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How Come I’m Not Rich?
“90% of putts that are short don’t go in.” - Yogi Berra
Why are some people able to become wealthy relatively easily, when most people struggle with their finances? In Canada, about 1 person in 50 is a millionaire and in the US about 1 person in 13 is millionaire* – which is probably a lot more than you thought. A recent BMO Harris study found that only 6% of millionaires inherited their wealth and 94% made it on their own.
In short, lots of people are wealthy and nearly all of the millionaires and billionaires made it all on their own.
From experience in talking with literally thousands of people and then seeing their complete finances, we can usually tell who is wealthy and who is not just by talking with them. We have found that the main difference between the wealthy and people that struggle financially is not their education, career, salary, type of family or anything like that. The main difference is the way they think about money.
Here is the secret: Wealthy people are focused on building wealth.
Most people struggle financially because what they believe about money makes them focus on other things.
Here are the beliefs about money that cause most people to struggle financially:
“The Sacred Cow” beliefs:
Here are 3 common beliefs that are a big part of the Canadian psyche. In our opinion, they are the main reason most people struggle financially. We put these 3 beliefs together and call them the “Sacred Cow”:
1. You should try to look like you are wealthy.
Most people are not wealthy because they don’t really want to be. They want to spend a million – not have a million. Most wealthy people are actually relatively frugal and are good savers (at least until they are wealthy). “Conspicuous consumption”, such as expensive cars, clothes, jewelry, electronics and even homes are signs of being a spender – they are not signs of wealth.
If you sense someone is trying to impress you by looking wealthy, he is almost definitely not wealthy. He is probably just a spender. Wealthy people usually downplay their wealth. It is the non-wealthy that try to impress others with money.
Years ago, when we used to go to the homes of new potential clients, we had what we called the “4-bedroom house and 2 minivans rule”. If we pulled up to a large, 2-story house with nice landscaping and 2 expensive vehicles in the driveway, we would just look at each other and shake our heads. They almost definitely have little money.
Then we would see their finances and in almost every case, they were up to their ears in debt. The house was fully mortgaged, they had credit lines that are maxed and credit card balances, and the vehicles were leased. It was shocking how often the value of the 2 vehicles in the driveway was more than their net worth!
Most millionaires live in ordinary neighbourhoods and few people know they are millionaires, as explained in the classic book, “The Millionaire Next Door”. Truly wealthy people usually downplay their wealth. They get a feeling of confidence from having money – not from spending money.
2. It is most important to pay off debt.
When we meet people with no debt, they are almost always among the poor or middle class. Wealthy people tend to have a lot more debt than non-wealthy people. Most Canadians tend to spend the bulk of their working life focused on paying off their mortgage and other debt, which we call “getting up to zero”.
Being in control of debt is obviously important, but wealthy people are focused on building their net worth – not on paying off debt. In fact, borrowing to invest in their business or in the stock market is almost always the reason they are wealthy.
Paying off debt is just “getting up to zero”, which will not make you wealthy.
3. The stock market is risky.
We find that most Canadians have a quite exaggerated view of how risky the stock market is, which stops them from ever having wealth. They are scared to invest a lot in the stock market. They believe the stock market is a gamble and crashes all the time, instead of focusing on the long term growth of the stock market.
You need to picture being wealthy. Imagine having a $5 million investment portfolio. You did not get there by investing in bonds. Properly invested mainly in the stock market, on average your net worth grows by $500,000/year. However, most years are not average. Quite often, your net worth grows by more than $1 million in a year.
But it also goes down several times a decade. In fact, once or twice a decade your portfolio drops by more than $1 million. In 2008, your $5 million could have dropped to between $3-3.5 million – a drop of $1.5-2 million. That’s a lot! However, you are focused on building wealth and know investing this way is what will grow your wealth in the long run.
Here’s the point: If you are scared to have a large stock market portfolio, then how will you ever build wealth?
Story of Reg and Rich
Just picture a typical Canadian named Reg. His parents taught him that “all debt is bad”, so his main focus financially during his life is paying down debt. He does not want to look poor, so he still buys a decent home, car and furniture, and travels regularly, but he always focuses on paying off his credit cards. He uses his extra cash to increase his mortgage payments.
He has some RRSPs, but he does not want to lose much money. Therefore, he invests conservatively partly in GICs and partly in balanced and income mutual funds. He focuses his investments so he can “sleep at night”.
Obviously, Reg will never become wealthy, will he? The way he thinks about money will prevent him from investing enough to ever become wealthy. He invests too conservatively to build any serious wealth.
His brother, Rich, has always wanted to be wealthy. He is constantly thinking about ways to invest more. He has a small business on the side and rents out his basement. He invests nearly all this extra money and his bonuses, mostly in addition to RRSPs. He does not spend a lot of time on his investments. He has a sensible approach and just keeps investing $30-50,000 every year. His entire portfolio is long term investments focused on growth.
