Most decamillionaires attribute their wealth to owning and investing in their own, rather than in other people’s, businesses, which include the ones listed on the various stock exchanges.  The millionaires state that they can control their own businesses, but they can’t control or dictate policy to public corporations, let alone determine prices in the stock market.  Most will also tell you they believe they are better able to operate a particular type of business than anyone else.  The “particular type” is the key element here.  Successful risk takers are market nichers – they do things that others do not do, or, at the very least, they do things in a market area where there are few competitors.

- Dr. Thomas Stanley’s Research via The Millionaire’s Mind

Related posts:

1. Here Is One of My Secrets to Making Money (Or, How I Once Bribed Women to Code for Me with Diamonds, Rubies, and Chanel)

The Secret: Strike Deals Where Everyone Has Limited Downside and Harness the Super Power of Incentive

Some of you have been writing to me privately and asking about the early days when we started out and were trying to build our companies.  I thought it would be useful to share some of the things we did during that time that worked out well … and maybe I’ll even talk about those things that didn’t work out so favorably.  I hope you find it useful in your own endeavors.

When Aaron and I started our first business years and years ago, we needed to get thousands of products coded and online.  That would have taken tens of thousands of dollars in cash upfront with no promise of payout later.  That was a risk we weren’t willing to take, so instead, we came up with an idea that mirrored Charlie Munger’s super power of incentive mental model.

We went to a jewelry store and department store to purchase a range of high-end gifts, which we knew would hold their value.  This included a diamond and ruby tennis bracelet, bottles of Chanel perfume, a diamond watch, etc.

We then approached several close friends and family members and made them a deal: If they were able to code [x] products successfully within 90 days, and those products were done well enough that they reached [y] in sales, we would give them the items.  We made it a competition.  That way, they were working as entrepreneurs and knew that if it didn’t work out, they got nothing (no paycheck) but if it did, they won big. 

The Moral of the Story

In other words, they had nothing to risk but time and had a shot at getting some fantastic gifts.  We had virtually no financial risk because, if things went poorly, we could either return the items or sell them for what we paid.  (Always have a financial backup plan.)  If things went well (they did), we got to pay them out of profits and not use any of our own cash. Everyone wins.

In the end, everyone was happy.  Giving those things away was one of the best experiences I’ve ever had because it felt good to reward those who worked hard and delivered results.  I visited one of the workers a few hours ago and was reminded of this program when I saw the gifts.  She let me take a photo with my iPhone.  I had forgotten what some of the things looked like, but I have to say: Aaron and I have taste.

What I want you to learn from this is how you structure your business deals is almost as important as the investment itself.  This is why Benjamin Graham said not to ask if “XYZ” was a good investment, but rather, “on what terms and at what price“. Had I added these people to payroll and created a fixed expense, it could have taken that company down before it got off the ground.  We forced the firm to pay for its own expansion out of earnings.

A Secondary Financial Lesson: Know Your Target Audience

(This experience also taught me something that I truly didn’t understand because I was, to be honest, a clueless guy: Many (not all) women love jewelry.  I mean love it.  They were more excited to receive items like this than cash.  I’d want the money.  Or stock certificates.  I grossly underestimated the power of stereotypes and was promptly rebuked by almost every female in my life with a giant, “duh”.  Had I known this, I would have gotten far more pieces like the bracelet shown here, which caused two hardworking, very intelligent women to almost fight.  The moral: Know what motivates your target audience. For me, getting paid in stock is a huge incentive.  For other people, not so much.)

Years and years ago, Aaron and I came up with an incentive system that caused a group of hard working women to help us launch one of our first businesses. This is the diamond and ruby bracelet that served as one of the prizes to those who delivered the highest performance.

Related posts:

1. Coco Chanel Only Owned 10% of Her Business – Intelligent or Stupid?
2. “Dreams Become Reality One Choice at a Time” – A Lesson on Life, Business, and Money
3. Where Do Most Decamillionaires Get Their Money?

Isn’t that a fantastic quote?  I got it from Tara Beth Workman a few days ago and I’ve been thinking about it since.  I realize that it is entirely true and that my life is a reflection of that.  All of our lives are reflections of that.  Let me explain.

This afternoon, Aaron and I decided to take an impromptu trip to Hall’s department store because we were restless and wanted to get out of the office.  Turns out, we hit a major financial milestone so rewarded ourselves by spending just shy of $1,100.00 at the Creed fragrance counter.  We called an audible and determined that this reward was more important than finishing the book (no, I’m not going to tell you what it is) so that is why I chose to buy more after my purchase of Creed bois du portugal and Creed original vetiver the other day even though I was supposed to put it off until after the manuscript was complete.

Our Lives are the Sum Culmination of Our Past Choices

You must unlearn what you were taught about money growing up if you were middle class or lower class. The $1,100 we spent today on Creed fragrances may seem excessive but it is the same amount a husband and wife would spend in only 5 or 6 weeks if both of them smoked a pack of cigarettes each day. Learn how to focus your cash on the things you want and cut costs in areas that go to someone else. YOU should be the beneficiary of your work ... not your utility companies, the car manufacturers, or the credit card issuers.

Years ago, I told my younger brother that every single choice we make either gets us one step closer to our goals or one step further away from our goals. For example, I am well off financially for a variety of reasons.  I also need to lose roughly 45 lbs. because I made some not-so-good choices and I eat very, very well at restaurants like Ruth’s Chris and such.  My present reality reflects those past choices; some good, some bad.

Small Things Make a Big Difference Over Time

Take the trip to Hall’s this afternoon.  It was part of the incentive system I was telling you guys about and why I’m able to get so much done even though I’m relatively young.  It started in college with small items from Hamilton Jewelers in New Jersey.  Even though dropping $1,100 may seem like a lot of cash for a few bottles of rare French cologne, it is less than a couple who smokes a pack of day spends in 5 weeks! Because we’ve bought bottles in the past, we now have thousands upon thousands of dollars worth of it at the office, as you can see from the picture (and that isn’t even all of them!).

Every choice we make, whether in life or financial, has a huge cumulative impact on our day-to-day circumstances. We are where we are *right now*, in this moment, because of the choices we made in the past. A small example, such as smoking, is a perfect manifestation, as I already explained.

Yet, the smoking couple would probably criticize me as a profligate or excessive, not realizing they are just as capable if it weren’t for their habit and that all of my purchases are tied to business success of much larger magnitude so it is mostly symbolic; a payoff for countless hours of work, giving up on going out with friends as we stay behind to solve some unexpected problem that stands in our way.

I don’t smoke, I very, very rarely drink alcohol, and I control costs like a Swiss Banker.  Only a few months ago, I switched over to more energy efficient light bulbs because I figured it saved us a few hundred dollars over the next couple of years!  Their choice to smoke drains their bank account whereas my lack of smoking and controlling of expenses means far more cash piles up over the course of the months and years.

Also, I still have never taken a single penny in salary from any of the businesses, because profits are for reinvestment!  None.  Zero salary.  That means I live on writing royalties and investment income.  In fact, I would bet money that I live on less cash per year than most of the people who are reading this right now.  Why?

• I avoided debt early in life so I don’t have a lot of fixed payments.
• I force myself to live on roughly what a public school teacher earns a year and reinvest everything else.
• The businesses always comes first.  Back in the early days, if we needed new computers and it meant I didn’t eat, that was how it was.  The companies were more important than my needs.
• I shove as much money as possible into retirement accounts for the tax deductions.  My favorite is the SEP-IRA, which has far higher contribution limits than other plans.  In fact, I can’t even touch most of the money I’ve built up because it won’t be available until the time I’m 59 1/2 years old according to IRS rules.
• As I mentioned above, I control costs ruthlessly.  Even our light bulb brand choices are studied.

Because of small choices I made a long time ago, I'm now in a position to walk into a retail store and buy the things I want without financial stress. It really is as simple as that. There is nothing stopping you from achieving the same thing. I'm no better than you are.

ALL OF THESE ARE DECISIONS I’VE MADE TOWARD ONE, SINGULAR GOAL: TO BECOME OBSCENELY, OFFENSIVELY RICH.  I am no better than any of you and that is why I have desperately tried share everything I’ve learned over the years … there are folks who make $36,000 a year yet have millions of dollars living better than others who make $150,000 and are almost on the edge of bankruptcy because they are leaking money everywhere, from $300 cable bills to giant Cadillac Escalades that will depreciate in value.  Building wealth has very little to do with how much you make but more about how much you keep.

Long before my parents became successful and wealthy, I grew up in a tiny house and there was hardly any money at all for anything.  In fact, I honestly don’t how my parents raised us and started their business at the same time.  Still, I knew that most of the wealth in the United States was made first-generation and very little of it inherited so I set out to discover how that was possible and they encouraged me every step of the way.  It’s been a rough journey at times (in Buffett’s words, there have been days I feel like a “bird that flew into the middle of a badminton match”) but it has been worth it.  God willing, I cannot even imagine how far along I’ll be ten years from now and I’ll still be relatively young.

Your goals don’t even have to be about money … they can be about a career, family, lifestyle, wardrobe, project … virtually anything that you can dream is possible.  After all, who would have believed the Wright Brothers when they thought that someday a several-ton pile of metal could soar through the air like a bird?

The Courage of Our Friends and Family

Furthermore, Aaron and I were smart enough to surround ourselves with friends and family who were the same way.  This is extremely important because the quality of people in your life will influence your decisions and level of faith and courage.  Just a few examples of some of our favorite people (and we are leaving out a ton of you guys – if you are reading this, you know who you are!):

• Joseph Woodhull got in a car with his girlfriend and traveled across the United States, leaving New York and moving to Portland to pursue his dream of freelancing.  Most people are too scared to leave the area where they grew up, let alone leave a job and pursue a passion to let them have the type of life they want.  His courage is inspiring.

