limiting the number of stocks you buy, researching to the nth degree an investment does not guarantee it will work as planned. But you do increase the odds by magnitudes of order it will.
Buffett has owned more than 20 stocks in his life. The 20-slot rule is not hard and fast. It is a metaphor to remind you to spend more time focusing on fewer projects.
Focusing on a narrow group of projects is the only way to maximize profits or pleasure. When I find a good company I keep adding to it. Index funds should be the bulk of more people’s investments. It’s an awesome idea so you can comfortably keep adding to the pile whenever funds are available.
In my practice I add clients selectively. Opening new offices and expanding rapidly might work as long as I accept the greater risks of growing my type of company to such proportions. When there is room I add to an already successful business model. It works and it is profitable.
Even in my marriage I keep adding to the one investment I have made. Having an affair or spreading it around is of no interest to me. There is no doubt I would NOT be happier playing the field or searching for something better.
At the risk of sounding cold, I am not looking for the absolute best stock on the exchange; I’m looking for one I can live with for a lifetime.
My marriage is the same way. I never intended to find the perfect person I would be most compatible with. Heck, she probably lives in Timbuktu. It’s not going to happen. I found someone, Mrs. Accountant, who I knew I could enjoy a lifetime with. No need to punch 8,304 slots on the dating card to come to that conclusion.
Or you can keep chopping your 20-slot card to bits in an attempt to find the ultimate investment or mate. But be warned; you will not be happy with what you get.
The difference between wealthy people and non-wealthy people comes down to a small set of habits anyone can embrace themselves. There is no special trick or secret. Wealthy people do things the average person does not. Super wealthy people like Elon Musk, Bill Gates, and Steve Jobs share the same wealth-building habits with a bit of luck to give them a push. The great news is you can be rich, too! No promises on the super-rich thing, but you can be a millionaire if you choose.
There is an advantage for people like me working in accounting. I see people from all walks of life and their true level of wealth. Over time it becomes apparent how their habits reflect in the level of wealth and quality of lifestyle they have. We stand in awe and envy when we see people retiring at age 30 or 40, and rather than learn their habits, we seek to tear down their success. The only difference between people who retire early and those finding a comfortable retirement at 65 is how soon the wealth building habits are learned. Here are the five things I see rich clients do on a regular basis and non-wealthy clients frequently do not. Not only do the wealthy have these habits, they exercise them daily.
Investing versus saving. It should come as no surprise wealthy people consume a smaller portion of their income than people with a low net worth. Around here we preach spending less than half your income, putting the reminder into investments.
Charlie Munger says you should invest first and only spend the left over. I agree. Wealthy people do NOT save; they invest. What they invest in is businesses. Real wealth creation does not come from a bank account or investments in commodities. Wealth is created when a business invests capital and receives a greater return than the cost of capital. I know it is a mouthful, but what this means is if you want to get rich and stay rich you need to invest in wealth creating businesses.
Business is a risky investment. The only way to mitigate the risk is to spread your investments over a broad range of proven profitable businesses. Might I recommend an S&P 500 index fund over at Vanguard? You do not need the knowledge or skills of a Warren Buffett to build wealth. You can attain wealth and remain rich by investing in an index fund. The market will have days, weeks, months, even years where the wealth building thing does not feel like it is moving forward. The stock price is not wealth! The companies you invest in create wealth from return on invested capital. Wealth can still be created while not showing up in the stock price for a while. Smart investors load the boat during these opportune times.
Small business owners, like The Wealth Accountant, invest most of their net worth in the same fashion. Running your own business is a great way to create wealth, only all your eggs are in one basket. So, enjoy your business. Only, be certain to diversify just in case.
Don’t panic! You know the kind of person I am talking about here. This is the person screaming at any provocation. Wealthy people keep their wits. Turbulence is not an opportunity to run around like a chicken with its head cut off. (Did I mention I come from a farming background?) Survivors of a catastrophe are disproportionately from those who kept calm in the face of danger. Most danger is perceived. Running in a circle screaming “FIRE” will get you killed; the rich mindset calmly walks from the burning building and to safety.
The same applies to wealth building. When clients call all concerned about the economy or stock market it is hard to calm them down. Only the people panicking call. Wealthy people are carefully picking their place to put more money to work creating wealth. Rich people love it when business prices (stock prices) are on sale.
