Blog | Personal Finance

3 Basic Principles to Build Massive Wealth

The more you leverage and the faster you re-employ your money, the faster you will build your wealth

In my blog, Two Rules to Put Money Back in Your Pocket, Now I laid out a detailed plan for you to start saving on your taxes immediately. Remember, almost any expense can be deductible under the right circumstances. This includes things like food, entertainment and travel—even your house.

Now that you know how to permanently reduce your tax liability, the question becomes, What are you going to do with all that money?

You may be happy enough just having it in your pocket. Let’s face it, refunds from the government just feel better than money that comes any other way. That’s what makes tax refunds so much fun. It’s money that you can use any way you want—all of it. The government doesn’t get any of it.

Years ago I worked with a client who was so intent on the government not getting his money that I was sure he’d gladly spend two dollars to keep the government from getting one dollar. He’d do anything to save taxes because he believed the government wasted our tax dollars on needless projects. I suspect he’s not the only one out there who feels this way.

I’m not recommending you spend two dollars in order to save one dollar of taxes. In fact, I’m suggesting just the opposite. I’m suggesting that you can save thousands of dollars in taxes simply by understanding the basic principles I’ve outlined in this book and by implementing them in your daily life, with a little help from a good tax advisor.

So what are you going to do with all that extra cash flow? Are you going to take a vacation, spend it on improving your home, or donate it to charity? Those are all worthwhile endeavors. Still, think about how much better that vacation could be, how much bigger your home could be, or how much more you could donate to charity if you took that extra cash flow and created some serious wealth.

I get it. You want to spend a little of it on yourself right away. You work hard and deserve a vacation. And if you work it right, you can deduct most or all of that vacation on this year’s tax return. But what if you focus instead on building a substantial amount of wealth so that you can have better vacations, a bigger home, and do more for your favorite charity in the future? Wouldn’t it be great if you didn’t have to wait 20 years before you could have everything you want?

Let’s look at how you can apply the extra cash flow from your tax savings to speed up the rate at which you build your wealth. The last thing you want to do after learning an entirely new way to increase your cash flow through permanent reductions of your taxes is to then invest all that money the old-fashioned way—by giving it to a mutual fund company or a traditional financial planner.

Here are the three concepts to produce massive amounts of wealth:

Compound Interest

When I was growing up, I’d always heard about the magic of compound interest. When I asked what it meant, I was told that compound interest is like magic because it increases even while you sleep, and it constantly gets bigger and bigger. Here’s how it works.

Let’s say you deposit $10,000 into a certificate of deposit (CD) at the bank. Suppose the interest rate you earn is 5 percent. After the first year, you’ll have earned $500. Now, let’s say that you leave the $500 in the bank. Now you have $10,500 in the bank. The interest rate of 5 percent is applied both to the original $10,000 and to the $500 of interest you earned over the previous year. So in the second year, you’ll earn $525 of interest. The extra $25 in the second year is interest you earned on the interest from the first year—compound interest.

It’s clear that compounding your interest is important. It should also be just as clear that it’s a pretty slow way to build wealth.

But what if you could increase your wealth much quicker and more substantially, all without increasing your risk? Well, you can with the real “magic” of leverage.

Leverage

Leverage is what happens when you earn interest on not just your money but also on someone else’s money. This is precisely what the bank does when it borrows your money. When would a bank borrow your money? Every time you put your money in the bank, it’s borrowing your money.

That’s right. Banks are in the business of borrowing and lending money. So how can you use this principle of leverage to increase your wealth? You just do what the bank does. You simply entice someone else to lend you the money that you then invest in something that pays you a better rate than what you are paying on your loan.

That’s right. The same bank where you might otherwise deposit (or lend) your money is also willing to lend you money for the right investment. Banks will lend you money to invest in a business or real estate. (Of course, they’ll also lend you money for personal reasons, such as a vacation, but they’ll charge very high rates of interest for this. It’s called a credit card.)

Notice that banks like to lend money to people on the right side of the CASHFLOW Quadrant—business owners and investors. That’s because there’s less risk on the right side of the CASHFLOW Quadrant. And banks will only lend to business owners and investors who have the knowledge to be successful so that they will likely pay back the loan.

Velocity

When I think of velocity I always think of a race car. How fast can I go? The same principles apply to the velocity of money. Just as with a car, the key to going as fast as possible without losing control is to gain knowledge and experience quickly and apply that knowledge and experience to the race. In the case of money, the race is to reach your dream. The faster you can gain knowledge and experience, the sooner you’ll reach your dream.

The key to financial velocity is to keep your money moving. Think about your compound interest with the bank. All you did was leave your money sitting in the bank. It wasn’t moving. So while it earned a small amount of interest, it took 10 years just to earn $6,288. Then think about what happened when you added leverage. You earned almost the same amount in the first year that it would have taken 10 years to earn relying solely on compound interest.

You could’ve earned still more by using the principle of velocity. Think about it this way. Leverage is really just compound interest using someone else’s money.

The only way to actually save money in taxes and to speed up your wealth-building is to first start implementing the strategies found in my book, Tax-Free Wealth.