It is often said that the three main sources of wealth creation are the stock market, real estate, and entrepreneurship. With this knowledge as a starting point, I embarked on a journey to find how people around the world had built significant wealth. I graphically documented and codified the results of my study into the chart below. Much of what I share comes from my experience of over 36 years as an entrepreneur, investment banker, securities analyst, investment portfolio manager, private equity fund manager, university professor, and investment newsletter editor and publisher.
The Wealth Creation Pyramid
1. The Stock Market
Starting on the right side of the pyramid, from the bottom up, the first category is how we like to invest in stocks. While there are many ways to invest in the stock market, in my experience as the CEO of my management consulting and investment management firm — as well as the vast amount of academic and practitioner literature that I have reviewed — I have found that value and dividend stocks produce the best long-term performance results of any stock selection methods. I created a model known as the Cassandra Stock Selection Model, which is a quantitative stock-picking model I developed 24 years ago to pick value and dividend stocks that also have good growth prospects. You can see this model in the chart above. (See a more detailed version here.)
2. Alternative Investments
Alternative investments can provide very attractive returns but also generally carry a much higher level of risk. Accordingly, I’ve placed them higher on the pyramid. There are many different asset classes that are considered alternative investments. Some examples are real estate, fuel sources, and private equity. Alternative investments may reduce the overall volatility of an investment portfolio and provide greater investment returns and diversification.
3. Special Situations
Investments in this category can take many forms. For example, a special situation could be a very undervalued real estate investment. Some stock analysts consider special situations to involve corporate event-driven actions such as mergers, spinoffs, liquidations, acquisitions, situations involving activist investors, and turnarounds. In almost all cases, stock analysts believe the target company or investment must be undervalued to be a good special situation opportunity. In the case of undervaluation, the more undervalued the better, as this provides a margin of safety. As with other investments, we calculate our estimate of the special situation’s intrinsic value where possible.
4. Visionary Ideas
We conceive of a visionary idea as a business idea or model that is new and transforming. By transforming, we mean that it is an idea or model that has not been used before, but that will have a significant influence on the way the world does things in the future. Examples of visionary business ideas from the recent past, which are playing a significant role in today’s world, are Starbucks and Uber. If we go back further in time, the automobile had a significant impact on the world when it was first introduced. Going back even further, the printing press transformed the world of its time. Visionary ideas that are moving to the forefront at the current time are self-driving cars and artificial intelligence, to name just a couple. These are the ideas that many entrepreneurs strive for and have been known to deliver both industry-wide disruption and success.
5. International Stocks
Starting down the left side of the pyramid, the first category is international stocks. Studies have shown that international stocks can provide good diversification for a stock portfolio. Buying individual international stocks, though, is not for everyone. Successful investing in international stocks requires knowledge of different countries and their languages, customs, and accounting standards. There are also major differences in international stock markets, currency issues, and the general reliability of international companies. For these reasons, it may be best for most people to invest in the international markets via well-run and knowledgeable mutual funds.
6. Real Estate
Real estate is one of the main sources of wealth creation. There are many types of real estate one can invest in — examples include single-family homes, multifamily residential, self-storage, office buildings, and industrial. There are many good real estate investment clubs around the country that help people invest in real estate. They provide education, networking, and resources, which can help you with entrepreneurial and business-related efforts. You can do a Google search to find groups in your geographical area.
7. Fixed Income and Cash
Fixed income investments such as corporate bonds, government, and federal agency, securities and cash have only limited wealth-building properties. They can provide reliable income, and many financial planners recommend that one holds a portion of their assets in these types of fixed income — particularly as they get older and their investment time horizon gets shorter. Many financial planners also recommend holding a certain portion of one’s assets in cash for liquidity, emergencies, spending, and other reasons.
In my years of experience, I have seen that starting one’s own business is one of the best ways to build wealth. The business must be successful, of course. Unfortunately, statistics show that most businesses either are not successful or, perhaps worse, are only marginally successful, leading one to a subpar means of making a living. But starting a business can be one of the most interesting challenges that a person can pursue. There are many resources for entrepreneurs who want to start and grow a business. The U.S. Small Business Administration is a good place to start.
9. Multiple Sources Of Income
Having multiple sources of income and wealth provides increased opportunity and diversification. Some people have two or more jobs, some have two or more businesses, some have a job and a business — a good strategy, in my opinion. Having two or more sources of income and wealth increases the likelihood that your total income and wealth will be greater over time. A word of caution though — in pursuing multiple sources of income and wealth-building strategies, be careful not to overextend yourself. This is especially true for business owners and entrepreneurs who have multiple endeavors operating at once.
Well, there you have it! These are nine of the most important ways of creating wealth. Good luck on your journey to building wealth –and have fun with it!