• Karen Ashe threw all of her belongings in a car and drove to Florida to apply for a job at the Walt Disney Company, where she now works.  Again, she just went for it knowing that failure was possible but determining the dream was worth the risk.  Not only does she have the courage to follow her dreams, she has the talent. If she told me that one day she would be CEO of the company, I’d believe it.

• Ashly and Ian Francis-Vallimont overcame personal and family obstacles, put themselves through college, and just make great decisions about life.  If they were to walk into my office tomorrow and tell me the Pacific Ocean had turned orange, I would believe it on faith alone because that is part of their character.  Ashly is taking some well-deserved time off after working for a major bank and Ian is a newly minted nuclear engineer.  They did this on their own through hard work and choices.  It just makes Aaron and I proud to be friends with them.

• Ellary Draper became one of the youngest professors in Texas history, is constantly advancing in the field of music therapy, and still finds the time to get joy out of life.  She got us to love spicy food, travel more, and say, “Screw work … we’re taking the day off.”  She has already earned her masters and will likely get a doctorate at some time in the future, as well.

• Gilberto Gomez moved to Mexico, found love, lost 50 lbs., took up ballroom dancing, became an aerobics instructor, did nude yoga, and just … lives.  The stories of Gil from college literally get my grandmother laughing so hard she cries.  He is like a fabulous, Hispanic version of Auntie Mame.  When and if he has kids, they are going to have the coolest life anyone could ever imagine.

• Kelsey, My Sister: She left Missouri, became a flight attendant for Jet Blue, traveled the country, met new people, lived in Boston, moved to New York and was fearless about it.  She had great stories from her travels, learned how to manage her money, and began investing in her early twenties.  It was a huge accomplishment when she had saved enough to buy her first share of Berkshire Hathaway through a retirement account back in the day.

• Caleb, My Brother: He had more discipline than anyone his age I know, saved virtually all of his income during his six-year contract in the United States Air Force, and by 30 years old, will be set for life.  It simply would not be possible for me to be any prouder of him.  He will be one of those guys pulling down $400,000 a year and playing golf all day not because society tells him to but because it is what he wants for his own life.

• Gabe, My Cousin: Is traveling Asia right now, after graduating from one of the best law schools in the world, William & Mary.  His tales from China, Thailand, and India are great.  He’s seen more of the world than most people do in a lifetime, and yet he still has an amazing career ahead of him as he is planning on clerking for a judge upon his return.

• My Dad: Went back to college and graduated at 50 years old because he wanted to finish what he had started during his youth.  Very few people go back and correct things that they want to do differently.

These really are just a handful of examples.  Aaron and I feel so extraordinarily lucky and blessed to have surrounded ourselves with people like this.  If I were to launch a hedge fund tomorrow or open a fashion house in Milan two years from now, not one of them would belittle it or question my judgment.  They may inquire as to the wisdom of certain moves, like any friend or family member would, but there would be no doubt that these people are on your side.  It is vital that you fill your life with people who are always on your side – that doesn’t mean they will always agree with you, but they will always believe in you. Business and life are hard enough.  If you have to deal with the people in your home and inner circle constantly belittling your dreams, it is just one more obstacle that you’ve allowed to take root.  It is completely unnecessary.

Something Like 1 in 24 Americans Is a Millionaire

In fact, I was having a discussion with one of my About.com readers the other day who was absolutely infuriated over the fact that I pointed out she lived in a nation where 1 out of 24 or so people were millionaires.  She insisted that it wasn’t possible.  I tried to tell her that the average American millionaire lives in a house valued at less than $300,000, drives a Toyota, has worked in the same job for decades, is married with children, is a college graduate, and has no outward signs of money. People have been brainwashed by shows like MTV Cribs.  They now believe if you aren’t dropping $800 on a pair of shoes you must not be rich.  It is an illusion!  Most of those folks end up broke.  Haven’t you watched the biography channel or read the news?

Given that each of us knows an average of 250 people really well (not recognizes, but knows in our own, personal lives), that means that an average person knows something like 10 or 11 millionaires.  Most of these people are “stealth wealth” so not even their friends know.  In fact, they could live in trailers, not have cars, and shop only at garage sales.  You must unlearn what the media has taught you!

Everything Begins as a Dream … Everything

Everything begins as a dream. From the largest skyscraper to the local carnival, the color of paint on your house to the shoes on your feet ... everything started as an idea in someone's head that they brought into existence through a combination of faith, perseverance, and capital.

We live in the greatest country in the history of the world when it comes to free market opportunities.  If you can come up with a good enough idea and sell it, you could be on QVC making tens or hundreds of thousands of dollars six months from now.  McDonald’s, Wal-Mart, Berkshire Hathaway, Coca-Cola, Tiffany & Company, Barnes & Noble, Amazon.com, Yahoo, Google, Microsoft, Apple … all of these were ideas that individual men and women dreamed into existence then figured out how to have them generate profits.  Sam Walton was made of the same elements you are … carbon, hydrogen, oxygen … he was a human living in this nation that took an idea and turned a tiny five-and-dime into a firm doing roughly half a trillion dollars in annual sales in less than 50 years.

Find out what you want to do with your life, what will make you sing every morning when you wake up.  Figure out how to make that occupation pay you money (in other words, provide some service or product that people find valuable enough they are willing to trade you their cash for it).  Then, scale it up so you can afford the lifestyle you want.  For some, all that requires is a fishing cabin and a sailboat.  For others, it may be a Park Avenue penthouse.  No one can determine that but you.  The thing is, if they did it, why can’t you?  The great thing about America is if we succeed or fail, it is entirely our fault short of “black swan” events (e.g., getting run over by a bus or having major family health problems early in a career).

Related posts:

1. The Bosendorfer Strauss Grand Piano – A Real Life Lesson in the Time Value of Money
2. Business and Money Wisdom for the Day – 07/05/10
3. Business Should Be Fun … If It’s Not, You’re Doing Something Wrong

When it comes to real estate, business acumen, and interior decor, Ozzy and Sharon Osbourne have my admiration.  Not only are their properties flawless in appearance, they use them as cash generators.

According to one of my favorite blogs, Mr. and Mrs. Osbourne purchased this 4,500 square foot, 5 bedroom, 5 bathroom beachfront property in Malibu, California for $5,100,000 in March of 2003.  Today, they rent it out for several months during the summer at $40,000 per month.

This is what separates those who are successful from those who can’t hold onto money, like former NBA stars.  You must keep cash rolling in the door and the cash you generate must exceed the cash going out by a considerable margin each year after paying taxes.  It is simple but that doesn’t mean it’s easy.  Here, the Osbournes are having their cake and eating it, too.

But, then again, I’ve been in love with their real estate since seeing Ozzy’s closet on MTV Cribs several years ago. That, and knowing Sharon’s business acumen and I was won over even though my personal music taste runs to singer / songwriters instead of heavy metal and, to be honest, I don’t think I’ve ever heard a single one of Ozzy’s songs.  Still, it’s so refreshing to watch people do things well.

Related posts:

1. Who New Jeremy Renner and Kristoffer Winters Were So Good at Real Estate?
2. The Housing Crisis Isn’t All Bad …
3. The Real National Debt Figures

I just sat down at the desk in my home investing office to start working on the book, as I enjoy a fruit salad of sweet grapes and bananas with a cup of black coffee ... which, actually, reminds me of the Palm Court Terrace at the old Plaza Hotel in New York City during college.

Last night, I cleaned up roughly forty pages of my new book. Tonight, I am hoping to get at least the bulk of the remaining “hard math” section done, which focuses on the formulas and equations (stuff like, “If I put $10,000 into an account seven years ago and now it is worth $32,150, what was my compound annual rate of return?).

This is always the part I enjoy least because it is very technical and I prefer talking about businesses, investments, and the philosophy of money. Still, the most gifted architect needs to know how to design functional buildings, so it is absolutely necessary before I can show my readers how to apply it in every day life.

I spent most of the day discussing the tea party movement’s takeover of the Texas Republican Party, as well as the proposed platform, with my grandmother.  It really is deserving of its own blog post so I can’ t talk about it now … there is just too much crazy to go into, especially once I got to the part about stripping people with learning disabilities of their employment protections under the Americans with Disabilities Act.

It is likely that I’ll be around the computer for the next few hours (or twelve, whatever) as I work.  What are your all’s plans for tonight?  (Yeah … that would be the Midwest upbringing.  That is how you say it.  Don’t be hating on the colloquially.)

Related posts:

1. I’m Working on a New Book
2. Working on the Book and Investing
3. Part I of the Next Book Is Almost Done …

Among the thousands of emails and messages I receive regularly, I came across one today that was sent to me on May 17th by Cale P. Here is the question that was posed:

I’m a pretty talented IT professional with great salary and a standard quality of living. I’ve known that I won’t be in IT for my whole career, at least I hoped. I have a natural ability to invent and I really would love to own private business(es) to see my decisions in a company flourish.

However, I’m unsure of how or when I will be able to reach my goal. I’m busy investing my savings to build my portfolio now. This includes dabbling in the stock market as of right now instead of full on investing. Mostly, I’ve just been saving bulk amounts of cash other than my investment in my home.

How should I, being someone who has a great deal of common sense but no college education in business, pursue owning a company? I could go into much more explanation like my career vs business but I would like to see if I can start the conversation before I write more.

The Rich Diversity of Cash-Generating Assets

It doesn’t necessarily require a formal education to become successful, but it does help.  Something north of 90% of self-made millionaires are college graduates, but that still means 1 out of every 10 have no college education.

That said, when we talk about “cash-generating assets” we aren’t just talking about businesses or stocks. The world is full of things that make your richer just by owning them because they throw off cash. The perfect cash-generating asset is one that produces a stream of money for you and your family to spend or reinvest and that increases its value every year to maintain pace with inflation. There are members of my own extended family that made money by owning car washes and storage units but no stocks. Still others invested everything in stocks and bonds. All ended up wealthy, but they chose different paths due to their own individual talents, experience, and risk tolerance.