He has an average home in an older neighbourhood and has lived there for more than 20 years. His family teases him about his 15-year-old Honda Civic, but he likes it.
Both Reg and Rich are in their mid-50s and appear to be doing fine financially. Reg has a newer home and much nicer car, but Rich has a calm confidence about him. The main difference is that Reg’s investments are $250,000, while Rich’s portfolio is over $5 million.
Think Like the Wealthy
The good news about this is that you can change the way you think about money. If being wealthy resulted from being lucky in how you were born, you would have no control. But since it is primarily a result of what you believe about money, it is within your control.
Here is how the wealthy think about money
Our experience is that the poor have most of their money in consumer items, such as a car. Middle class people have most of their money in their home or other real estate. Wealthy people have the bulk of their wealth in their business or in the stock market (many businesses). That is why they are wealthy.
Wealthy people are also usually prudent with their investments, but the big difference is that they save a lot and are focused on investments they expect to grow long term, instead of investments that fluctuate less short term. They tend to be confident in investments because they are optimistic about the future – not fearful and pessimistic about short term risk.
The reason they are multi-millionaires is that they have millions invested in their business or in the stock market. Wealthy people are wealthy because they are focused on building wealth. Specifically:
- They are usually frugal and good savers (not big spenders).
- They are focused on building their net worth (not paying off debt).
- They are generally optimistic about the future (not fearful and pessimistic).
- They are focused on long term wealth-building investments (not short term risk).
Learn to think like the wealthy and you can become one of them.
* Spectrum Group
“Disclaimer: Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Opinions expressed are the personal opinion of Ed Rempel.”
About the Author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching. If you would like to contact Ed, you can leave a comment in this post, or visit his website EdRempel.com. You can read his other articles here.
51 Comments, Comment or Ping
1. FrugalTrader
@Ed, great article, thank you. I’m not sure I agree with your 2nd sacred cow belief. I believe that most would benefit most from paying down debt as it offers a guaranteed return – a return that they would not likely get from the market. Most people simple do not know how to invest, or have the temperment to hold through the tough times – these people would likely outperform by paying down debt.
May 25th, 2011 at 9:47 am
2. The Investment Blogger
Great post topic! In regards to Sacred Cow #2 (It is most important to pay off debt), I think one a bit more elaboration may be needed. One of the keys to becoming wealthy is focusing on paying off BAD debts. These are debts that do not generate money (credit card, mortgage, car, etc.). The wealthy use reasonable (low) amounts of debt (and sometimes no debt) to help with business & investment. Extra cash saved from paying off bad debts can be used to pay off other non-cash generating debt such as the home, but also a portion would be used for investing & business.
I also notice the main difference between those that are and will become wealthy is what they feel are most important to them and their goals. They tend to see money not as a means to purchase more “things”, but a way to allow them to have a certain lifestyle and focus on what is important to them. For many, its doing whatever they choose each day, spending time with loved ones, etc. And in order to achieve this, while they are building wealth, they sacrifice material goods/luxuries until they can truly afford them.
May 25th, 2011 at 9:52 am
3. Steve
I am going to ring in here again with the 2nd Sacred Cow. Perhaps we misunderstand Ed but being focused on paying off debt is critical. I assumed he meant a focus on building wealth instead of paying off homes and CCs (paying off CC’s is a no brainer, you should have zero your whole life for that one!)
I have colleagues that I would call fairly money smart, and the bottom line is the ones who poured money into paying off their mortgage before redirecting those funds to investing have far more net worth then the ones that amortized their mortgages over long periods so they had more funds available for investing. Why? paying off the mortage was a guarenteed, high after-tax return. Most people can’t make a diverse portfolio outperform the net gains of paying off a mortgage.
I’d say that holding good debt (investment loans) while holding bad debt (everything else including principle residences and cars) is foolish, get rid of bad debt before you think about leveraged investing. Doing this will still get you rich with less risk early in your net worth building days.
Get to the ‘zero point’ as fast as you can, then spend the rest of your live building weath.
May 25th, 2011 at 10:09 am
4. My University Money
Excellent post Ed! I definitely agree with you. I had to laugh about your rule of thumb when pulling up to a house. I work as a school teacher, and if you could find a group that more perfectly subscribes to your “average” Canadian theory I’d like to see it. My co-workers spend what they have content in the knowledge that they have pension coming (we hope). They think that the defined benefit plan is the best thing in the world when in reality all it is, is the government forcing some fiscal discipline on you. Personally, the defined benefit plan frustrates me a little as I would rather have my own money in my investing hands.
