Ok, here is my short guide to creating generational wealth.
Sure one can inherit wealth. And sure one can luck into it. But my question is more fundamental:
How can wealth be created in a systematic way? How is it kept? And how is it passed on to the next generation?
I think you need two things:
- An investment engine
- Investment leverage
The “engine” here is the base that makes everything else possible. And the “leverage” is the tool you use for scaling to a larger base.
First, the engine.
In truth, the engine I am describing here is nothing but a well diversified investment portfolio. Get a Registered Investment Advisor to run it and have them explain all of the math and reasoning to you. Diversification is the only real investment safety there is. So this is important.
They should point to something like this:
- 30% Fixed Income Basket
- Domestic, International, Emerging
- 40% Equity Basket
- Domestic, International, Emerging
- 30% Alternatives
- Domestic, International, Emerging
Based on a similar allocation to this, a reputable Registered Investment Advisor should be able to tell you that this combination over the last hundred years (or however long) will average an X% return.
And that return, based on market draw-downs over that same time period, you can have a withdrawal rate of X% per year, that allows you to never touch your principal investment.
I think that a relatively conservative portfolio can be constructed that allows a 3-5% return.
- $100,000 would give you a stable income of $4,000 per year.
- $200,000 would give you a income of $8,000 per year.
- $500,000 would give you a income of $20,000 per year.
- And $1,000,000 would give you a income of $40,000 per year.
This diversified engine should change as you grow. On the small side, a small Registered Investment Advisor will do. On the large side, you could evolve into a formal Family Office.
Now, investment leverage.
The leverage I am describing here is using bank debt as a tool to buy businesses and/or real-estate.
So we ask the question: With our investment engine producing $40,000 per year, how much debt are we able to service with that?
$40,000 per year – at 6% on a 20 year loan – is enough to borrow $460,000, and adequately service the monthly loan payment of $3,295.58.
So now you go out and find a business or piece of real-estate for sale for $460,000. Borrow $460,000 from the bank. And buy it.
But here is the crux. The business that you buy must be able to service the debt just borrowed. Formally, bankers define this as the Debt-Service Coverage Ratio.
Debt-Service Coverage Ratio = Net Operating Income / Debt Service
Now you have your diversified portfolio making $40,000 per year, a business making $40,000 per year, a job making your regular salary – and $40,000 per year in debt obligations.
After all debt has been paid off, all business/real-estate profits should become income back into your investment engine for future diversified income, and future leverage.
Rise. Repeat.
Finally, start
How does one get started with the base to do this from?
There are three ways:
- Inherit it.
- Earn it through a high income.
- Simply save it.
After all, a $500,000 portfolio can give enough income to service a $250,000 bank note, and this – depending on where you live – is enough to get started by buying a duplex to rent out.
If this still seems completely out of reach, the most practical way I know is for a dual income household to live off of one salary and save the other one.
Saving $50,000 per year, at 6% interest, takes about 8 years to save $500,000.
Like I said, this is generational wealth, not a get rich quick scheme…
Now go do this. And teach it to your children.
It make take you a lifetime to get to a $1,000,000 or $2,000,000 base – but when you do, you will be buying million dollar businesses and soon leaving your job to do it full-time.
If you do the math, you will quickly see that only a few iterations into this can build a massive business.
And, if you are lucky, it will all still be going and growing exponentially a few generations later.
Ideas in this post overlap with this fantastic series by Naval Ravikant.
And don’t miss watching Donald Miller explains the basics of all this.