There are countless asset types that can produce passive income. As you learned in the article on the Capitalist Class that I wrote for About.com, a division of The New York Times, to be a member of this economic rank requires at least $35,000 per month in passive income. It doesn’t matter if those earnings come from stocks, bonds, hotels, movie theaters, ice cream stands, song copyrights, book copyrights, patent licenses, sales commissions from a networking business model such as Avon or Mary Kay, or shares of a privately held family business.

In my own case, I start by asking one very, very important question …

What product or service can I give the world that will solve a need or want it has and for which it will be willing to pay me the most money for the least amount of work or investment on my part?

A Case of an IT Investment in My Own Life

This project allowed us to collect a "royalty" on sales generated by a business in which we had to invest no money of our own and where we have no day-to-day responsibilities.

In my own life, I have used information technology to create streams of income.  A few months ago, Kennon Green Enterprises, LLC approached a local manufacturing firm and struck a deal where we created the online ordering platform for their clients and, in exchange, we were paid 5% of sales.  Every day I wake up, we are collecting an on-going fee of 1 penny for every 20 pennies the company generates in sales.  That means for every $1,000,000 million in revenue they generate, we get $50,000 that has virtually no cost against it. Our total financial investment was less than $500 but we had the experience to put a system like that together.  The system wasn’t fully operational until a couple of weeks ago, but I expect we will report six-figures in taxable profit from this one operation in fiscal 2010.  It literally brings in money as we sleep.

This has been one of my favorite streams of earnings because it represents how using a specific knowledge base can result in a win-win for everyone involved.  It took us less than a month of work and yet we will now collect huge profits.  This is a “business” in a sense, but there are virtually no downsides.  We have very little money invested, only time and talent.

The idea came to me as I was drinking coffee and reading a magazine, while Aaron played The Legend of Zelda: Twilight Princess.  It didn’t require us to take out loans or risk our own capital.  That is what I mean when I say a “perfect” cash generator.  If the project failed, we weren’t out much, yet if it succeeded, it could have a big influence on our net worth due to the power of compounding.

Not Everyone Should Operate a Business

Furthermore, just because someone is good at creating wealth with one asset type does not automatically mean they will do well in another; e.g., someone who made hundreds of millions of dollars investing in technology patents because of an engineering background may be terrible when it comes to choosing individual stocks for his portfolio.  Doctors are notorious for making horrific investments because their skill set in medicine doesn’t translate in any way, shape, or form into finance.

Some People Just Cannot Run a Company Without Losing Money

For some investors, a McDonald's franchise would be an absolute gold mine that minted money for their family for decades because they are great operators. They know how to cut costs, increase sales, and manage employees. For others, it could be a huge disappointment and money losing disaster. Thus, you cannot ask, "Should I invest in a McDonald's franchise" any more than you could ask, "Should I become a professional golfer or a dentist?" It depends on your own strengths, talents, interests, and skills.

Consider the case of Warren Buffett. Although he was the greatest investor of the 20th century, Buffett was horrible at running a business himself. According to some reports, not only did he lose substantial money investing in a service station in Nebraska during his twenties, but also later, when he tried to run the insurance companies during Berkshire Hathaway’s formative years, he lost the company hundreds of millions of dollars. Thus, there seems to be strong evidence that if Warren were put in charge of the day-to-day operations of one of his business, such as the Borsheim’s jewelry store, it wouldn’t be successful for long. Still, Buffett amassed billions of dollars because he realized that he isn’t good at running a company. His strength lies in identifying and valuing great businesses and motivating the people who do the day-to-day work. By focusing on this one area, where he excels, he has built a reputation and record that will be studied for centuries.

Likewise, if you fall into this same category, attempting to buy a company and run it yourself could cause you to lose everything you invested (and potentially more). In our grandparent’s generation, they called a person that could run a company a great “operator”. Indeed, in his memoir, Dave Thomas, the founder of Wendy’s who dropped out of high school and amassed a nine-figure fortune, lamented that many great business leaders are not, in fact, great operators, and that is what it takes to run a business such as a restaurant or a retailer.

The heart of a good operator is someone who realizes that sales minus costs equal profit. They know how to find the right blend of revenue and profit margin to result in the highest possible return on equity. Sam Walton, for example, focused on making only a few pennies for every dollar in sales. His model was based upon huge volume that got the return on shareholders’ money as high as 60% during the expansion years of the 1960’s and 1970’s. Tiffany & Company, on the other hand, focuses on high profit margins and a more exclusive sales clientele. A good operator would be successful whether he or she was running either business.

If you don’t have that talent – the ability to count pennies and drive new business through the door – then owning something like a franchise might be a disaster for you because your success will come down to how effectively you can watch the bottom line, hire quality employees, and satisfy customer needs. You may be a brilliant accountant or investor but if you lack those specific skills, you are going to get your ass handed to you, for lack of a better phrase.

Others Make It Work for Them

In my hometown back in the Midwest, there is a lawyer that has a practice in criminal law.  He also used his earnings to buy control of a chain of ice cream businesses throughout the city.  Every day, as he is in the courthouse arguing cases, he and his family are bringing in sales from ice cream cones, banana splits, shakes, malts, and more.  My guess is the business is successful because he was able to use his job to get the company off the ground and he doesn’t need to “live out” of the earnings.  Any time you can hold something for investment and aren’t forced to use the money it generates to pay bills, your net worth is likely to expand faster.

Clearly, this lawyer knows how to manage sales and costs.  If he didn’t the chain of ice cream businesses would be bleeding money and he would have to cover the expense from his legal income.  For him, given his interests and talents, owning these frozen treat stands is a perfect business strategy that will help him grow wealthier.  For someone else, it would be an unmitigated disaster that could eat up all of their savings and force them into bankruptcy.  That is one of the reasons I cannot say, “Go buy a business!”  Some people have the skills, while others don’t.  History has shown that a well-run company, however, is a “gift that keeps on giving” in Buffett’s words. That is why I enjoy talking about them.

The Challenge Is Greatest at $5 Million and Below

The most frustrating part for those starting out is that it can be difficult to raise money, borrow funds, and do substantial products until you reach the $5 million net worth figure, at which point it becomes far easier to access capital. Suddenly, big projects such as hotel ownership, franchise area developments, and a host of other opportunities become available almost overnight.

To make matters worse, the challenge is more difficult at $5 million or below, which is where virtually all self-made millionaires begin!  In other words, if you have $5 million in net worth, you could invest your assets into a mid-tier hotel franchise such as a Hampton Inn, then pay one of the handful of high-profile hotel management firms to manage your property in exchange for 5% of the revenue.  You are never going to have to step foot in your real estate and yet, provided you have a good location and management company, each year a stream of profits is going to be deposited into your bank account.

Options like that, which are so readily available for those with the money to hire quality people, aren’t available in the early days.  After all, it requires a special type of genius to be able to buy a hotel and grow it into a fortune.  A complete idiot, however, could inherit a property of hotel investments and live off the dividends they threw off annually.  Some commentators have theorized that money creates its own gravitational pull, just like a planet.  The more you have, and the larger your fortune, the more money gets attracted to it because you are presented with bigger and more lucrative opportunities.

(It is possible to do this on a smaller scale because you can hire single family or apartment building management companies.  There are some of these firms in small towns that will take care of choosing new tenants, signing leases, and much more for a pre-arranged fee and revenue sharing schedule.  That way, you just choose the individual investments but they take care of running them.  Sure, you are giving up more money, but if you aren’t an operator, that may be worth it.)

Know Thyself

With all of that said, if I were a regular employee trying to figure out where to begin creating passive income, I would ask myself several questions:

• Do I have the skills or desire to become an operator?  Do I want to deal with choosing signage for a chain of ice cream stands or watching payroll costs for employees?  If not, owning and operating a business is out of the question.  If I am a good operator, the options become endless because I can do almost anything from investing in a new commercial office building to buying a set of waffle houses.
• Can I create assets that will generate cash?  I, for example, have tens of thousands of finance articles that generate thousands of dollars each month in royalties, as well as a book, etc.  These were created “out of thin air” in that they didn’t require any money to start generating cash, just my ideas and some time.  Barry Manilow is worth hundreds of millions of dollars now, but he started by writing famous jingles for television products.  His earnings from these projects are what made him rich long before he was a hit songwriter.  He created something out of thin air and turned it into cash, which is really useful when you are starting without a lot of money.
• Do I want to have to learn detailed accounting rules, how to value individual stocks, etc.?  If not, a better idea may be to create as much passive income as possible and on the equity portion of your portfolio, dollar cost average into low-cost index funds.  Over decades, you, effectively, could ignore the volatility and compound your money at somewhere between 7% and 11% if history is any guide.  Thus, it would serve as an augment to your cash generators; a way to inventory profits, as it were.

Of course, I have a lot to say about stocks and bonds, but until the question of “are you an operator” is answered, it is pointless to discuss.  So, I put that out there: Are you an operator?

Related posts:

1. How to Read an Income Statement Updated
2. Why Income Inequality Will Always Exist as Part of the Post-Industrial Revolution Global Economy
3. Thanks a Lot, Greece … Bought Some More Berkshire Hathaway

Whenever we have a major project, there is always a television series or movie playing in the office.  It sort of serves as a deadline (e.g., “We need to get the new pen company launched by the end of the first three seasons of Friday Night Lights“).  For us, it works amazingly well.

Right now, we are watching a South Korean series that translates as “The First Shop of Coffee Prince”, which is  a modern Victor/Victoria where a hardworking young girl is mistaken for a boy because she dresses in jeans and is the family’s breadwinner.  Anyway, the boy that she seems to be in love with is the heir to a coffee fortune.

