In my last column, I laid out a simple process for building wealth. It looks like this:
1. Make money.
2. Spend less than you make.
3. Invest the difference.
4. Repeat for decades.
But there’s a secret in those four steps. It’s when the real money is made – or can be made. Knowing the secret, though, isn’t good enough. I’ll give you the secret in a few moments. The hard part is the doing. Truthfully, very few people will ever successfully exploit the secret, even when it’s known.
Most people think the real money in life is made during your working years. That seems reasonable. After all, that’s when you have a steady paycheck padding your bank account every few weeks. It’s when you are investing for the future.
But if you faithfully follow the four-step-wealth-building process outlined above, that’s not at all when the real money is made. Instead, the real money – the real wealth – is made after you quit working and are no longer receiving a paycheck for your time and labor.
Let me explain.
Let’s say we have two individuals, Sam and Kate, both of whom followed the four-step process for decades and are now 65 years old and ready to retire. They did so well, in fact, they each accumulated a retirement portfolio worth $1.5 million. They each expect to withdraw $50,000 annually from their portfolios for spending needs in retirement.
It’s what they each do next that ultimately determines whether they simply do well with what they have accumulated or whether they build serious wealth. It all comes down to investing – particularly, investing aggressively.
Sam enters retirement and does something very popular – and frequently very prudent – he decreases the risk of his retirement portfolio. He decides to invest 50% of his account in stocks and 50% in bonds. Over time, he earns a respectable 7.3% average annual return.
Kate takes a different approach. She chooses to remain aggressive with her investments and keeps 90% in stocks and 10% in bonds. Her average annual return clocks in at 9.7%.
Both Sam and Kate live to be 90 years old. So what do their portfolios look like at that time?
In an average market environment, Sam probably ends up with a portfolio value of $3.6 million. Think about that: He started with $1.5 million. Then, think about this: It took Sam 40 years to generate his $1.5 million portfolio, working and saving over his entire career. But in a matter of 25 years – from age 65 to 90 – his portfolio added another $2.1 million in value, despite withdrawing $50,000 every year for living expenses. The real money for Sam was made after he quit working.
What about Kate? How did she fare?
In an average market environment, Kate probably ends up with a portfolio worth $7.0 million – more than 4.5 times her starting amount and double what Sam amassed. What was the difference? Kate was willing to accept more risk. And that, it turns out, is the secret.
If you want to generate big wealth, it’s probably going to happen after you retire, and you must accept substantially more investment risk.
Frankly, most people should not follow this approach. Even for those who could financially, most won’t because stomaching the potential drops in value along the way is too terrifying.
And that’s okay.
Life isn’t about trying to create the biggest pot of money possible. But if that is your aim, you know the secret. Use it at your own risk.
Justin Lueger is President of Invisor Financial LLC, a registered investor adviser firm in the State of Kansas. All opinions expressed are his own and should not be viewed as individual advice. He can be reached at firstname.lastname@example.org.