Building wealth

A big house in Los Angeles.

A big house in Los Angeles.

Millennials aren’t thinking enough about savings and retirement. Articles like this one focus on how fads like ‘avocado toast’ are to blame — my generation loves luxury and living on credit, opposed to stowing away their hard-earned cash.

‘Cash under the mattress’ isn’t the way, however, to build wealth. Instead, many people look to investment vehicles such as real estate and the stock market. This post challenges that idea — I think that in order to build wealth, I need to do one thing well: focus on high-leverage activities that use my skill sets. This article will review my mindset, why I don’t believe in traditional ways of building wealth, and my hunch on why building a business is the best way to do so.

Immigrant mentality

Well, not exactly. I was born in raised in Mississauga, ON (Canada, for all my ‘Murican readers), although both my parents immigrated to Canada as young adults. I won’t go into detail (some background in this post), but I was raised in a pretty frugal household. Lifestyle aside, this shaped my mentality towards money — both the need to conserve it and the drive to earn it.

My parents grinded to be able to raise my brother and I in a financially stable household. Credit card debt, mortgages, and car payments were foreign to me, as my parents prioritized paying everything off ASAP. This was for better and for worse — money (while not abundant) was never a dinner table conversation, however I didn’t learn how to leverage debt.

Our family got burned, like many others did, with our investments (mutual funds) by the 07-08 financial crisis. The only investment vehicle I knew growing up was a Guaranteed Investment Certificate (GIC) account, which typically returns 2% to 3% annually. Put your money in, lock it up for 1-3 years, and forget about it. When starting college, I ventured into the stock market and made some great gains on Shopify, Amazon, and Square (more here). Hurray!

My mindset has changed in recent years. In my opinion, my parents worked hard to allow my brother and I to take risks. I’m fine with calling it ‘privilege’, because in many elements, that’s what it is (earned or not). I don’t have a family to support, wife/kids, or hold much debt (student or otherwise). Hence, I should be open to taking risks in my financial planning, and ‘wealth building’.

My privileged position to take risks means that reasonable gains (i.e. S&P grows 8% annually according to Investopedia) are insufficient. Due to my Type A / Alpha personality, my goal in life is to 10x or 30x the wealth of my parents. Is that possible using traditional investment vehicles?

Real estate, stocks, and ‘traditional investing’

Well, let’s find out! And by that, I mean let’s do some back-of-the-envelope math that explains my thinking. Disclaimer: I’m a Political Science graduate, so this math is far from foolproof. In fact, it may even be foolhardy. If that’s the case, please send me a message before my mom sees this, so I can fix it :)

Base scenario (income)

To make things easier, I’ll set up an example: let’s say my parents have built a net worth of $1MM CAD. My goal, therefore, would be to build a net worth of $10MM CAD or $30MM CAD. To further simplify this, I’m going to lean on a 10-year projection. Keep in mind, the goal of this section is to set up a base scenario, not to be exact with what I would earn (without ‘investing’).

The average business graduate makes around $70k CAD per year, but for argument sake, let’s bump that to $85k CAD. Post tax, this would leave me with around $63k CAD of disposable income (calculated here). I’ll set some parameters below on what my annual expenses might look like:

  • Rent: $12,756 ($1,063 / mo average)

  • Food: $3,396 ($283 / mo average)

  • Entertainment: $5,340 ($445 / mo average)

  • Insurance: $2,722 (quote from AllState on my 2010 Lincoln MKX)

  • Misc: $1,380 ($65 for phone, $50 for gym average)

A total of $25,594 of expenses; leaving me with $37,406 of disposable income. Again, being pretty conservative here — no vacations, buying clothes, etc. The challenge now is to project what my income would be like after 10 years. After some limited Googling, I found some ways to project this…

5 years out — The typical route for many business graduates is an MBA around ~ 2 years in. The MBA takes 2 years to complete, which means my approximate salary (5 years in) would be that of an MBA graduate. Attending a good MBA program means an average salary of $103,024 (see here); to give the same boost I did post-undergrad, let’s go with $125k, or $86,585 post-tax. Minus the same expenses (would likely go up, but for argument’s sake), $60,991 left in Year 5. Again, I’m assuming I’m earning $$ while I’m doing my MBA (usually not true), but bear with me.

10 years out — this one was a lot harder. I’m still on Google (cutting into my Netflix time…), and found a few answers. This Quora article projected average increase in salary, but was somewhat aggressive. I altered it using this Global News article, using a 7% increase for pay raise, 12% for promotion, and 20% for job-switching (aggressive). Using these projections, and a flat rate of expenses, I would make $105,111 post-tax & expenses in year 10.

Option #1 — Investing in stocks

To be realistic (and honestly I did this after calculating the first time), no one invests ALL of their disposable income. It is recommended that you save 20% of your income for a rainy day, or externalities (illness, vacations, etc.). So, I redid the calculations to factor that in (see here)

Using the S&P annual return rate of 8%, and compounding it (I think that’s the word) over a 10-year period, I would have amassed $788,114. This is pretty solid; just by investing and matching the market, I would have saved around ~ 17% more than if I just kept my money in the bank. However, it doesn’t match my optimistic goals — I wouldn’t have even 1x’d my parents’ wealth, 10 years into my career (WITH an MBA). Furthermore, I’m not considering that I would pay tax on the investments I’m making (TFSA contribution maxes at $6k per year).

Counter point: Wouldn’t this compound for the remainder of my 35-year career? For kicks, I calculated that at 8% annual return. I would be left with just over $11.6MM at the age of ~ 67. This assumes I never buy a home, have kids, go on vacations, increase my expenses (since the age of 22…), and invest ALL of my disposable income into the stock market.