In response to Steve’s comment above: Steve, despite what your anecdotal evidence might tell you, this just doesn’t make sense. Sure the mortgage paydown was guaranteed, but what was the overall return? Probably around 4-5%? The average stock market return over the last 200 years is over 10%, and even pessimistic predictors will use 8% as a benchmark. It’s just pure logic that your return would be higher looking at building wealth from day one. Of course the best method is the Smith Manoeuvre which I know Ed will get into!
May 25th, 2011 at 10:19 am
5. Dilbert789
To comment on the comments, #2 I think really depends. If you have a mortgage at 5+%, that’s like a stock market return of 8% after tax. So it might make sense to pay off the mortgage. However if you can borrow at 3%, you should be able to beat that with stock market returns. Therefore it would be better to invest. Every leveraged item should be looked at the same way.
May 25th, 2011 at 10:27 am
6. bubak
This article makes it clear why the big six banks are losing so much money. They put all of their capital into mortgages and loans at rates that will never make them rich. If instead they invested in random startups and rented out the basements of their branches, they would be raking in millions in profits.
May 25th, 2011 at 10:29 am
7. Millhouse
How is “millionaire” defined here? Someone with a net worth of a million bucks or someone with investable/liquid assets of a million? Is it family or individual?
With the 1 in 50 number, I can only assume that refers to liquid assets (since so many people are now real estate millionaires) of the individual. Almost 1 in 10 Canadian households are now RE millionaires.
Any comments or clarifcation?
May 25th, 2011 at 11:23 am
8. Jim Yih
Ed, I think your sacred cow number 1 was perfect. I see that myself.
Naturally sacred cow 2 is controversial. In my travels, I see the opposite. Wealthy people have less debt as opposed to more debt. I like Investment Blogger’s notion of good debt vs bad debt.
In terms of sacred cow number 3, I also think wealthy people respect and understand the importance of having GICs and safe investments in the portfolio. Although they have stocks and equities, they never expose themselves to too much risk.
Anyhow, I thought this was a great article!
Jim
May 25th, 2011 at 11:27 am
9. Dan
@6….while that made me laugh :), completely misplaced comment. The banks revenue models arent built around just mortgages and loans. One of the biggest cash grabs are from commercial loans, and consumer bank fees. Also, they are able to lend out 10 times the money they have in deposits. So if a bank has 100 dollars, they can lend out, 1000. So interestingly enough, the reason they are so sucessful is due to the fact they are able to leverage so heaviliy, amongst many other reasons.
The only stat i question in this article is that 1 out of 50 ppl is a millionaire. This of course has to include their primary residence. I work in an FI, and in a rich province at that, and i dont think one out of 50 ppl i see is a millionaire.
May 25th, 2011 at 11:49 am
10. Miss T@ Prairie Eco-Thrifter
Great post. I have seen all three of these in play numerous times. My hubby and I are surrounded by peers who are all about looking the part, #1. They want the big house, the fancy car, and the big trips. I must confess, I have sometimes felt the need to try to keep up with them.
When it comes to #2, this is something new to get my head around. It has been drilled into me to pay off debt and worry about networth later.
As for #3, yes, I too think the stock market is risky but I am working on getting better at taking some risks as I know this is the only way to get ahead.
May 25th, 2011 at 11:58 am
11. Mel
Great Post…!!!
I have been following your blog for a long time. Love all your articles for Canadian :)
BTW, You mentioned that 1 in 50 Canadians are Millionaire. May I know the avg. age of the Millionaires? I just want to know if I still have a chance to become one of them in the future :p
May 25th, 2011 at 12:41 pm
12. matt
I really enjoyed this….it all makes sense to me and I think I fall somewhere between 2 and 3. I do invest, but I am also very focused on paying off my mortgage, with the intent of taking the money going to my mortgage and investing that.
May 25th, 2011 at 1:10 pm
13. cannon_fodder
I see a lot of commonality between what I’ve seen and this article.
I don’t believe in the idea that if you just think of something you really want it will come to you. But, I do believe that if you think, and plan, and implement that you can achieve success.
One challenge I can imagine is when you have reached wealthy status, but in a quiet manner, those you’d like to help won’t believe you can afford it!
May 25th, 2011 at 1:52 pm
14. ITS
I found most of this article as how should I say this nicely “blowing hot air”…
Being wealthy is a completely relative concept, just like happiness. Whatever makes Ed happy wouldn’t necessary translate into a lesson in happiness.
So, I say. Pay down your debt, invest only in what you are comfortable with, as opposed to the stock market only bs, and enjoy life to the fullest.
May 25th, 2011 at 2:38 pm
15. Sarlock
#1 is the most important step, especially in the early parts of a journey to becoming a millionaire. If you are spending what you earn, you’ll never be able to grow your net worth and will be perpetually mired at roughly the same net worth the entire time.
