Why is it that only one percent of the population are truly wealthy, only four percent are financially independent which means they could live without having ever to work again, 15 percent have some savings at retirement, and 80 percent of the population are dependent on pensions, still working or broke at retirement? How could this be in one of the richest countries in the world? Why does every first world country have the same dreadful statistics?
Early to bed and early to raise helps make a person healthy, wealthy and wise’ is a time honoured proverb that seems to have run into some difficulty in the modern world. The World Health Organisation informs us that anxiety and depression will be the number one disease in the world by 2010. And despite the fact that Ireland is now one of the wealthiest countries in the world, about 23 percent of the population are living ‘at risk’ of poverty. As high as 72 percent of workers are unhappy going to work every day. So, while health, wealth and happiness are still the big three aspirations that most people seek in their lives they seem to be under pressure on all fronts.
The answer to the question Why do the rich get richer and the poor get poorer‘ has intrigued me for more than 20 years, and having researched the subject exhaustively I have come up with some conclusions.
First, let’s consider who are the wealthy few and, more importantly, how do they become wealthy?
Wealth management bankers outline three divisions or levels of wealth:
The Mass Affluent: There are probably 100,000 or more ‘ordinary’ millionaires in Ireland, when the asset value of private homes are considered. Many are accidental millionaires because of their property based wealth. The population now has 600,000 men and women in their late 50s and 60s who may well represent the first Irish leisured class who have down-traded their family homes at exorbitant gains. These are jokingly called the ‘worried wealthy’.
High Net Worth Individuals: There are 15,000 HNWIs in Ireland, in the category of €2-25 million, and they constitute the real core of wealthy Ireland.
The Ultra Wealthy: Many of these are ‘old gold’ or family empires and fall into the €26 million + category. A further refinement from the Revenue Commission shows that there are 250 individuals with net assets of over €50 million each. These two categories alone have estimated assets in excess of €43 billion according to the same source.
Today 85 percent of wealthy people are self-made, first generation, millionaires (the other 15 percent inherit their wealth), and all the indicators suggest that there are five pathways to becoming wealthy as follows:
1. Business Owners
The ability to start and build your own business entrepreneurship accounts for 74 percent of all self-made millionaires. There are about 150,000 business owners in Ireland. The casualty rate is high with 58 percent of start-ups failing within five years yet more than half the population dream about setting up their own business. Managerial incompetence and inexperience is the number one reason for business failure. Interestingly, the average self-made millionaire has been broke or nearly broke 2.4 times before becoming wealthy.
2. Corporate Managers
Being a highly-paid executive in a fast-growth or very successful company is another way to get rich. About 10 percent of HNWIs get wealthy by being well paid and promoted as professional managers, earning stock options, bonuses, and getting involved in profit sharing schemes. Ireland is well endowed with multi-national organisations that produce wealthy individuals.
3. The Professionals
About 10 percent of self-made millionaires are doctors, dentists, lawyers, architects, engineers, consultants and others with specialist degrees who can charge high fees for their services. Their specialised knowledge makes their contribution extremely valuable and their clients pay above the norm for their services. They get paid more for what they have done services rendered and their expertise than for what they do in any specific transaction. According to the Competition Authority the average income of a senior counsel is €270,000 while the top 10 percent earn more than €600,000 a year.
4. The Sales Supremo
An interesting category of self-made millionaires about five percent are professional sales people. These people never started their own business, or earned professional degrees, but became very good at selling a product, and are well paid for doing it. However, they managed their money very smartly, invested it intelligently, and made it grow until they become millionaires. Some sales executives earn huge bonuses and commissions because they create value in the sales process and deliver exceptional sales growth, the most important ingredient in business success.
5. The One Percent Rest
The final category of self-made millionaires fall into the general category of entertainers, sports stars, authors, lottery winners and all other sources. These get lots of media attention but merely make up the numbers in real wealth terms. They are the exceptions to the rule in almost all cases for their category. For example, film stars make millions, but 90 percent of all actors earn very average incomes. Sports stars get lots of news, but most full-time sports professionals just about survive.
You may already fit into one of these categories or you may be exploring which option is best. To the lay person money has a bad reputation because most people don’t have enough of it. To justify their lack, you will hear them say, ‘money is the root of all evil’ or ‘money will not buy you happiness‘. Both of these ideas are completely wrong. They are used only to rationalise the failure to have money. Money is not the root of all evil; disastrous money management could be! In fact, money makes sense in a language all nations understand.
