SECRETS OF THE RICH

The capitalist class consists of households with incomes of at least $350,000 to $500,000. Often, they are successful business owners, politicians, athletes, and executives. With 90% of wealth not inherited in the United States, almost all are self-made.

As you learned in Class in the United States and Household Income in the United States, the capitalist class represents the top 0.9% of income. Sometimes called the super-rich, members of the capitalist class often have incomes of at least $350,000 to $500,000 per year, which would require several million dollars in assets to generate. Since we know that more than 90% of wealth in the United States is not inherited, how did the men and women who make up the capitalist class get to where they are? What can we learn from them?

In this step-by-step guide, part of our How to Get Rich guide for new investors, we'll reveal the secrets of the capitalist class. You'll learn what they do differently that results in building wealth. You'll find out the philosophies that helped them reach a place where they are financially independent enough to spend time with family or travel the world.

A High Income Isn't Enough to Truly Join the Capitalist Class
Before we begin, let me reiterate the example I provided in Class in the United States to illustrate the difference between merely having a high income and truly being a member of the capitalist class.
Imagine two men, Greg and John. Greg is a medical doctor and earns $300,000 per year. He has to show up to work regularly, using the rare skills he’s acquired through a very expensive medical school education and years of on-the-job training. If he dies, or goes into a coma, his family will receive little or no income because he’s unable to work. John, on the other hand, owns a $3,000,000 limited service hotel that generates $300,000 per year for him. He doesn’t have to run it or be involved in any way because he pays a management firm to set rates, staff the property, and maintain the standards required by his franchise agreement. If John suddenly passes away or is incapacitated, his property will continue to mint money, drowning the family in cash. The family also has the option of borrowing against the equity they have in the property to acquire another hotel or expand, increasing profits further.

I've always said that the purpose of investing is to make your money work for you so that it generates cash regularly instead of (or in addition to) you having to sell your labor. In this case, John is truly a member of the capitalist class because he owns assets that generate cash for him as a result of providing needed services to the economy. In other words, John is not important or respected because he is rich; he is rich because what he has built fills a necessary need in society and the money is evidence of that. Greg, however, is very well off and experiences a standard of living among the highest in history. But he is not a true member of the capitalist class. To be, he would need to take his earnings from practicing medicine and build a collection of cash generating assets that could work alongside him, pumping out money as he focuses on healing people at the hospital.

#1: They Work on Projects that Pay Dividends for 25+ Years, Not a Single Paycheck
The capitalist class focuses on projects that will pay dividends long after they've done the work instead of on earning a single paycheck. Years, even decades later, the checks still arrive in the mail for long-forgotten effort.

The single biggest distinction between the capitalist class and the lower classes is that the members of the capitalist class focus their efforts on projects that will continue to generate dividends for years, if not decades. The lower classes do the same work, but exchange it for a paycheck that is gone once they've spent the money.

This philosophy explains a great deal why I was wealthy enough to launch a series of companies following college instead of going to work for a firm such as Goldman Sachs or Merrill Lynch. During my undergraduate days, as my friends got jobs at a local coffee roaster and Banana Republic, I focused on growing a small online company. While not in class, I'd take my computer to Starbucks, sit in the reading chair by the window, and work on expanding the business. Many of them thought I was crazy for not getting a job (and some thought it laziness). Yet, today, they've long spent the $9 an hour they received for their labor and that same online company delivers upwards of $60,000 per year in earnings to me despite requiring less than two or three hours of work each week.

To be perfectly honest, I don't even remember some of the projects I did, but like clockwork, the cash is deposited into my brokerage account each month. At the end of the year, I pay my self-employment, Federal and state taxes, and the balance gets added to my investment portfolio of stocks and bonds.
I didn't work any harder than my friends. In fact, I had a much better work environment and had total control over my time. They were frightened of failure, whereas I was willing to take that risk. The single philosophy of focusing only on projects that would result in me collecting income for long periods of time after I'd completed my work allowed me to move back to the Midwest and start my holding company. Although we began with letterman jackets, today, we have a range of subsidiaries selling everything from diamond-tipped fountain pens and upscale baby gifts to wedding supplies and cashmere scarves. The money from these operations gets paid up to me at headquarters, where I can redeploy the cash into new ventures, acquisitions, or investments such as stocks, bonds, or real estate.
This philosophy is used all the time by the capitalist class. Take the Drury Inn. The highly acclaimed upscale limited service hotel in the Midwest was began by a family that owned a construction business. They finally realized that instead of building hotels for other people, they could construct their own property, earning money for decades on the guest revenues. To borrow a phrase from a very wise business consultant: In effect, the construction company got paid once for every nail that was pounded into the building. Now, the nails are more like an annuity stream. The same cost. The same effort. Far different consequences for the owners, who receive huge monthly cash flows from the properties, some of which are valued at $15 million or more.