My father, who is a millionaire, is a perfect example of someone that you’d never suspect was that wealthy: he lives in a small-ish house, drives a $20,000 car, wears clothes bought at a discount store, watches TV on an old 25 inch tube television (why buy a new one when the current one still works?) and scours the internet for good deals before buying anything. I plan to follow that example and so far it is working out well for me. My peace of mind is far more important than showing off to my friends and neighbours.
May 25th, 2011 at 2:51 pm
16. Ryan
Sacred cow might be better written that Millionaires are not afraid of debt. They understand how to make debt work for them, as contrasted with others who are afraid of debt, and therefore pay it down as quickly as possible and will not be comfortable using debt as tool to grow net worth.
Just a thought…
May 25th, 2011 at 3:29 pm
17. Be'en
Already 55 yrs old with 5 million dollars in net worth, and Rich still drivess a 15-year old car and lives in an “average” house? What’s 5 million dollars for then?
I am sure a lot of people who have paid off their houses and other debt are “calmly confident” about their future.
Trying to be wealthy for the sake of being wealthy? Doesn’t make much sense to me.
May 25th, 2011 at 6:45 pm
18. ITS
“Trying to be wealthy for the sake of being wealthy? Doesn’t make much sense to me.”
Very well put. I couldn’t have said it better myself!
May 25th, 2011 at 8:33 pm
19. Financial Success For Young Adults
It’s so true that the wealthy have a different mindset. I first read about this in the millionaire next door and I was honestly surprised. I started spotting more millionaires that were not flashy. I assume that if I see a mercedes benz or flashy jewelry, 9 times out of 10 it’s someone who is in over their head in debt.
May 25th, 2011 at 9:25 pm
20. Paul Meane
As a Financial Planner, I understand that you prefer that people pay you to invest their money instead of paying down their debts… but in a society where so many people have so much debt, it is very bad advice to give.
May 25th, 2011 at 9:29 pm
21. krantcents
Your description of wealthy people is not limited to a geographic area! Although I do not identify myself as wealthy, I have accomplished a sizable net worth. I have always been a saver, most of my net worth was in my business and now is in the stock market.
May 25th, 2011 at 10:36 pm
22. Ed Rempel
Hi FT & many others,
So #2 about paying off debt is a surprise? The key point here is that paying down debt is not usually the main FOCUS of the wealthy. The main focus is building wealth.
The debt is not the issue. The wealthy tend to be utilitarian about debt. If debt helps them build wealth, then borrowing is good. If it is a drag, pay it off.
For example, many wealthy people own a business and will borrow a lot to build their business. We often hear them say something like: “I can borrow at 4% and I’m making 15% on my money in my business.”
Debt is also usually not the main issue. For example, in the US, 90% of the millionaires still have a mortgage. They could pay it off today, but they don’t. Why not? It is not important enough to them. Their mortgage is at 3% and is tax deductible, so paying it off is not priority. They have better uses for their money that can build wealth faster.
Of course, they will pay down debt. They keep their debt payments under control and keep enough “powder dry” so that they have access to cash for emergencies or great opportunities.
Debt is managed, but paying it to zero is not their main FOCUS.
Ed
May 25th, 2011 at 11:09 pm
23. Ed Rempel
Hi Steve,
I don’t know about your colleagues, but our experience is the opposite of yours. The people that focus on paying off their mortgage tend to adjust their lifestyle and have a few great years after the mortgage is paid off and before they retire. However, they have little wealth and often are making massive cutbacks when they retire.
They may look like they have a lot of money once the mortgage is paid off, but they have not invested much over the years.
In fact, when people ask us if it is better to pay off the mortgage or invest, the main question we ask is: “Once the mortgage is paid off, what percent of the mortgage payment will you invest?” If the answer is less than 90%, then focusing on paying off the mortgage just leads to spending – not more saving.
When we do projections, the “percent of the mortgage payment that will be invested” is the most important factor.
Very often, paying off debt is a sign of fear of investing. People are afraid of investing and the stock market, so they focus on paying off debt. Once it is paid off, they are still scared to invest, so they spend. Then they retire – and obviously they have small portfolios invested conservatively.
In contrast, the people that focus on investing earlier give their investments a long time to work. Plus, they always have payments through their life, so they are never tempted to increase their lifestyle for a few years before they retire.
We find the people that focus on investing early tend to have portfolios many times higher than those that focused on paying off the mortgage.
The big issue here is that most Canadians spend the bulk of their working like focused on paying off their mortgage and other debt. That is their main focus. It gives them a secure position while they are working, but of course, that it not the road to building wealth.
Ed
May 25th, 2011 at 11:22 pm
24. Ed Rempel
Hi Millhouse,
The 1 in 13 millionaires in the US refers to net worth. About 2/3 of them have investable assets (excluding real estate) of more than $1 million, as well.