My favorite reason for this show is the grandma, the founder of the original empire, the CEO of the family foods business, and the one with the money.  I swear, this woman answers almost exactly as I would in a lot of situations.

For example, she tests her grandson (the coffee heir) by making him take over a failing coffee house she owns.  She demands he triple sales in a short period to return a satisfactory return on investments.  If he can prove he is capable, he will receive his inheritance, while she is still alive.  She uses incentives.  Otherwise, he will lose the trust fund, house, car, etc.

Anyway, one of her grandson’s employees (her grandson is, effectively, the “coffee prince” for which the store is named) accidentally orders $30,000 worth of coffee and they don’t have the money in the budget that his grandma gave him.  He calls her for help.  Instead of buying the coffee from him, she offers to loan him capital!  At 10%, which is 5x the rate on South Korean government bonds.

So coffee prince says, “Never mind!  I don’t need your loan.  I’ll do it myself.”  Grandma hangs up the phone, and very, very pleased remarks …

It was part of her grand plan!  You see, grandma is really dying of cancer and wants to make sure he is responsible enough to take part in what she has built.  Coffee prince originally demanded $150,000 for capital expenditures but she only gave him $50,000 to teach him the value of money and how it can be scarce.  Coffee Prince doesn’t know about grandma’s health condition.  She says she has lived a good life and now that it’s time to check out of the mortal coil, she will put everything in order and play video games on the computer.

Seriously, Coffee Grandma, you are awesome.

Related posts:

1. The Douwe Egberts Coffee Machine at Headquarters

For every $1 in home value lost by a seller, there is $1 saved by the buyer. No one is talking about this, but the housing crisis represents a massive transfer of wealth to the younger generation (35 years and under) from the older generation.

As Warren Buffett pointed out in this year’s letter to Berkshire Hathaway shareholders, for every house that falls in value and pushes one family into bankruptcy, another American family benefits from the lower prices as new households are created due to the younger generation graduating from college, settling down, and moving out of their parents’ houses.

So, the 50 year old that lost all of their home equity is in trouble, but the 22 year old getting married now has much more affordable housing options available, resulting in more cash in his or her wallet each month.  As Buffett put it:

Prices will remain far below “bubble” levels, of course, but for every seller (or lender) hurt by this there will be a buyer who benefits. Indeed, many families that couldn’t afford to buy an appropriate home a few years ago now find it well within their means because the bubble burst.

No one is talking about that, though, because it’s somewhat harder to measure.  This is my point when people talk about being at the mercy of the economy … I don’t buy it because there are always intelligent things to do.  If you thought housing was going to fall years ago, you could have shorted the housing market index or construction companies.  I read one account the other day where some of the nation’s top home builders sold everything they owned, approached the private wealth management division of UBS, and put their entire net worth in high-grade bonds.  The newspapers were full every day of headlines screaming, “Housing hits new high!”  How many people took advantage of it?

No related posts.

Final Fantasy XIII is released tomorrow. I'll still update the blog (probably) but the business activity is halted for the week. Although, I know myself, I'll probably end up going into my investing office and playing on the television there because I had one put over the fireplace for CNBC but is more often used for taking a break in the middle of the afternoon.

When I tell you that the first stage of financial success is having control over your time, this is what I mean …

When I was a kid, the worst thing in the world was getting a video game for your birthday (ahem, Chrono Trigger), and then waking up the next morning early so you could play it before leaving for school.  All throughout the day, it’s all you could think about because the characters would be calling to you … what happens next in the plot?  You run home after school and play all day.

Tomorrow, Final Fantasy XIII is released.  I’ve been playing the series since I was in fifth or sixth grade and Final Fantasy VI (then called III in the United States) was released and Ruby took me to the mall and bought it for my birthday.  Nearly two decades later, I have a copy of Final Fantasy XIII for XBOX 360, along with a collector’s edition of the player’s guide in hardbound copy, set for delivery.

Now, I don’t have to go through that excruciating dread of going to school or the office when I’d rather be home playing the game.  I’ve informed everyone that I am not to be disturbed for the week.  Why?  I’m going to sit in front of my beautiful high definition television at home, turn on the fireplace, and play the game undisturbed.  As I progress in the game, I’ll still be collecting dividends, rents, royalties, and profits in real life because of the decisions I made years ago.  I explained how terrifyingly similar my path to wealth was to the same one used by players making money in Fable 2.

I think the thing that probably makes or breaks any Final Fantasy series game, besides plot of course, is the battle system.

Aaron has informed me that he will be taking the week off to play the game, although he still plans on going to work in the mornings to get some things done that he wants finished.

This is a perfect example of everything I’ve been trying to teach my friends, family, and readers for years.  Financial success is being able to do what you want, when you want, and still afford the things you desire.  I get closer and closer each day to where I want to be, but I have had total control over my time my entire life – I’ve never had to work for anyone else because of my excessive habit of saving so much of my income.

Related posts:

1. First Impressions of Final Fantasy XIII
2. I Beat Final Fantasy XIII Tonight
3. 15 Hours of Final Fantasy XIII

One of the Things That Helped Me …

I thought of this "stupidity insurance" as writing my own self-insured retirement plan or insurance policy that would guarantee that by the time I was ready to stop working, I'd be able to take $21,422.71 per month after taxes WITHOUT EVER SAVING ANOTHER DIME after my 30th birthday. Anything else I built up - my businesses, my houses, my art collections, my brokerage accounts, my main retirement accounts - is extra (and, frankly, where the *real* money will be). The account should maintain its value of $6,426,814 over time, meaning that the whole sum could be left to my heirs or given to the family foundation for charitable purposes.

From time to time, you may come across reference to my “stupidity” insurance or my “reserve” fund.  I’ve had a bunch of readers write me over the years and ask about various comments I’ve made so I thought it might be useful to explain it.  My parents, siblings, and Aunt Donna have always known about my investing but virtually no one else did when I was a child (by the time I got into high school, though, it was all I talked about so hiding it was no longer an option).

For those of you who are older than 14, this isn’t going to do any good unless you have children or grandchildren that may benefit from some personalized version of it (which is why I’ve never written about it).  By the time I was older, we had put almost all of my siblings on a modified system that helped to guarantee they would enjoy the same outcome in their own retirements.  This plan has some resemblance to the dividend trust program I described in an article on student loan debt.

How the Stupidity Insurance Fund Came About

One of the first things I did when I was a child and figured out the time value of money, and how powerful it could be, was to create a plan that would ensure that no matter what I did or how successful I was, that I would retire rich.  For years, I called this my “stupidity” insurance or my “reserve” fund because it was designed as a sort of self-written insurance policy that no matter how royally I screwed up or how bad things became in life, there was a huge “compounding machine” working in the background for me.  I started toying with its development when I was in 4th grade in a tiny town called Savannah (before I was in 7th grade, I had lived in seven or eight different cities because we moved a lot).  I think it came about because of the biographies I read where you’d have formerly successful business people that lost everything, or millionaire rock stars that ended up bankrupt and broke.  My goal was to do everything possible to make that a virtual impossibility.

The program worked like this: If, starting at 14 years old (which was 4 years in the future at the start of the program), I could save $500 per month by working after school or doing side projects for people, and I could park the money at 5% until I was 30 years old, I would have roughly $141,945 in this insurance fund.  I’d kick in the extra $55 to make it an even number, so let’s call it $142,000.

This $500 was my “insurance premium”, so I didn’t think of it as saving or investing because that is what my brokerage accounts were for – for all intents and purposes, this money didn’t exist to me.  I treated it like an expense, or a car payment.  I did everything possible to get it into tax-advantaged accounts such as a Roth IRA or SEP-IRA because I wanted the money to be able to grow tax-free when it reached what I called “the vesting date”, which was my 30th birthday.  This was the date at which I would stop contributing money to the fund and split everything that had built up since I was a kid into different asset classes (stocks, bonds, mutual funds, real estate, options, etc.) and invest it in such a way that it could be passively ignored for years.  In many cases, the law requires you to take distributions from your retirement accounts by the time you are 70, so that would be 40 years of compounding.

By putting money into assets that generate cash and grow in value over time, like businesses that are attractively valued, the money in this self-created retirement plan or retirement insurance policy silently compounds for decades in the background as we all go about our lives.

If this passive money earned 10% (I have a history of earning much more, and I planned on utilizing things such as self-directed IRA accounts that would allow me to actually buy an apartment building or hotel, for example, as the money grew but I’m keeping it there for the sake of conservatism; most people should bet on 7% to 8%), by the time I reached 70 years old, the “insurance fund” would have $6,426,814 in it.  There would be virtually no taxes owed on this money because of the types of accounts in which I had placed the funds.

Most research shows that even in a Great Depression scenario, withdrawals of no more than 4% per year mean that you’ll never run out of money.  At a 4% rate, I could take $257,072.56 in dividends out of the account each Christmas for the rest of my life.  That’s $21,422.71 per month after taxes that I could live upon, simply because of money I saved from the time I was 15 to 30 years old without ever contributing another penny.

To put it another way: I would never have to save another penny beyond my 30th birthday, and anything else I built up such as businesses I started, retirement plans, brokerage accounts, home ownership, etc., would all be extra (and, if I did my job correctly, would dwarf the insurance fund in value at retirement). But if I utterly, totally, and completely screwed up life and blew everything I ever made and became a total profligate, I’d still retire with a monthly income of $21,422.71 after taxes plus any social security for which I qualified.  That’s why I called this my “stupidity” insurance.

The Psychological Effect of Having Your Own Stupidity Insurance

Some psychologists and money managers have written about similar programs, which they call your “go to hell” money.  They call it this because you know that no matter how bad things get, whether or not you lose your job, change careers, or get divorced, if you are unhappy, you can get up, walk out of the building, and tell everyone to go to hell.