Do you want to be rich or wealthy? There’s a big difference. There are a lot of pseudo symbols of richness, like the school or college you attended, or the prestige attached to your occupation, or the neighbourhood you live in. Rich can be status oriented.
Being financially independent or wealthy is building a lifetime asset. The best measure is your net worth. Net worth is the current value of your assets less your liabilities. Wealth generation requires more an attitude of mind in the first instance and is the result of a lifestyle of hard work, perseverance, good financial planning and, most of all, self-discipline.
The one-sentence key to financial success is ‘spend less than you make‘ Wealth is not income. Wealth is more cash-flow from other source to build passive asset sources. High income rich people may make big money but also have big mortgages, heavy taxes, and penal repayments. Big wage earners often get their wages to spend to maintain their high status lifestyle. They are often prisoners of a high standard lifestyle. Status-seekers in other words. Wealthy people have been interviewed, studied and observed exhaustively and one of the best books on the subject has sold three million copies. The authors of The Millionaire Next Door point out that, Those who look rich, and those who are rich‘ can be very different.
Most wealth generators, on the other hand, have a self-employed attitude and use their money to invest in their business or for future personal and family enrichment. The sad part of this is that many high income earners in the executive world have small levels of accumulated wealth. They live from paycheque to paycheque. Another figure to ponder is that economic wealth per head of population is €36,100 which ranks us as one of the most prosperous countries in the world.
Wealthy people play the tax game superbly by building up enough assets to generate sufficient income to support themselves. The objective is to legitimately gain tax relief and benefit as an investor and therefore minimize the amount they pay to the Exchequer. The bottom line is that PAYE employees and the self employed (to a lesser extent) are almost fully caught in the tax net and typically pay marginal tax at 46 and 48 percent.
Business owners/directors can accumulate large profits in a company and only pay tax at 12.8 percent. Tax shelters and rental property schemes reduce the pain of taking profit out and they pay tax at 42 percent on the rest.
Investors, of course, live off income from their assets (rental income, share dividends) and don’t need to work in the normal way to live. This is true wealth in action. The twin question for you to consider is, Which category are you in now employee, self-employed, business owner, investor and which option will you be operating in, say, five years time?’ You may, of course, have an ideal mix of all four options that you prefer to work with.
People argue that wealthy people are ‘lucky’. Luck, however, has been defined as ‘LabourUnder Correct Knowledge’. It is when preparation meets opportunity. In other words you make your own luck. Luck is really a matter of probability. There is a probability that virtually anything can happen, and you can personally increase or decrease the likelihood of something happening or not happening.
For example, there is a probability that you could be killed in a car accident, but you can reduce this probability enormously by not driving after taking drink, driving within the speed limits, and wearing a seatbelt.
There is a 5 percent probability that you will become a millionaire in the course of your lifetime. On the flip side, there is a 95 percent probability, according to all the current statistics, that you will not save one million euro in your lifetime. However, the law of averages dictates that luck is a function of the number of things you try. If you put yourself ‘in harms way’, and try more things more often, the luckier you get. Risk and commitment seem to go hand in hand. Without commitment there is hesitation, the chance to draw back, always ineffectiveness.
The Rich Executive vs. The Wealthy Business Owner
John Butler was recently coaching a high income executive earning more than €200,000 a year whose finances were in a total mess. Living beyond his means for years and with a seemingly total inability to spend less than he was making, his affairs were debt ridden, stressful and putting his whole career on a knife edge because of his inability to concentrate on key performance factors. This highly educated professional, with two university degrees under his belt, was paralysed at the idea of personal financial mastery. His net worth was negligible and his robbing Peter to pay Paul philosophy was causing tremendous problems in his marriage and a total confusion in his own mind between the fact that he could earn such a high income and yet be in such a mess. Butler worked closely with him over a six month period to get his attitude changed and helped him make some basic but key financial decisions.
By contrast a business owner Butler was advising on the sales of his business had net assets of six million euro in a well spread portfolio of nest eggs’. He was moving from business owner to full-time investor with a goal to increasing his net worth to €12 million in five years. Both men were in their early 40s. One was rich the other wealthy.