Option #2 — Investing in real estate

Most people want to own a home at some point in their life. However, does it make a good investment? Traditional logic says yes — the value of property increases year-over-year, not to mention the rental income that you can make off of it. It does come with a mortgage and down-payment, but you would supposedly surpass that through your capital gains, right?

Time to find out! I have even less knowledge about real estate than stocks, so once again, I’m trusting Google to guide me through it. There are a TON of factors to consider — what type of home am I buying? Is it a condo, detached home, etc.? How many bedrooms?

For the sake of this scenario, I’m going to go with a 2-bedroom, 2-bath condo in Toronto that I can rent out to (2) people each month. According to the Financial Post, this would cost me $558,000 in 2018. Let’s see how that adds up:

Down-payment: $111,600 (20% of the total), which I should have by Years 2-3 in my income projections. So, I’ll assume I’m not investing my first 2 years of income, and be able to make the purchase in Year 3.

Counter point: My parents could co-sign a condo for me, and this would allow me to make the downpayment immediately, paying them interest + only having the cost of the mortgage. I’m not including my parents’ in this model, aside from in my investment motivations, to make matters simpler.

Awesome, I’m a home-owner! And real estate always increases in value, right? Historically, yes — the National Association of Realtors (USA) says it increased by an average of 5.4% from 1968 to 2009. An 8-year projection from 2008 to 2016 saw GTA home prices increase by a whopping 63% (see here). And, if we look at just 2017 to 2018, it only increased by 1.8% in the GTA (see here). So, for the sake of this argument, let’s just use historical price increases — 1.9% annual increase, from 1982 to 2019 (see here). My condo would be worth $636,580 by Year 10.

Counter point: I’m investing in real estate because of the exploding value, what if it keeps going up? Using the 63% growth mentioned above, the condo would be worth $958,440 by Year 10. Keep this in mind!

Mortgage: $28,512 per year ($2,376 per month, according to the same article)

To avoid over-complicating things, I’m going to assume that I do not live in my condo and keep the same level of expenses. This allows me to rent out the entire property, treating it as a true investment vehicle. See below:

Rental Income: $33,732 per year ($2,811 per month, according to this article)

Net-net, I would walk away each year with $5,220 in rental income. Not bad, especially if my post-tax salary in Year 3 is $50,128. Over the span of 10 years, my condo would appreciate an additional $78,580, which is $7,858 per year. So is it fair to say that I’ll make $13,078 per year?

At minimum. This starts at Year 3, and there’s a high likelihood that I will make enough money to purchase additional properties in the span of the 10 years. I tried estimating this, assuming I could purchase a new condo of the same value every ~ 2 years, and make rental income throughout. I would have amassed close to $3MM in property value, and $120,060 in rental income over the 10 year period.

From what I can tell, investing in real estate is a lot more lucrative than putting your money into an index fund. Hiring a property manager (6% of rent; $2,023 per year) means it’s not time-consuming either. Even with maintenance fees, the property value alone is hitting 3x of my parents’ wealth in a 10-year span. This looks like the best option so far.

Remember I said to keep the 63% growth rate in mind? Looks like it would be $3.7MM instead of $3MM, when applied to the same scenario (calculated here).

Option #3 — Investing in… Business?

Okay time for some heavy personal bias, but you’re on my blog, so you signed up for that! I think both stocks and real estate are boring. It’s a way to hold a 9-5 and make ‘passive’ income, in a way that is glorified by the 4-hour Work Week and envied by those who are married to their job. It’s not for me, however, the highest leverage way to build wealth .

The barriers to buying a stock or buying a property are very low. You don’t need operational knowledge for the renting (property management). ‘The market’ and its consistent returns are open to everyone. My dad, who was a mechanic his whole life, trades Shopify in 5-10 day windows, and has 2x’d to 3x’d his retirement savings in the past few years (more on this in a future post).

High leverage activities are ones that make the most of your skill set, and the time you allocate to them. I’m a marketer, which means I have a pretty good understanding of how to ‘grow’ products — direct-to-consumer brands, B2B or B2C software, etc. Should my goal of building wealth not align with the career that I’m building?

I would argue yes. That’s why I signed up for this Micro PE course, that walks you through the nitty gritty of buying a business — including outreach, contract templates, getting financial leverage (read: not your typical mortgage), growing the business, and switching from ‘active’ to ‘passive’ investing.

In the first few videos/lessons, one thing stands out — someone who starts a business needs to figure out product, customers, and make revenue. By buying a business, you already have guaranteed demand, sustain the payback period (i.e. $2k monthly revenue, even if you don’t grow), and get the years of training + labour for free. The challenge? Finding businesses that don’t need daily nurturing (time-intensive), or are already producing high yield due to a good founder (expensive to buy).

Over the next 2-3 weeks, I’ll be completing the Micro PE Course, and I’ll write a review on this blog. Sign up here to take the course with me, or wait until after my review to make your decision. I’ll also be sharing the growth tactics + internal conversations that I have when going through this process — the same one I apply with Abacus Growth, helping companies like Atmosphere, Walden, and PolicyMe.

Will this really deliver more ROI than investing in stocks or real estate? TBD, but I’m excited to find out. Subscribe to my blog for updates!

More disclaimers: Obviously, this post did not delve into the particulars of stocks & real estate, but I hope it did walk you through how I think about them. You can make 150% a year trading stocks, or several millions by ‘flipping’ houses. While I may incorporate those in my wealth building strategy, that isn’t the game I’m trying to play :)