The main benefit of the program is intellectual freedom to pursue what you want to do without fear.  It could be argued that one of the reasons I launched companies after graduation, rather than take a job at Merrill Lynch or Goldman Sachs, was because I knew if I failed, I’d still end up rich and I could always get a job tomorrow.

Related posts:

1. Some Interesting Surprises Hidden In Your Insurance Policy
2. What Is Kennon, Green & Company Ultimately Going to Look Like?
3. How One of My Family Members Used Shares of U.S. Bancorp to Build Substantial Wealth

When I was a child, I would read Scrooge McDuck comics by Carl Barks and Don Rosa. I realized that, while everyone else worked, Scrooge owned everything from the banks to the ice cream factory and the profits kept rolling into his money bin day and night. I realized that's how I wanted my life to be so I could focus on doing the things I enjoy and can give a lot of money away later in life.

Early in life, I developed a theory that there were five levels of building wealth that most self-made men (and women) go through to reach financial independence.  It was started by my love for Carl Barks Scrooge McDuck comics.  When I started reading the Federal Reserve reports of consumer wealth, empirical studies, and other sources of data, and discovered that 90% of those in the United States who are millionaires made the money on their own - that is, they did not inherit it – I started refining my theory.  It helped guide me when I lived in a series of small towns throughout my childhood, saving nearly every penny I could from working after school and pouring it into my investments.

Level 1. A hard working man gets a job in construction and is paid by the hour.  In effect, he sells his time in exchange for a set rate.  When he is done, he collects his wage and that is it.  He will never again receive a penny unless he agrees to sell more time to someone else in the future.  He is always at the whim of the economy and an employer.

Almost all millionaires started here because 90% of high net worth individuals in the United States came from those who inherited little or no money.  The only way to ever make a decent living from this level is to increase the rate at which you can charge for your labor.  By going to law school, medical school, or business school, someone can demand $100 per hour instead of $9 per hour working at a discount store because their skills are harder to find (rarer) and in demand by the public.  The term “wage slave” has been used to describe this level.

Level 2. The hard working man takes some of his savings, built up by spending less than he earned over several years, and starts a new limited liability company to hold his investments.  He contributes the money to purchase the materials to build a house.  He works on it himself to lower costs or, if he doesn’t know construction, hires someone.  He rents the property out to tenants.  Whereas at Level 1, he could only hope to make money from the time he spent on the project, he will now begin collecting rental income that will flow into his household’s income statement every month for years, if not decades, into the future barring some unforeseen disaster.  That is, he is collecting cash each month even if he doesn’t get out of bed in the morning.

Most people never get to this stage because it is difficult to have the discipline to save money and come up with enough money to get off the ground.  It’s a painful, slow process that can cause a lot of burnout, especially if you have no one to guide you and show you how easy it can be.  Instead, they give up and stay at Level 1 forever, always worried about hanging on to employment or making enough to cover the monthly bills.

There is a "tipping point" that is reached when you're building wealth. The first $100,000 in savings is the most difficult, painful, horrible experience for most people because your money isn't big enough to start earning money for you. If you can get beyond that threshold and start collecting cash generating assets, no different than someone collects stamps or baseball cards, the rest will take care of itself. Your job then becomes risk management.

Level 3. The tipping point is reached when the hard working man no longer needs to live off the rental income generated from the property.  This means that he is contributing savings from his job as a construction worker plus the after-tax earnings from his rental house to his limited liability company.  Before long, he is able to construct or purchase a second property.  Suddenly, like a tree planted in a field, the first young oak tree, which began as a sapling, begins to throw off acorns.  The wealth is still small, but it’s becoming self-generating and that is the key.

Level 4. Through years of reinvestment, pouring more money into his investments, and intelligently putting money to work at the highest risk-adjusted rates of return, the small limited liability company our hard working man founded now generates so much money that he can write checks for new properties, hotels, car washes, or whatever else he believes will generate a decent return out of the annual after-tax profit.  Should he choose, he could live off the income generated from these investments without ever working another day in his life (that hardly ever happens because, as I told you yesterday, once you get to this stage, business should be fun or you’re doing something very, very wrong).

Financial independence has finally been reached.  The hard working man can give shares of the company to his children or grandchildren, or he can donate them to a family foundation, using the dividends each year to support charitable causes that are important to him.

According to the Federal Reserve survey of consumer finances, this represents the top 0.9% of wealth in the United States and typically requires a household income of $400,000 to $600,000 per year (that’s a monthly income ranging from $33,333 to $50,000). I wrote an article about this in 10 Secrets of the Capitalist Class at my Investing for Beginners site at About.com, a division of The New York Times.

Charlie Munger said it best when he opined about Berkshire Hathaway, "We want to own businesses that drown us in cash." Once you get enough of them under your belt, compounding starts to take over and suddenly your businesses generate enough money for you to buy more businesses.

Working for the money by selling your labor doesn’t really count, in my opinion.  It has to be passive income from assets that you own. Otherwise, you can’t pass it on to your family or support charitable causes after your death.

Level 5. This is simply Level 4 on steroids.  By most empirical evidence, it begins at roughly $20 million in net worth, which generates roughly $2 million a year in household income.  That’s nearly $167,000 per month.  This is the kind of money that you can begin saving up to develop hotels, endow chairs at universities, travel comfortably in private jets, or (as many of them do) continue to live the same way you always have and continue to expand the investments.  Warren Buffett still lives in the same house he bought when he was in his 20’s.  Back then, he had a few thousand dollars.  Today, he’s worth more than $60 billion.

Summary. As a kid, I’d study wealthy people and classify them by how they generated their money.  Even a musician follows the same path as an industrialist.  Take Elton John.  He is estimated to make $40 million per year by Forbes.  Of this, approximately 50% comes from selling his time in the form of concerts.  The other 50% comes from his ownership of the song rights on the music he composed.  That is, every time someone plays “Bennie and the Jets” on television or in a movie, he gets a check.  Every time someone covers one of his songs, he gets a check.  Every time it sells on iTunes, he gets a check.

Elton never graduated beyond Stages 1 and 2 but Oprah Winfrey, on the other hand, used her money to buy up local cable television businesses.  Most people don’t realize that her “investment company, Harpo, now owns countless local stations and it’s possible you are paying part of your cable bill directly to Ms. Winfrey.  Her money makes money for her now, so even if she never recorded another show, the stream of earnings would keep on rolling into headquarters.  That’s why she earned $250 million versus Elton’s $40 million.  That’s a big difference.

Related posts:

1. The Importance of Frugality in Building Wealth
2. Misconceptions About Wealth
3. How One of My Family Members Used Shares of U.S. Bancorp to Build Substantial Wealth

When I talk about the idea of tap dancing to work, in the words of Warren Buffett, I’m not kidding or making a joke.  You should wake up every morning and jump out of bed because you can’t wait to spend your time focusing on something that makes every part of you – physically, mentally, emotionally, and spiritually – satisfied.  This is going to be different for everyone.

Building a financial net worth that allows you to live any way you wish and enjoying your life are not mutually exclusive.  You can make money following your passion if you are wise and intelligent about it.  There is a man working for a major ice cream company that is paid, literally, hundreds of thousands of dollars as the head ice cream taster.  There are people who test roller coasters for a living.  I have arranged my whole life to allow me to sit in a beautiful office, read all day, and acquire stuff because that’s what I enjoy.  Something in me is satisfied when I pass a building and know I own that, or shop in a store and know I have a few thousand shares parked in some operating company somewhere that no one knows about but Aaron.

In fact, this philosophy is terrifyingly close to the one espoused by Molly throughout high school: Follow your bliss.  There are people who have built fortunes making bow ties by hand and selling them from the trunk of their car (seriously).  There are people who travel the world and get paid to write about it.  Find your bliss.  Follow it.  And find a way to make it self-sustaining.  Money isn’t the goal, it’s the by product.

In other words, don’t work for someone else doing something you hate so you can “someday” be financially independent.  You may need to do that for a few years as you figure out the details, but instead map out a plan to make money as you do something about which you are deeply passionate.

In my office, I keep an ever-expanding collection of Monopoly collectibles to remind me that building a company, generating profit, enriching my shareholders, and creating jobs should be fun.  It is a real-life version of Monopoly.  If we want, we should go buy houses and rent them out to tenants.  Or hotels.  Or water utilities.  The point is, if you focus on risk-adjusted return on capital, in an industry you love that is lucrative, and you don’t take yourself too seriously, you’re going to do well over time.

Business should be fun. Growing an empire is like a real-life game of Monopoly. If you like it, why not buy real houses or hotels? Why not acquire shares of power utilities or water companies? Don't take the game too seriously. I'm convinced that by remembering that money is an illusion - you can always get it if you provide a solution to someone - life is far less stressful. Here's a picture of some of the Monopoly collectibles on the fireplace mantel in my office to remind me of this.

Related posts:

1. The 5 Levels of Building Wealth
2. Back to Business …
3. An Interesting Observation from Aaron

“The problem is that people, particularly younger people, have come to focus on the trappings of wealth over everything else – including the work or savings to accumulate the wealth to be able to reasonably afford luxury brands.  When we think about “rich,” we think about acting rich over being rich.

The Mercedes Millionaire worked hard to achieve success.  First it was about the success, and then came the high-consumption lifestyle – which is congruent with their level of success.  Buying a Mercedes hardly puts a dent in their financial statement.  Contrast them with the acting-rich actors who work to acquire brands with which to imitate the consumption lifestyles of the Mercedes Millionaires.  Not surprisingly, wannabes in general are less satisfied with their lives and have lower levels of job satisfaction than do millionaires.  Driving a leased Mercedes, wearing an expensive watch, or filling up a heavily mortgaged home with Grey Goose will not make one rich or happy.