The stats for the US are:
Net worth over $1 million
May 25th, 2011 at 11:59 pm
25. Ed Rempel
Hi Millhouse,
The 1 in 13 millionaires in the US refers to net worth. About 2/3 of them have investable assets (excluding real estate) of more than $1 million, as well.
The stats for the US are:
Net worth over $1 million 1 in 13
Investable assets over $1 million 1 in 20
You are right that my figures for Canada may be outdated, Millhouse. I’ve been using figures from Wikipedia showing 251,300 millionaire households in Canada (1 in 50) in 2009. But the Deloitte Centre for Financial Services shows 1,745,000 millionaire households (1 in 8) in 2011. Canada used to have a lot fewer millionaires than the US proportionately, but we had a huge surge in the last decade. We have more than 4 times as many millionaires vs 10 years ago.
There is a big difference between wealthy and millionaires, though. People with a paid off $1 million home and no investments are obviously not wealthy.
In determining the wealthy, for this article, we are referring to people with high investable assets. In fact, we find that normally $2 million is where the lifestyle can start to change significantly.
We think of $2-5 million investable assets as “beer and pretzels millionaires” and over $5 million as “wine and cheese millionaires”. This is based on the lifestyle you can afford for the rest of your life.
Ed
May 26th, 2011 at 12:22 am
26. Ed Rempel
HI Be’en and ITS,
I guess you are in the “spend a million” group, not the “have a million” group?
It may seem pointless to you to have wealth, but there is a feeling of confidence and security that comes from knowing you will always have enough money and knowing you can afford whatever you want.
Most people without wealth end up worrying about money a lot, especially when they get closer to and into retirement.
In fact, when we do custom retirement plans for our clients, we find that most of them will need between $1-2 million in investments when they retire. This is future dollars, which would be worth about 1/2 of what it is today.
My point is that having $1-2 million in investments is not wealthy. It is about having a reasonably comfortable retirement, and it is about security and confidence.
Ed
May 26th, 2011 at 12:38 am
27. donald
Great article,thank-you for sharing!
May 26th, 2011 at 2:24 am
28. Andrew
Hey based on this article I’ve decided to stop paying off my mortgage.
Instead I’m going to put all of our savings into the stock market. Does anyone know a good financial planner?
May 26th, 2011 at 9:25 am
29. Steve
Hi Ed, thanks for your response!
I guess I should clarify who I include/exclude by ‘money-smart’. I do also have colleagues who rush to pay off their mortgage so they can afford vacations, cars and toys. They are NOT money-smart. And as you suggest, I am not looking at the appearance of wealth, I’m talking about actual investment assets.
I have a few colleagues that paid off their primary residence before 35, then re-invested nearly 100% of those payments into investing for the next 10 years. They are money-smart.
I’m contrasting this with other colleagues who are on track to pay off their mortgage by 45 or 50, and instead of been investing the balance over the years. They are also money-smart.
These individuals all have marginal rates at 44% and up. As noted above, my observations are anecdotal, but the people who relentlessly eliminated all bad debt (including home) as fast as possible actually seem to have higher networth at 45. Not because the numbers say so, because human behaviour seems to say so.
I’ve also noticed that those that paid off the house and cars first, then invested usually refer to those things as ‘depreciating liabilities’ rather than assets. Those that still have mortgages and car loans seem to consider those a big part of their networth.
Once again, attitude and behavior, not numbers seems to make a difference.
May 26th, 2011 at 10:19 am
30. Freedom 40
@ Ed….
Interesting read. Trying to figure out where I fit. Currently have approx $250k in investable assets and $200-250k in equity in my home. 34 years old. Continuously having to convince myself not to pay down my mortgage (at prime – 0.75), but really hate debt. I could probably pay off my mortgage with about $125k in non-reg (dividend yielding) assets……should I? I am the type that will be disciplined with my savings after mortgage is paid (i.e. 100% of mortgage payments would convert to savings). Am I a typical Canadian?
May 26th, 2011 at 3:30 pm
31. Beer and Cheese Man
I’m working on mortgage payments for the following two reasons:
1) The average stock market return is dependent on many things – the timeline that you look at, the types of stocks that you hold, fees, dividends, etc.
2) Mortgage interest in Canada is non-deductible. (I’m too lazy to implement a Canadian-style Smith Manoeuvre.)
Once the mortgage is paid off, we will be putting 100% of that into investments.
That said, I’m just as happy with “beer and pretzels” as I am with “wine and cheese”. :-)
May 26th, 2011 at 5:43 pm
32. Bob
Kind of a misleading article.
The Wealthy can afford to be utilitarian about debt, because if that investment goes sour, they still have a place to live. The Middle & Lower classes don’t have that luxury.
The real test would look at how currently Wealthy individuals dealt with their money before they were wealthy.