Rich people rarely follow the herd. They blaze their own trail by keeping calm when the world seems on fire. It reminds me of a story about an old stockbroker and a young stockbroker. It was the Cuban Missile Crisis. President Kennedy just announced on TV he targeted 50 Russian cities in the event of a nuclear war. The market began selling off. The young stockbroker started screaming to sell. The old stockbroker quietly started buying stocks. “What are you doing?” the young broker screamed! “There could be a nuclear war!” The old broker nodded and smiled. “There could be,” the old stockbroker said. “If it does not happen my stocks will soar in value; if it does happen my trades will never clear.”
One final adage before we move on. Remember, the next 100% move in the stock market is up, not down. If I am wrong it will not matter. Therefore, the risk is NOT being invested in the 500 biggest wealth creating enterprises on the planet. You can call Vanguard after you finish reading this post.
Belief. Plenty has been written about the Law of Attraction. Rich people know they are rich, feel they deserve it, and act accordingly. This may sound strange, but most people do not believe they will ever be rich, do not feel they deserve to be rich, and take the necessary steps to make their reality true. I see a skeptic in the crowd.
Think of it this way. How much money did you earn 10 years ago? Twenty years ago? Prices have gone up a bit during this time frame, but what about your investment rate? If your annual income is currently $80,000 per year and in the past it was $40,000, why did you spend more as it came in? You see, when you refuse to save/invest half your gross income you are acting like you do NOT want to be rich. Over the years I have actually had employees self-destruct after getting a generous pay increase; deep down they felt unworthy and took steps to destroy any hope they would have of becoming wealthy.
Wealthy people have vision. They know where they are, where they are going, and how they will get there. For the rich it is like going on vacation for the rest of the population. We can see ourselves in Costa Rica or on a Mediterranean beach; the rich see themselves with a lot of money invested in income producing investment. Take your vacation vision and apply it to wealth creation and soon you too will be rich.
Lean heavy on professionals. Non-wealthy people like to take shortcuts on the important stuff. Poor people save $100 on tax preparation fees only to overpay their taxes by $2,823. Some things are worth doing yourself, other are not. Rich people know the difference.
Over the years I have owned several businesses. Some of the businesses require a significant amount of legal work. Because I deal with legal issues daily I have a reasonable understanding of law. With the exception of tax law, I use attorneys extensively. I actually keep attorneys on retainer to run ideas past them and have an attorney as a full-time employee. Nothing can destroy wealth faster than legal issues. There is no number so large ever invented a plaintiff would not asked for it.
In the tax field I see people doing their own taxes and overpaying far more than my fees would ever amount to. Since taxes are your biggest expense in life left unattended, it is an absolute necessity to have a tax professional in your corner if you want to be rich. I might add the professional needs to be competent as well. I should not have to say it, but I do.
Poor people also tend to skimp on health issues. Rich people tend to smoke less, over consume alcohol less, use illegal drugs less, and engage in fewer risky activities. Risky behavior is expensive and a destroyer of wealth. If you are going to be rich you may as well be alive to enjoy it. Wealthy individuals tend to have an annual exam and discuss health issues with their doctor. Rich people deal with medical issues early before they become life threatening.
Professionals provide the expertise wealthy people need to build and preserve their wealth. This does not mean the wealthy avoid research. The rich review medical literature and familiarize themselves with the law. This self-education allows the rich to have a more meaningful discussion with their professional team.
Take a healthy interest in the tax code. The tax code is huge and the interpretation changes daily as the Tax Court and IRS regulations seeks to clarify your tax liability. The host of taxes we are hit with each day means taxes takes as much as half our income. This simple fact makes taxes the single largest expense in our life. Reducing the tax burden is an easy way to super-charge wealth creation and preserve wealth.
Tax professionals can do wonders for your personal financial statement. Still, no tax professional understands you like you do. I hate it when I work with a long-term client and discover there is a missing piece to their finances I was never made aware of. I keep asking questions so I do understand my client, but there is no guarantee I will know everything I must know to maximize results. Trust your tax professional, but verify.
Taxes are only boring in a vacuum. When tax savings provide massive financial security the tax code reads like a Stephen King thriller. Educate yourself on tax issues and question your tax pro. Any professional who does not have time to learn who you are cannot do his job! I must know my client to earn my keep. The best way for me to do my job is for you to understand at least the fundamentals of how taxes affect you.
There you have it, the 5 things rich people do that you don’t. Time to step up your game. Special thanks are in order to a younger version of me. This post is a continuation of an article I published on January 20, 2010: 5 Steps to Retire Rich.