When an aspirational looks at a Mercedes Millionaire, he only sees what is on display.  He focuses on the leaves of the oak tree, not its roots.  But the values and work habits of millionaires, like the roots of the oak tree, are what support their lifestyles (the leaves), not the other way around. Who should the aspirational seek to emulate instead?  The Toyota Millionaire.  This advice may be painful for some hyperspenders.  For them, a Toyota would never do.  The very thought of a Toyota in the driveway makes them queasy.”

- Page 197, Stop Acting Rich by Dr. Thomas Stanley

Related posts:

1. Where Do Most Decamillionaires Get Their Money?
2. You Have to Focus on Valuation Metrics in the Stock Market!
3. Wisdom for the Day – 07/02/2010

Everyone focuses on the stuff the rich people collect. Yet, the biggest secret is that the rich are really collectors of rents, royalties, dividends, and interest. Whether song rights, hotel ownership, businesses, sales commissions, stocks, timberland, or patents, these are the things they truly amass. Instead, people read or watch television shows about the original works of art and the wine cellars, which are mere side hobbies that occupy very little time. Do not focus on what the rich buy for consumption, but rather, what they buy to generate more earnings streams. You'll often find that for every $25,000 watch they bought, they purchased an $800,000 apartment building and that the watch came long after the assets were in place. This single shift in thinking will greatly enhance the probability of you achieving the same ability to live how you desire.

Related posts:

1. How Much Money Is Rich?
2. Focus on the Roots Before the Leaves
3. The 5 Levels of Building Wealth

Every time you shop at a company, see their products selling well, or hear good things about a firm, it is an opportunity to research a potential investment idea. It doesn't mean you should actually buy shares, but it might just be a great place to start your search. Think of all the investors that found Wal-Mart Stores, Nike, Dollar General, Microsoft, Home Depot, Walt Disney, or Coca-Cola long before they had appreciated 10,000% or more (but were known in virtually all American households).

Years ago, I wrote an article called Finding Investment Ideas for Your Portfolio for About.com, a division of The New York Times.  I’ve been thinking for the past few days about how it is that I seem to come across so many opportunities and then I realized that most people like me are always looking whereas the average American isn’t.

By that, I mean that every time I walk into a business, without exception, the first thought that occurs to me as I look around is, “I wonder if this company is publicly traded.”  If it looks promising, I add it to a mental list and during my regular research periods each week, I pull all of the information I can about the company, or the corporate parent, and begin attempting to value it conservatively. It only takes a few, or even one, great investment in a lifetime to be financially independent.

If my friends and family could actually hear my thoughts, it would be amusing.  As we walk through the aisles of Wal-Mart, I am thinking to myself, “Wal-Mart has a net profit margin of 3.3%.  So, if I buy this $49.95 video game, the stockholders, who are the owners, are going to generate after-tax profit of $1.65 on the sale.  With a dividend payout ratio of roughly 30%, $0.50 of that will be distributed as a cash dividend and the remaining $1.15 will go toward expansion or stock buybacks.  With 3,810,171,967 shares of stock outstanding, each share of the company is entitled to $0.000000000433051 of the profit.” Sometimes, I actually pull out a calculator to compute figures as I stroll besides the shopping cart.

It’s almost like a game of chess, or solving a puzzle where the pieces are constantly moving and half of the box is missing.  I love the game.  Particularly, I like that if I’m right, I make money for the people about whom I care, so they can buy nicer clothes, pay off their debt, take vacations, or send their kids to music lessons.  That matters to me far more than the idea of owning a Net Jet.  It provides me with a real sense of satisfaction.  Most people can’t say they actually make a difference in people’s lives.  I can.

Yet, this idea of looking for such opportunities never occurs to most people.  Here’s an example from my own family …

Ed’s Sporting Goods: An Example In My Own Family

Members of my extended family owned a business called Ed’s Sporting Goods that at one time was the largest sporting goods retailer and team dealer in Northwest Missouri.  Now, it was a successful business – far more successful than the average entrepreneur and something about which the owners are, and rightfully should be, proud.

Dollar General is a perfect example of a simple business, with an easy to understand model for making money, that people could have purchased and become very wealthy from over a period of 10+ years. The company was bought out by a private equity group several years ago.

I remember going out to lunch with my Grandma Kathryn at a local Chinese restaurant (we’ve done that since I was a kid whenever we’re both in town) and talking about stocks.  She said that for years she had been thinking about buying shares of stock in Dollar General but had just never gotten around to it.  I understood this perfectly because I had done the same thing with Apple (despite making a ton of money on companies such as American Eagle Outfitters, I stood by and watched Apple skyrocket 1,400% without buying a single share, even though I switched from PC to Mac both personally and at my businesses, knew how well it was doing, and greatly admired its management team!).

Had they taken just a tiny portion of the sales of Nike products and used it to buy shares of Nike stock, they would have had north of $4 million today from this single decision.

Anyway, a few days later, this got me thinking about how we often ignore what is right in front of our face because we are familiar with it.  During its 25+ year rise, Ed’s Sporting Goods was a huge dealer of Nike products, from shoes to apparel.  I started working on the math and asked myself, “What if they had taken just a tiny amount of the cash – even as little as what they spent on a part-time employee, and had instead regularly bought shares of this company that they knew, from first hand experience, was doing very, very well?“  I don’t remember the exact result, but I figured that my Grandmother and Uncle walked away from somewhere north of $4 million by missing that opportunity.

Why?  People aren’t taught to look for those opportunities unless they come from wealthy families which, at that point, we were not.  They also missed Wal-Mart, which placed two of its first 150 stores in St. Joseph and Warrensburg, where some of the first Ed’s Sporting Goods were!  Walton’s company was literally a start-up right alongside their retailer, in the same city, and they shopped there personally.  The same thing with Microsoft.  The store, due to its screen printing business, was one of the first to adopt Microsoft DOS and later, Windows 3.1.  The same goes for Rawlings Sporting Goods, which is now part of Berkshire Hathaway.  And Blue Chip Stamps, which my dad said they used in California all the time, which is now part of Berkshire Hathaway.  And Benjamin Moore, which operated a store next door, and is now part of Berkshire Hathaway.  And Champion apparel.  And Reebok.  And Pepsi, which apparently my Grandfather drank all the time.  The list goes on and on … but it shouldn’t be depressing, it should be exciting that every few years, we are all presented with more investing opportunities.

The Bottom Line

The bottom line of this is to point out that we are all surrounded by opportunity all the time.  Here’s the million-dollar question (literally): How many people do you know who actually devote hours each day to identifying and then acquiring those opportunities?  Most people would rather spend time studying new washer and dryer models, upgrading their furniture, or reading the sports pages.

There’s nothing wrong with that.  But if you spend more hours each week planning on spending money, such as looking at new cars or houses, than you do planning on how to acquire more cash-generating assets, the result is going to be a drastic reduction in your standard of living. This pattern seems to be playing out with a lot of my friends from college who now seem to realize that you aren’t successful because you have the house, or you have the car, or you have the clothes.  Those are merely by-products of having the wealth, which (again) consists of cash-generating assets.

Related posts:

1. Trying to Disprove Your Own Ideas
2. Coco Chanel Only Owned 10% of Her Business – Intelligent or Stupid?
3. Our Investment Research Process

How The Marketing Industry Continues to Convince Average Americans They Know What a Millionaire Looks Like

The average American millionaire owns less than 6 bottles of wine in his or her home, and paid $13.09 to $14.54 or less for each bottle. They shop at stores like Costco, Target, and Wal-Mart.

A few days ago, I quoted something from one of Dr. Thomas J. Stanley’s books: “In the United States, there are three times more millionaires living in homes that have a market value of under $300,000 than there are living in homes valued at $1 million or more.” For the past few days, I’ve been studying more about average household income in the United States and, specifically, the purchasing habits of the wealthiest Americans.  It is exactly what I’ve experienced in my own life, and fits precisely with those I know.  Yet, so many of my friends and family continue, almost obstinately, to attempt to emulate a certain “lifestyle” by building a bigger house or buying a nicer car, without first getting their financial foundation set.

Most Millionaires Never Made More than $80,000 in Annual Income

A perfect example: I see friends in New York order Grey Goose vodka, which Stanley discusses in his book.  Chemically, it is virtually identical to every other vodka brand because almost all vodka companies use a “base” from one of three suppliers (with Archer-Daniels-Midland being the largest), with the base shipped in giant tanker trucks across the highways, or in railroad cars.  So, for all intents and purposes, “the Goose” is identical to Smirnoff.  Put plainly, that $60 bottle you  use to signal that you are wealthy when, in fact, you are broke and have credit card debt?  It wasn’t that long ago it was sitting in the back of a chain-smoking truck drivers’ cab at a dirty rest stop in the middle of Nebraska.

Buying the luxury items does not make you a success.  The success comes from having lots of cash coming in, little debt, and the ability to be financially free so you can take control of your own life and spend time how you want with your family and friends. You are not a success because you wear Chanel glasses.  They actually get you further away from your goal.  You are a success if you have the cash to pay for the Chanel glasses using dividends, interest income, and profits from your investment holdings.  The difference is like a war hero.  It’s against the law to wear medals you didn’t earn in combat (seriously).  In the economic world, however, you can fake it by purchasing the “badges” even if you do it on credit at 30% interest and haven’t earned them.  Prada, Gucci, Montblanc, Grey Goose, Burberry … it doesn’t matter.  If you are financially independent, these are legitimate, wonderful ways to award yourself.  I actually own $200 Burberry ties and $1,200 Montblanc pens.  The point is, those things came long after I had built my first business and was on to my second and third, my retirement accounts were funded, my taxes were paid, and I had money saved for an emergency.