And this is where Ed’s article is partially right — the best way to become a millionaire is to start a business. But (and this is where Ed’s article is misleading), I’m very skeptical that when people are borrowing money to start a business they are thinking about the debt in terms of “building their net worth”. They are thinking about that debt in terms of building up a business. It is only when you have lots of money to play with (i.e., you are already Wealthy) that the mindset changes from using debt to buy things (including “good things” like the materials to build a business) to using debt to simply make money.
Implying that lower/middle class Canadians should adopt a “use debt to make money” mindset and that to become a millionaire they should borrow to invest in equities is ridiculous.
May 26th, 2011 at 6:23 pm
33. Bob
Let’s also not forget that there is a bit of sample bias here, too. By discussing the traits of “The Wealthy”, we forget that there are lots of other people who had the same traits and tried the same strategies, but failed – sometimes catastrophically.
After all, fewer than half of new businesses last longer than 3 years, and how many lower/middle-class folks are actually capable of using leveraged investing as a reliable income stream/capital growth strategy?
May 26th, 2011 at 10:39 pm
34. Jungle
Ed great article.
Bob if you are looking to see what the wealthy did before they were rich, read The Millionaire Next Door-great book if you have not read it already.
I think some posters implied that Ed was saying to leave debt alone. I think he’s referring to what is known as “good debt.” (ie mortgage and investment debt) With the interest rates today and people that have the minus prime rates, I agree that paying down the mortgage seems kind of silly.
I agree with what other posters said, saying that the money psychology will get most people during investing and paying off the mortgage will defeat this. But the house will not pay income for retirement. (Unless you have renters..)
I agree with Ed in that people are scared of the stock market. I am scared of the stock market today. For example, I was having great difficulty aligning my allocation (or lack thereof) and I am deciding on what to do some extra cash from first and last rental income..put it in TFSA or pay down mortgage? Paying down the mortgage is easy, but I know that putting it in TFSA can grow as well. Just in the short term you can not expect to see magical results with they I prefer to invest (index), but they come after 20-30 years.
May 26th, 2011 at 10:56 pm
35. Bob
Jungle,
I’ve read the book. Ed’s article is essentially just an abstract of the book’s back cover.
But, my second point applies to The Millionaire Next Door.
“Nassim Nicholas Taleb [author of The Black Swan]criticised the premise of the book on the basis of two instances of survivorship bias: that there is no mention of the accumulators who have accumulated underperforming assets, and that the United States had just gone through the greatest bull market in its history at the time of the book’s publication. He suggested that the authors should lower the net worth of the observed millionaires to compensate for the effect of the unobserved losers, and to consider the fate of accumulators following prolonged periods of recession such as in 1982 or 1935.[7]“
May 27th, 2011 at 1:25 am
36. Glenn Cooke
Ed, you can tell us. But we will.not.listen. :)
May 27th, 2011 at 10:56 am
37. Sarlock
Re Debt:
I run a business and continually keep it fairly in debt because of the leverage advantage it offers me. This is the same with most savvy business owners.
If, in an average year, I can earn $100k after-tax profits on $2mm in sales, that gives me a 5% profit margin.
Now compare these two scenarios:
The company requires $1mm in equity+debt to function.
Scenario A: All $1mm is my own money and the company has no debt. Peace of mind, right? $100k/year on $1mm equity yields a 10% return.
Scenario B: $500k in my own money and a $500k loan from the bank at 4%. This reduces profits to $80k/year due to the $20k/year interest expense. Now I earn $80k/year on $500k equity. Aha! That’s a 16% return.
Additionally, I have $500k in funds personally that I didn’t have to invest in the business and can invest that in my own portfolio.
Further, if something happens to the company and it goes under (things happen), in Scenario A I lose $1mm in invested equity. In Scenario B, however, the bank takes half the hit and I only lose $500k (assuming I didn’t sign a personal guarantee for the company).
This, in a nutshell, is why debt isn’t a bad thing with companies. You won’t find many larger companies that don’t have debt on their balance sheets for this reason. You want to keep a reasonable amount of leverage there to boost your returns.
Why do banks happily invest at 4%? Because they can borrow the money at nearly 0% and enjoy a 10:1 leverage ratio. They don’t need to chase yield because they already have a sweet arrangement.
May 27th, 2011 at 12:58 pm
38. Bob
Sarlock
Right, it often makes sense for businesses, but this is not quite the same as for personal income (bankruptcy rules differ with corporations, etc.). But, again, this type of thinking is really only possible for non-business applications once you have the 1 million dollars to play with. Ed makes it sound like this sort of leveraging is something lower/middle class individuals should be doing. Having 1 million in cash to play with hardly qualifies as that sort of scenario.
If, instead of 1 million, the person only had 100,000 to their name, would you still advise leveraging half of their net worth and investing it in the stock market?
May 27th, 2011 at 4:37 pm
39. Hopper
Hi Ed,
Overall you have great advice. Generally similar to ‘Rich Dad Poor Dad”.
