Do you suffer from investing intimidation? Building wealth doesn’t have to be complicated. There are core principles that, when applied, will guide you to success. However, making money is very different from earning money. When you work a job, your paycheck is directly tied to your time. However, when you invest, the money you make far exceeds the time you spend researching and purchasing your assets.
Building passive income does not entail passivity in the investing process. Wealth builders actively cultivate their resources. You should never invest in what you don’t understand.
There are fundamental finance principles that every wealth builder knows, and this blog will shed light on five of them. They are:
- The Law of Conversion
- The Law of Compounding
- The Law of Income
- The Law of Leverage
- The Law of Acceleration
The Law of Conversion
The essence of The Law of Conversion is creating value. It is a foundational law of wealth because wealth is created when you convert a lower-valued asset into a higher-valued one. Take raw materials like wood or recycled paper, for example. Artisans or manufacturers can turn those materials into products like furniture and journals. Suddenly, they are worth much more.
It works the same way with real estate. Investors learn how to purchase a property for less than it’s worth, so they have instant equity in the home. Then, they add additional value by renting it out, rehabbing it, or both. Let’s say I’m looking at a single-family home that needs new carpet, paint, and updated appliances. So, I negotiate a lower price point and create a higher value by renovating the house. When I’m done with it, the house is worth far more than I paid for it.
Some of the biggest mistakes I’ve made in my life involved trying to multiply before I was fruitful. Good investors grow their assets from their increase so they don’t wipe the foundation out from under their feet. The Law of Conversion involves multiplying what is already in your hand before you seek new opportunities.
Applying the Law of Conversion could be as simple as buying one house and learning how to manage it before you turn it into an investment property and purchase another one. The same principle applies to business. If you want to own several coffee shops one day, you must ensure you can be profitable with one first.
The Law of Compounding
Albert Einstein called compound interest the most powerful invention of the 20th century. It’s interest on interest, which grows much faster than interest on a principal amount. The Rule of 72 exemplifies the Law of Compounding. It means that if you divide the interest rate on an investment into 72, the answer is how many years it would take for your money to double. For example, if your APR is 10% (roughly the annual return for the stock market), it would take 7.2 years for your money to double.
Let’s look at how this applies to real estate. On average, homes appreciate between 3.5-3.8% per year (This is a modest estimate–between May 2021 and 2022, the average home appreciation was over 14%!) If you bought a property for $300,000, you would earn at least $10,500 per year in appreciation.
Not only did I make $10,500 on my property at a 3.5% return, but my down payment was only 10% on that $300,000 property. This means I put $30,000 down on that asset to acquire it, but I got $10,500 in appreciation. That’s over a 35% return! According to the Rule of 72, I would double the $300,000 at 3.5% in about 20 years. But I would double my initial investment of $30,000 in just over two years! Can you see why the law of compounding is so powerful?
The Law of Income
Every wealth builder needs to know how they are going to get paid. Let’s say you work at a job and don’t receive your paycheck. If you have any common sense about you, you’ll go to your boss and say, “Show me the money!” However, people don’t expect their investments to pay them the same way. They invest in what they don’t understand and hope for the best. To abide by The Law of Income, you must know how and when an investment will pay you before you decide to add it to your portfolio.
If you invest in stocks, you have to sell them to get paid (unless they’re dividend-producing stocks.) If you invest in an IRA, you’ll need to wait until you’re 59 1/2 to take your gains. The key is to balance long-term investments with short-term ones. If all your investments don’t pay you for several decades, you’ll miss opportunities because you won’t make enough passive income to actively stay in the game. That’s why I love real estate. You don’t have to sell to get paid because you can generate rental income from the property.
The Law of Leverage
Archimedes said, “Give me a lever long enough and a place to stand, and I can move the world.” A lever enables you to move more than you could by using brute strength alone. That’s the power of leverage. Investopedia defines leverage as “using borrowed capital for (an investment), expecting the profits made to be greater than the interest payable.” In other words, the law of leverage gives you the ability to take control of an asset by using good debt.
Good debt allows you to purchase a larger asset that appreciates. Bad debt, such as consumer debt from credit cards, goes toward purchasing liabilities that will decrease in value. When paired with wisdom, an example of good debt is a mortgage. Let’s say I used $20,000 for a downpayment on a $200,000 property. If I got a 10% return that year from a mixture of appreciation and cash flow from rent, I’d make $20,000–a 100% cash-on-cash return. That’s the power of leverage–it allows you to use debt to multiply your returns (which allows you to pay off the debt more quickly.)
The Law of Acceleration
The Law of Acceleration builds upon the Law of Leverage. Let’s use the example of the real estate we purchased for $20,000. Remember, the average appreciation rate for real estate has been around 3.5% annually. So, if you refinance the property in 24-36 months, that same property should be worth approximately $214,000–$221,00 during that time frame (depending on the market). Also remember that you paid a downpayment and have been paying off your mortgage, both of which put equity into your property.
So, if you have enough equity in your property (at least 20%), you can refinance and take money out to purchase another property. With the same $20,000 you started with, you can acquire two $200,000 assets. With patience and wisdom, you can rinse and repeat the process in 2-3 more years. The Law of Acceleration allows you to purchase multiple assets with the same pot of money.
Do you want to learn more about how you can make money and maximize your resources? The 2023 WealthBuilders Conference will show you how to apply these laws of wealth to real estate, business, paper assets, and more–all from a biblical perspective. Join us in Denver, Colorado, or online via livestream February 17th-19th. Click here to learn more about the Conference and how you can register.