Sometimes, I seriously ask myself why I’ve written more than 10,000 articles on investing, saving, and wealth management over the past 10 years.  Doing so has consumed a huge part of my life and, although I’ve made a nice chunk of change in royalties and advertising revenue sharing, there are better uses for my time.  And then, something like this keeps me up – it’s 5:02 a.m. now – because I can’t stop thinking about how I wish that I knew this stuff when I first started out on my own.  I’m putting this all out there so that someone, somewhere, will see that it is possible and that most of the stuff you see on the news or in magazines about the wealthy is a lie.  I do it for the same reason I plan on someday wrapping my holdings up in a single investment vehicle and letting friends and family buy shares – I know how good it is to wake up in the morning and decide how you’re going to spend your day.  I want you to have that same freedom because it is wonderful and we live in the greatest country in the world, judging by our opportunity to create our own destiny relative to the historical alternatives.

How to Know Someone Is an Idiot (It’s Not About the Money!)

The argument that infuriates me more than any other, and lets me know that I’m dealing with an idiot, is when someone says, “I don’t care about the money.”  You know what?  Neither do I! I care about having control over my life and not being subject to someone else’s arbitrary decisions.  I care about having money to give to charity.  I care about knowing if something happened to my family, I could support them.  I care about knowing that through the operating businesses, we create jobs so that people feed their family and save for retirement.  I love knowing these things.

Whether you are a composer, a computer programmer, a school teacher, or a social worker, if you don’t retire wealthy, it is your fault and your fault alone. Hell, an 18 year old saving $300 per month until he’s Warren Buffett’s age at 10% compounded would end up with more than $12 million. That’s why I started working on this when I was 10 years old!  It’s.  Just.  Not.  That.  Hard.  (Note: There is one notable exception: A health crisis.  More innocent people declare bankruptcy due to health problems than almost any other cause in this country and it’s a shame.  We’re better than that.  Someone who is in that position has done nothing wrong.)

I have a family member who came to me when he or she (I’m going to say “he” because I don’t want to keep repeating that) was 18 years old.  He wanted to do exactly what I had done and began putting aside $850 per month, split between a brokerage account and a Roth IRA account.  On top of this, he saved 10% of his pay through his employer’s 401(k).  He never earned more than $28,000 per year. A few years later, he had nearly $35,000 saved.  He could never save another penny, and at a 10% return, he’d have just over $6 million by the time he’s Buffett’s age. That is what I’m trying to get across to people.  If you get it done right, and early, and spend less than you make, compounding will do all of the heavy lifting.  In fact, educators (public school teachers in general) are disproportionately represented among the ranks of millionaires relative to their population due to the frugality common in the industry!  There’s no pressure to show up to work in a BMW 9 Series.

The next time you drop $50 or $100 for a bottle of wine, just remember that statistically, most American millionaires shop at Wal-Mart, Target, and Costco, paying less than $15 for their wine collection (which consists of roughly 12 bottles, on average). Millionaires are, by definition, millionaires because they spend their time focusing on prudently spending less than they earn, generating new sources of income, and earning a good return on their investments. As a group, they would rather own an extra 30 shares of Wal-Mart Stores, Inc. common stock, giving them a bigger share of the retailer's profits and cash dividends, than a case of Dom Perignon. That is why they continue to earn money as they sleep or spend time with friends and family, while most people have to wake up each morning and drag themselves to a job about which they have very little passion.

Related posts:

1. The 5 Levels of Building Wealth
2. How One of My Family Members Used Shares of U.S. Bancorp to Build Substantial Wealth
3. The Importance of Frugality in Building Wealth

By simply putting $300 extra each month into shares of U.S. Bancorp, the firm that owns his mortgage, instead of paying off principal each month, this family member should end up with an extra $535,000 net in 30 years, plus own his house outright, and be collecting approximately $33,000 annually in cash dividends.

A member of my close family has been using a technique to build substantial wealth that doesn’t require a high income or any specialized knowledge, extra work, or effort.  I was so impressed by the way he implemented this program, I thought I would share it with my other family and friends (as well as anyone else who reads my blog) without giving away who it is.

Each month, he has a house payment of approximately $1,500, payable to U.S. Bank.  He decided that instead of making an extra $300 payment along with his regular mortgage bill to lower principal and pay the debt off early, he would instead establish a direct stock purchase plan and have that same amount automatically used to buy shares of U.S. Bancorp.  He was convinced the balance sheet of the bank was strong, and the fact that the CEO earns more in cash dividends from his outright ownership of U.S. Bancorp stock made him feel confident that management would act in the best long-term interest of shareholders compared to other banks, where huge bonuses and perks rewarded failure.

The commissions charged for this service are negligible, typically $2 per transaction.  This means that every year, he is investing roughly $3,600 in U.S. Bancorp common stock, with instructions that all of the dividends should be reinvested.  The mortgage on his home loan is roughly 5.5%.  How much will he make in extra profit from this transaction?

Let’s assume that shares of U.S. Bancorp will compound at 10% per annum, with the dividend reinvested, over the next 30 years.  Based on his special “savings” program, when he pays off his home, the deed will be mailed to him and he will be completely debt-free.  At the same time, this small direct stock purchase plan will have nearly $600,000 worth of shares of U.S. Bancorp common stock!  Based on its historical dividend yield, this will generate roughly $33,000 per year in pre-tax income, or $2,700 per month. He will have paid an extra $100,000 or so in tax-deductible mortgage interest, so a net $65,000.  Thus, this move gained him roughly $535,000 30 years from now simply because of how he invested his money.

To recap, he’ll own his home outright, have $600,000 in this account virtually no one knows about, and be earning $33,000 per year from checks getting mailed to him.  This is on top of his businesses, retirement accounts, savings, and “real” money.  You’d never know it.  He drives a 10+ year old Ford, eats at McDonald’s, and lives on very little money each year.

This just goes to show you that most millionaires are regular people, statistically, that invest their money well.  They are teachers, dentists, bankers, coaches, and business owners.  Yet, when you tell people in the lower classes this, they refuse to believe it because of the image that Madison Avenue has sold them.  They don’t realize that they are likely living in the same neighborhood as a millionaire, who drives a pickup truck and has more money than many of the professional sports players on the local NFL team.

In the United States, there are three times more millionaires living in homes that have a market value of under $300,000 than there are living in homes valued at $1 million or more. – Dr. Thomas J. Stanley, Stop Acting Rich … And Start Living Like a Millionaire

Related posts:

1. Family Member Speculating on Citigroup Options
2. Misconceptions About Wealth
3. The 5 Levels of Building Wealth

Here's a perfect example of the type of frugality that allowed me to achieve my own financial independence in my early twenties. Following college, I switched from my regular $12 gourmet coffee to much less expensive Folgers coffee. This move saved my household approximately $520 per year. Why was I willing to do that? Imagine if I chose instead to take that money and buy shares of J.M. Smucker's, the parent company of Folgers Coffee. At 10% compounded, this one move will mean I'll have an extra $733,423 by the time I am Warren Buffett's age, which is 52 years in the future. That's more money for my family, charity, or my businesses. What I have to do is decide whether or not giving up the experience of the gourmet coffee is worth that extra money. There is no right or wrong answer. The goal is the maximization of human happiness and in this case, I would rather have the satisfaction of knowing that with each sip, I am compounding more money. For instance, I could have given up coffee altogether and saved even more, but I'm not willing to sacrifice that experience for additional wealth. That's what I mean when I tell you there is no right or wrong answer, but you must be willing to live with your choices. (Of course, given my extremely nice Douwe Egberts Coffee System at headquarters, this might not be the best example, even though the savings and investment figures are real.)

I was up until 6:30 this morning reading Stop Acting Rich … By Thomas J. Stanley, Ph.D., the author of the incredibly successful The Millionaire Next Door and The Millionaire Mind.  It’s remarkable because so much of what the “average” millionaire did to achieve his or her wealth is exactly, precisely the same things I, and members of my own family, did to become financially independent.  The premise of the book is that most people get in financial trouble trying to emulate the purchasing patterns of the wealthy, yet don’t try to emulate the financial assets that allow them to spend that kind of money without financial stress.  In other words, people want the “badge of success”, such as the Mercedes S600, but not the success itself, such as owning three hotels worth $14.2 million that generates $1.5 million in pre-tax profits whether or not the owners get out of bed in the morning.

Here, I had a huge advantage in my family culture.  I have members of both sides of my family who still live in the same house they bought 25 or 30 years ago and have had it long paid off completely, drive nice, older model cars, and pour a large percentage of their income into investments such as rental houses, privately controlled businesses, stocks, bonds, mutual funds, car washes, etc.  Over time, this adds up to a substantial sum.  This means that as a child, I was conditioned to view my “success” by the total size of my business holdings, and how much money they generated for me, rather than by the size of my house or the car I drove.  If I had walked in and spend $70,000 on a car, they wouldn’t have been impressed, they would have basically called an intervention to tell me how foolish I was, the interest wasn’t tax-deductible, the asset itself was depreciating, and I could have used the same amount of credit to get my hands on something small, such as a single family property.

Today, as I write with $1,300 fountain pens and wear a $3,000 Montblanc watch, I’m afraid that’s all some of my friends and extended family members see because that’s what our society’s consumer-driven culture has conditioned them to appreciate.  They don’t see the far more important things that both Aaron and I do that allow us to achieve that.  I wanted to provide an example of some of the things that we undertake, on a constant basis, that allows us to enjoy these things without hurting our financial plans.  If tomorrow, God forbid, the world fell apart and we needed to rebuild our capital base, I would sell the Jaguar, stop spending on luxuries, and go ultra-frugal again because my balance sheet is more important than my pride. I have no need or desire to impress people.  I want my independence.  Since I graduated from college, I have never had to work for anyone else, I spend all day spending my time how I please, whether reading books, playing videos games, or launching new companies, and I am not willing to “sell my time”.  (That doesn’t mean I would never take a job for someone else.  If I believed that they had far more experience in a certain field and I was interested in learning it, I would gladly subject myself to them for the sake of more knowledge.)  The fact that people aren’t willing to do this has lead me to the conclusion that most people fail to achieve what they want in life for one of two reasons, pride or fear.  Often, they are one and the same.  Whether starting a business, going back to college, dating, or losing weight, these two self-imposed factors are likely to stop nearly everyone who wants something better than they now have.