One thing to add is that the average person is likely an employee, not a business owner. While the average millionaire likely is a business owner.
As an employee, one is more limited and taxed higher. That leads to investing in stocks, which un-experienced and un trained people usually don’t make their 10% a year. Also now all the eggs are in the “stock market” basket.
May 27th, 2011 at 5:25 pm
40. Andrew2
Dan and Sarlock, can you explain how Canadian Banks can leverage 10:1 on deposits. From my understanding, this is only true for US banks because of their Reserve Requirement. Canadian banks have no legislated Reserve Requirement. They have Capital Requirements but this doesn’t tie their lending to their deposits directly.
As for owning businesses, the wealthy people I know do not have much invested in the public stock market. Most of their investments are in private stocks that they either sell to other individuals, other private and/or public companies, or the public stock market upon IPO, or hold onto because the companies they own are profitable and pay out good dividends.
Most of these individuals prefer spending effort maximizing tax sheltering over borrowing money to invest, although they will borrow the money to invest if they see that a reasonable return on that money is highly likely. Also, many companies have short term cash flow requirements that require borrowing to cover. Many of these individuals actually loan money to their own companies at interest instead of going to banks or other investors.
Most of these individuals own holding companies to hold their investments because there are tax advantages (dividend transfers between companies aren’t taxed), and many own holding companies in foreign countries to take advantage of the tax breaks given there so they can reinvest more of their profits to make more profits. The tax hit comes at the end when they need to withdraw money from the company to spend. It is similar to the concept of an RRSP.
Tax sheltering makes sense because even when you are taxed at 50% of your capital gain, that is a minimum savings of 7.5% on income at the minimum tax bracket of 15% that can be reinvested.
May 28th, 2011 at 12:58 pm
41. Mark
Great article – I totally agree that nobody gets rich spending money and too many people don’t realize this.
However, I have a philosophical difference of opinion with respect to investing and debt.
1) Investments (in stocks or a business): The rich got rich investing and/or building a business. However, how many people out there invest and end up losing money? Look at average investor returns compared to the index and you’ll see that most dramatically underperform (because of too-frequent trading, etc.). And how many businesses fail each year? There’s a potential survivorship bias in saying that the way to get rich is by investing because that’s what the rich do. I think the question should be changed from “do the rich invest” to “can you get rich by investing”.
2) Debt: Some forms of debt is good. And those that successfully lever their way to success will end up very rich. However, for every successful leverage story, how many failures are there? Yes, many rich levered their way to prosperity, but going into debt to invest or build a business won’t make you rich, given the average underperformance and failure rates.
Here’s my other problem with debt – it leaves you very vulnerable. Vulnerable to asset price fluctuations (which can quickly leave a leveraged position underwater), vulnerable to the whims of creditors which have their own agendas, and vulnerable to changes in the cost of borrowing.
May 28th, 2011 at 2:42 pm
42. Ann G.
Thanks for the great post. There are always thing to be learned by taking a look at those that are successful
May 31st, 2011 at 12:33 pm
43. cannon_fodder
I know I’m not typical when it comes to my philosophy about investing, debt and leverage.
For me, paying down my mortgage aggressively replaced the need to invest in bonds and other fixed income investments. It was far better (return vs risk) than any bond fund or fixed income fund I could buy.
We had two years where we not only could maximize contributions to RRSPs and RESPs, but also maximize mortgage prepayments. Not long after that our unyielding focus on not spending raises/bonuses proved to be very fortunate.
Since my wife and I are not conspicuous consumers, we would always take care of debt repayment (the mortgage was are only debt) and investing for retirement.
But when we found out about the Smith Manoeuvre it was the perfect opportunity for us to have our cake and eat it, too. The amount of equity we had built up (due to those years of massive prepayments and increases in our periodic payments) allowed us to jump start a non-registered portfolio just before the big meltdown (but close enough to be able to pick up stocks that had been battered a bit).
We embraced the use of “good debt” to create an investment portfolio that would hasten our journey to financial independence. Less than three years later the SM portfolio is 3x the SM HELOC, the SM portfolio dividend payments are 2x the SM HELOC costs, the mortgage is retired and financial independence came 10+ years sooner.
Personally, I think it is harder to save your way to wealth than it is to invest your way to health. And just because a lot of people make poor investment choices doesn’t mean that it jis a flawed concept.
We now have more debt than at any time in our lives yet we are more financially well off than at any time in our lives. It doesn’t have to be a contradiction.
