Wealth Planning

5 Strategies the Wealthy Use to Grow their Fortunes

By
Dominion
Updated:
May 13, 2024
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8 min read
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We often attribute the immense wealth of ultra-high net-worth individuals (UHNWIs) to luck, windfalls, or massive inheritances. However, while these factors can certainly play a role, they don’t tell the whole story.

Many UHNWIs are strategic and practical. They’ve harnessed specific methods to protect and significantly grow their fortunes. Even better, these strategies aren’t exclusive to the uber-wealthy. Individuals at any financial level can adopt and benefit from these same wealth-building principles. So, with that in mind, let’s explore actionable strategies the wealthy use to fuel their financial success.

Strategy 1: Take Control of Taxes

One of the most significant ways UHNWIs set themselves apart is their focus on minimizing their tax burden – always within the bounds of the law. Reducing taxes frees up a greater percentage of their income for strategic investments. They understand the crucial distinction between your W-2 income and building your balance sheet:

  • W-2 Income: Wages, salary, and income earned from your 9-to-5 job are taxed, often heavily. Building wealth purely from your job without strategic tax tactics will make that climb toward financial security feel even steeper.
  • Balance Sheet: Your balance sheet comprises all your assets and liabilities, essentially showing your net worth. Focusing on expanding your balance sheet means putting your money into assets that increase in value (appreciation) or produce additional income (cash flow).

How does that look in practice? Let’s compare two wealth-building scenarios:

  • Traditional Salary: You land a $100,000-a-year job. After taxes, you might be bringing home closer to $65,000. That money fuels your lifestyle. With smart budgeting, maybe you have some left over for savings or stocks. This growth trajectory is more linear and slow-paced.
  • Building Your Balance Sheet: That same $100,000 is used as a down payment on a rental property. The mortgage, maintenance, and property taxes are offset by rental income, and you enjoy long-term appreciation in the property’s value. These kinds of assets often come with significant tax advantages, as well.

The second scenario builds your balance sheet in a tax-advantaged way, while the first focuses primarily on wage income. It’s about strategically shifting focus from seeing money primarily as something you use to fund your lifestyle to something you put to work to create more wealth.

Strategy 2: Master Changes in the Economy

The world of finance is filled with constant buzz and short-term market fluctuations. These daily ups and downs, fueled by everything from earnings reports to global news, create a lot of noise. Successful investors, particularly UHNWIs, look beyond this noise and focus instead on shifts or changes in the economy.

These shifts refer to the underlying, deep-rooted trends driving the larger economic landscape over long periods of time. They’re different from temporary market jumps and dips. The latter are underlying currents, whereas short-term fluctuations make waves. They are affected by the shifts but more erratic and unpredictable.

Some examples of economic shifts include:

  • Inflation: The persistent rise in the price of goods and services over time.
  • Unemployment Levels: Long-term trends in unemployment rates affecting labor and overall markets.
  • Consumer and Business Sentiment: The underlying confidence levels consumers and businesses feel about the direction of the economy.
  • Housing Supply and Demand: Imbalances here can impact real estate price growth and other sectors.

Understanding where these shifts are coming from is crucial for solid long-term investments. They give us a map to assess investments with more insight and less knee-jerk reaction to temporary market events.

Strategy 3: Consider Investing in Alternatives

Most typical investors favor a simple mix of stocks and bonds. UHNWIs, however, recognize the power of alternative investments. “Alternatives” encompasses investments outside those traditional asset classes, including:

  • Real Estate: Properties (commercial, residential, land)
  • Private Equity: Investing in privately held companies or ventures
  • Hedge Funds: More complex funds aimed at mitigating risk and outperforming markets
  • Commodities: Physical assets (precious metals, oil, agricultural products)
  • Collectibles: These can include high-end art, rare wine, etc.

You might be asking why you should consider alternatives. Importantly, they offer several advantages. These include:

  • Diversification: Alternatives often have a low correlation with traditional markets, spreading your risk.
  • Potential for Higher Returns: Historically, some alternatives have shown stronger returns than the classic mix of stocks and bonds.
  • Less Volatility: While not without risk, alternative classes are sometimes insulated from the intense upswings and downswings common in public markets.

Of course, due diligence and understanding of these alternatives are key. But they explain why you’ll see wealthy investors allocate a much bigger portion of their wealth toward alternatives – often upwards of 50% – compared to the average investor, whose alternative holdings rarely surpass 5%.

Strategy 4: Use Debt as a Strategic Tool

Many of us hear the word “debt” and see it as the enemy of financial stability. We’re taught to save and only buy what we can afford to pay for in full. While avoiding frivolous and high-interest debt is sound advice, the wealthy view debt differently. They understand the power of “leverage” – using borrowed money to increase investment potential.

Let’s use an example to see what this might look like in action:

  • Using Cash Only: You have $100,000 saved to purchase a rental property outright. Your return on investment is tied directly to the performance of that single property.
  • Utilizing Leverage: Instead, you take out a mortgage on that same $100,000 property. A significant part of your purchase costs is financed by borrowed money. You might need to make monthly mortgage payments, but your actual cash invested is substantially lower than with the outright purchase.

So, what is it that makes the leverage scenario intriguing? There are a few reasons:

  • Potential for Increased Returns: With less of your own cash tied up, you could hypothetically acquire additional properties instead. These multiple properties increase your overall earning potential across your real estate portfolio.
  • Tax Advantages:  The interest on debt used for business or investment purposes is often tax-deductible, offering even more tax savings to those skilled at Strategy 1!
  • Hedge Against Inflation: The beauty of fixed-rate debt (like a mortgage) is that inflation effectively devalues the money you have to pay back over time. Essentially, you’re borrowing “expensive” dollars now and repaying with “cheaper” dollars down the line.

Of course, leverage, like all strategies, carries risk. Higher debt can magnify losses in a downturn. However, UHNWIs don’t make borrowing decisions blindly – they analyze risk carefully, which takes us to Strategy 5.

Strategy 5: Understand Risk-Adjusted Returns

A common saying is that higher returns always come with higher risk. While often true, we need a more nuanced way to weigh opportunity when building wealth. UHNWIs focus on risk-adjusted returns. This means they don’t solely fixate on the promised gain. Rather, they rigorously analyze the level of risk inherent to each investment opportunity.

Let’s look at a couple of options:

  • Option 1: An investment promises an average annual return of 10%.
  • Option 2:  An investment with an average annual return of 12%.

On the surface, Option 2 seems superior. However, what if Option 1 is a relatively stable investment in a well-established company, while Option 2 involves investing in a riskier startup with high potential reward, but also a greater chance of failure?

Comparing opportunities merely by their promised return would be an apples-to-oranges situation. Instead, investors need to calculate a risk-adjusted return – normalizing the return by some kind of risk factor.

The math here can get complex, but the main takeaway is simple: Wealthy investors take the time to assess how much risk is truly baked into an opportunity, making them more successful in selecting appropriate investments for their own risk tolerance.

Ready to Take Charge of Your Financial Future?

While we may not all become UHNWIs overnight, the strategies used by the uber-wealthy can significantly empower our finances, irrespective of our current net worth. If you’re ready to explore smarter tax techniques, build on strategic investments, and optimize your wealth plan, turn to the experts at Dominion.

Our tailored approach provides insights and solutions crafted for your unique circumstances. Contact us today to see how we can help you build wealth for generations to come.

Dominion

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