The Secret to How We Got Where We Are

The major secret of becoming financially independent is to convert as much of your earned income into passive income as possible.  I’ve written about this extensively on my About.com site, especially the recent special I unveiled called How to Get Rich.  Most people start out by earning a paycheck.  If you spend less than you earn, you can take the surplus savings and put them to work in cash generating assets.  In my case, I have zero desire to be a landlord in the traditional sense so I’m not willing to invest in single family residences.  Someday, I may buy large hotels, however.  This is an extension of my personality (I don’t like dealing with individual problems, but rather enjoy focusing on strategy and big-picture stuff as the day-to-day managers handle the rest).  To achieve that, you have to learn how to be frugal and make your money go further.

Here are just a few examples of how we achieved that early on in our lives:

• As a teenager, Aaron worked as a janitor in a factory, sweeping floors and cleaning up after people.  He paid cash for everything so he could build savings instead of paying interest to banks and credit card companies.  When you aren’t behind the eight-ball, it’s a lot easier to build up your resources.  In his early twenties, he continued to take jobs over the summer between paying for college, including doing work outdoors for a local manufacturing plant.  Did he want to do this?  No.

• My freshman year of college, I supplied almost all of my initial clothes from an Army Surplus Store in Princeton, NJ.  For a few hundred dollars, I was basically dressed for the year, even though it looked terrible.  Later, after one of my online businesses started generating cash, I was able to walk into Banana Republic, spend what I wanted, and not worry about the bill because it was paid in full.  Holding those shopping bags full of thousands of dollars of clothes was one of the most satisfying things I had ever accomplished, even today, because I had done it with earnings from my ideas rather than my direct labor.

• 

  Long before the Jaguar, Lexus, huge office, townhouse, grand piano, fountain pens, cashmere coats, and basically buying anything we wanted, Aaron drove a 1993 Ford Escort (for which he paid cash) well past 150,000 miles. As friends and family drove nice, new cars, he made a choice to put his money to work in investments because his balance sheet was more important than his pride. That's why he is basically retired in his 20's, too. Most people don't have the emotional strength to do that - to appear poor - because they are too insecure about themselves and their position in the world.

  Throughout college, I refused to buy a car and Aaron drove a 1993 Ford Escort with more than 150,000 miles.  Virtually all of our friends drove much nicer vehicles.  Why were we willing to look dirt poor (believe me, if you saw the car, you’d know what I was talking about) when we could have easily afforded something better?  We wanted our money to go into our investments.  Instead of making car payments, we were buying shares of American Eagle Outfitters before it went up 700%.  We took shares of EnPro, a spin-off of Goodrich, when they were valued at virtually nothing.  We bought stock in companies such as Direct General and Yankee Candle before making a mint in the private equity buyouts.  Every dime we would have spent on a car would have been a dime we didn’t have to put into these “compounding” assets.  If we had to choose between our pride and our pocketbook, the latter always won.  (Besides, there’s a really interesting sense of self-satisfaction that comes from someone looking down on you in one of the wealthiest counties in the United States, while in the back of your mind, you are laughing to yourself that your assets are generating more each month, whether or not you do any work on them, than this person could earn from a full-time job.)

• We do a lot of shopping at Wal-Mart, Target, Sam’s Club, and Costco.  We also buy a lot of office supplies through wholesale distributors, in bulk.

• We take advantage of bank programs, such as the American Express Plum Card, which allows us to earn more than 2% cash discounts on our purchases.  By putting as much of our wholesale earnings as possible on these cards and paying them off within a few weeks, we can generate thousands of dollars in annual savings for bills we would owe anyway as part of doing business.

Related posts:

1. The 5 Levels of Building Wealth
2. How One of My Family Members Used Shares of U.S. Bancorp to Build Substantial Wealth
3. Misconceptions About Wealth

Making money online can be incredibly easy if you know which metrics are important and how to focus on the right things.

I’m sitting in my investing office, looking over the river behind the property, figuring out what I’m going to do for the day. I’ve got a cup of coffee in my Seattle’s Best mug from Border’s and am listening to Roosterspur Bridge by Tori Amos. The ideal would be to plow into a giant pile of stock reports but that isn’t going to be possible for a few days because the operating businesses need my attention. We have so many opportunities over the next twelve months to explode in revenues and profits by taking business from weakened competitors that I’m driving everyone pretty hard. Aaron, as always, has been patient, long-suffering, and wonderful.

One of the questions I often get asked is how, exactly, we make money. Moreover, most people want to know why we’ve succeeded when others have failed. To explain how easy it really is to create a large amount of wealth, I wanted to go through and work the problem backward (as Charlie Munger would say, follow the mathematician Jacobi to solve all of life’s problems: “Invert! Always invert!”). By seeing how we think about these things at our company, you can gain insight into whatever it is you are involved in yourself.

Let’s begin with a simple premise: You want to make $10,000,000 after taxes by selling your business and walking away when the deal closes. You own an online retail site. How do you do it?

The Three Metrics that Matter
In online e-commerce, there are three metrics that matter. Any good analytics program can provide this data by putting a bit of code on your pages – Google Analytics, which is free, is one of the best. These three metrics are:

• Monthly Visits: This is the number of times a person comes to your site each month. It is not page views. It is not hits. If the same person comes to your site every week for four weeks, that would count as four visits. For a traditional retailer such as Wal-Mart or Target, it would be the number of times someone walks through the doors.
• Conversion Rate: The conversion rate is the percentage of visits that result in a sale. If you have 100 visits and 2 orders, your conversion rate is 2% (2 ÷ 100 = .02, or 2%). The higher the conversion rate, the more likely you are meeting your customer’s needs. A “good” conversion rate is usually between 1% and 3% but it depends upon the nature of the ecommerce site. The easier it is to checkout, the more attractive your prices, the lower your shipping rates, the better your search engine optimization, the higher quality your product images, the more professional and informative your descriptions, the higher your conversion rate.
• Average Basket Price: This is the average sales ticket for orders placed on your site. For a baby gift site, an $80 average order may be good. For a furniture site, $700 may be acceptable. If you try to increase the average basket price by increasing product prices, you could lower your conversion rate. Thus, the conversion rate and average basket price have a powerful, inter-connected relationship. Just realize that if you are targeting an average basket price of $150, you aren’t likely to get there if you only sell $19.95 products.

Those three metrics – monthly visits, conversion rate, and average basket price – determine the success of an online business. Going back to our earlier problem, let’s answer the question: How could I make $10,000,000 after taxes by selling the business?

The Math of Working Backwards
Working backwards, it becomes evident that you’d need to sell the company for $14,000,000 to end up with $10,000,000 after taxes. Once you’ve reached that size, most good businesses will sell for about 10x EBIT, which means earnings before interest and taxes. This would not be the case if you were a traditional retailer because you’d have fixed expenses, real estate, capital-intensive inventory requirements, and much lower profit margins due to the business model. For a successful, growing company with high margins, it’s reasonable. You may have to wait for a better economy, but it’s reasonable, especially if you can find a competitor that has a strategic reason for acquiring your business.

That means that you would need to make $1,400,000 in pre-tax income ($14,000,000 sales price ÷ 10x EBIT = $1,400,000 operating income). If your cost structure is right, you should be able to generate 28% operating margins with a successful e-commerce business. If you can’t do that, you’re doing something wrong. My guess is, you’ve become intoxicated with sales and forgotten that profits are what matter. Thus, to generate $1,400,000 in pre-tax profits would require sales of $5,000,000 per year ($1,400,000 ÷ .28 = $5,000,000).

If $5,000,000 in online sales sounds daunting to you, remember to go back to our three metrics. Monthly Visits. Conversion Rate. Average Basket Price. Once you play with those numbers, you realize just how do-able it is. To hit that sales level, it would require only 1,000,000 visits per year, a 2% conversion rate, and a $250 average basket price. To put it another way, you only need to build your site so that it’s large enough that 2,740 people visit you from search engines or shopping portal search day (1,000,000 annual visits ÷ 365 days = 2,740 visits per day). At a 2% conversion rate, you could expect this to yield 55 orders each day. At $250 per order, that’s $13,750 in daily sales, or $3,850 in daily pre-tax profit at 28% operating margins. That gets you to your goal of $1,400,000 in pre-tax profit in a year. Find the right buyer, and you can sell for $14,000,000, pay your $4,000,000 in taxes, and walk away with $10,000,000.

Change How You Think About the Problem
Thus, the problem is not, “How do I make $10,000,000?” so much as it is, “How do I get 2,740 to visit my site each day, convert 2% of them, and have an average basket price of $250?” You can change the numbers around depending on your product mix. If you only have an average basket price of $125, for instance, you would need to get 5,480 daily visitors. It is entirely your choice how you construct your business. The point is, that thinking of the problem like that makes it far easier. Almost anyone, with enough work and dedication, can create that kind of search engine traffic. This is the reason I moved from Princeton, NJ back to the Midwest to launch our Internet companies in 2009 following the success of the first in 2007. It’s a better business model.

In my case, we aren’t really interested in selling the companies. Instead, I want the businesses to pay their income taxes and then pay up the net profits to headquarters where I can use them to invest in stocks, bonds, mutual funds, real estate, options, acquisitions, startups, or whatever else I think offers us good value for our money. That is why I call my businesses the “cash generators”. They provide me with the funds necessary to compound. Someday, our objective is to take the company public so friends, family, and colleagues can own shares and grow wealthy along with us.

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1. A $31,000 Lesson on Paid Search
2. Health Care Reform Taxes Will Hit Top 1% of Households
3. Interesting Political Fact on Taxes