May 31st, 2011 at 10:05 pm
44. WittyArtist
Excellent post! :) I loved it, especially the story with Reg and Rich. Now I realize that the wealthy people I know don’t like to show off; they don’t display expensive jewelery, clothes etc. And if I think of those glittering and bragging one can see the spender there. I’m really amazed by your remarks:) Another thing I liked very much was the emphasis laid on our thinking. If we think small of money or even fear it, it’s no wonder it won’t come to us. On the contrary, if we are open, optimistic and relaxed, sky’s the limit. Congrats for your way of writing! :)
June 2nd, 2011 at 7:16 am
45. Jungle
I think we need to increase our income and lever quite a bit to gain some wealth fast (like 15 years). Problem is, housing is so expensive in Toronto and we need an upsize and face some lifestyle inflation.
Next year we should be able to lower our mortgage rates and I will not be using extra cash flow to pay down 3-4% mortgage. The TSX comp pays more than half of that in dividends right now.
June 2nd, 2011 at 7:41 am
46. Ginger
I like this article, but part of the reason for that is I am doing what I am suppose to according to this article. I am investing, paying minimums on my “good” debt and increasing my net worth. I have debt but it does not affect my life much and by having the debt I was able to buy a duplex which doubles as both a rental and my primary home.
June 13th, 2011 at 1:22 am
47. Sal
“Middle class people have most of their money in their home or other real estate.”
Tons of people have become rich by investing in real estate. I agree that the middle class have most of their money in THEIR home, but many wealthy people have the majority of their investments in real estate, which also provides them monthly rental income which they can further invest.
July 18th, 2011 at 9:25 pm
48. Ed Rempel
Hi Sal,
The people that become rich investing in real estate are generally rich only “by middle class standards”. A recent survey showed that, for people with a net worth over $5 million, on average they have only 22% of their net worth in residential real estate of any kind.
Wealthy people all made it there by investing in companies – either their own or the stock market. Some of them invested in real estate companies (13% of the Forbes 400), but these are mostly commercial or development, more often than residential.
Real estate usually grows very slowly (1/6 of the stock market growth in the last 30 years) and requires a lot of manual work (we call it a PITA factor). We have done retirement plans for thousands of people and usually find that retiring with rental properties requires a far higher net worth than with other investments. For example, you would probably need $5-10 million in real estate to give you a retirement lifestyle similar to $1.5 – 2 million invested in the stock market.
That is why we think of real estate as the middle class asset. Even having $5-10 million in residential real estate probably means you are still middle class, since your income will still not be extremely high. Most people with multiple rental properties are essentially DIYers, spending a lot of time doing repairs and collecting rent. Do you know people with rental properties that are living a luxurious life?
You will find the odd exception, but we find people that are impressed by real estate are middle class. Wealthy people are usually more impressed with large stock market portfolios – and particularly with philanthropy.
Ed
August 15th, 2011 at 12:46 am
49. Amy
I do not know what the point of the Story of Reg and Rich is. The fact is that having credit card debt is BAD debt to have. Reg should be focused on paying off his credit card. To me it looks like he spent money he did not have, so now he has credit card debt. That is NOT how you become wealthy. Borrowing money to invest is better as long as the asset grows. Borrowing money on assets that lose value over time like cars and sometimes real estate like the us housing market is not a good investment. On the other hand buy a house and renting the basement out is a good idea, let someone else pay the mortgage.Rig parents should have told him not to get into credit card debt, not smart.
October 14th, 2011 at 5:24 am
50. SST
@Ed: “In Canada, about 1 person in 50 is a millionaire and in the US about 1 person in 13 is millionaire* – which is probably a lot more than you thought.”
Actually, it’s a LOT less than that.
When you factor out ‘primary residence’ from net worth, the millionaire rate drops to just 0.8% in Canada (1 in 125), and 1% in the US (1 in 100).
October 14th, 2011 at 11:27 am
51. Ed Rempel
Hi Amy,
Perhaps I did not explain it clearly enough. The point of the story of Reg and Rich is that Reg only focused on paying off debt and never built any wealth.
We actually see people in that situation a lot. They spend most of their working life paying off their debt and their mortgage. This often gets them well into their 50s with a paid off house, but still little in investments. This means their retirement plan is a major compromise.
We have also seen people that ran into debt problems, but then turned their life around and managed to pay off their debt. However, after that, they were unable to change their mindset to start investing. Ten years after paying off their debt, they still had hardly any wealth.
The big mistake many Canadians make is that they try to become financially secure by paying off debt and investing very conservatively. However, they end up just having very little money to fall back on and a compromised retirement.
Real financial security comes from having a huge nest egg. That is what Rich did.
How would you feel if you had a portfolio of $2 million in the stock market?
- Nervous because you have $2 million in the stock market. OR
- Secure because you have $2 million in the stock market?
It may feel risky to have a lot of money invested, but that is what real financial security is. You can rely on this portfolio for cash needs and to provide income for your future.
That is why Rich was more secure than Reg.
Does that explain the story better, Amy?
Ed
July 21st, 2012 at 2:01 am
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