#2: They Diversify Income Sources as Well as Assets
Diversification of income is just as important as diversification of assets yet you're unlikely to ever hear the financial media or a financial planner talk about it. The riskiest place you can be is depending upon an employer for a paycheck.
You often hear the financial media, as well as stock brokers and financial planners, talk about the importance of diversification. But they almost always focus on diversification of assets. The capitalist class realizes that the much bigger danger is focusing on diversification of income source. We discussed this powerful concept in How to Utilize the Berkshire Hathaway Model In Your Own Life.

You inherently know this, even if you don't follow it yourself. Who would you rather be: a highly paid executive earning $300,000 from a manufacturing company or a middle manager earning $100,000 at your job plus collecting another $200,000 in real estate rents, dividends on stock holdings, consulting fees, etc.? The latter is in a far safer place and much more likely to survive recessions or bear markets.
In fact, diversification of income not only lowers your risk, it makes it easier to get rich because you can use earnings streams to buy undervalued assets when everything crashes. If you had been the executive earning $300,000 and been laid off, you probably wouldn't have been in a position to come up with money to invest when bank stocks such as Wells Fargo hit $10 per share. Yet, if you had been the middle manager, you could have used your profits outside of your salary to buy those cheap shares, even if you had lost your job, because you wouldn't have needed every penny to cover your bills.

#3: The Capitalist Class Prefers Passive Income Over Active Income
The more money you earn from passive income sources, the more time you will have to find new opportunities, study new ventures, acquire more knowledge and skills, find great employees, and spend time with your family.
Members of the capitalist class value their time. That's why they want the biggest chunk (if not every penny) of their cash to be generated from passive income sources. As you learned in Introduction to Passive Income, passive income doesn't require you to actively be involved to earn a living, freeing you up to focus on more important things, such as your family.
Passive income can come from sources as varied as:
Rent from real estate properties
Patent royalties for an invention
Trademark licensing fees for characters or brands you’ve created
Royalties from books, songs, publications, or other original works
Profits from businesses in which you have little or no day-to-day role or responsibility
Earnings from Internet advertisements on a blog or website you own
Dividends from stocks, REITs, equity mutual funds, or other equity securities
Interest from owning bonds, certificates of deposit, other other cash and cash equivalents
Pensions

Residual income for a sales person on accounts that are typically renewed automatically such as a sporting goods representative that earns a commission on his accounts, bringing in a few thousand dollars per store per year for simply servicing the customers once they have been opened
Here's an example of passive income in my own life. A few weeks ago, one of the new companies I founded in the summer of 2009 approached a local manufacturing business and signed a contract to create a software platform that would let this firm's wholesale customers order through a password protected site, track the progress of their purchase orders, track packages in real time, send messages, pay invoices, and much more. In exchange, the company didn't pay us a penny, but rather allowed us to add a 5% surcharge on all orders that came through. On the $1 million in revenue this generated, we should earn about $50,000 per year in profit because the system has no cost to us and there will be little or no maintenance going forward (perhaps a few hours each month). That money will go directly into expanding our other companies or buying shares of stock.

If we pay $18,000 in taxes on that profit, this leaves $32,000 for our shareholders. Assuming we can earn 15% on book value (easy for us) over the next 20 years, this stream of after-tax profit is worth nearly $3,278,200 to me and my shareholders. Every day we show up at the office, our goal is to find projects like that and have the money reinvested in cash generating assets. It's extremely simple. There's no reason you can find opportunities in your own life to solve people's problems and make money doing it. The secret is you must focus on how you can achieve the objective without being actively involved. If you're forced to work more hours, there's no point!

#4: The Capitalist Class Understands the Nature of Money
Money, like seed, can grow through the power of compounding. Wealthy families realize this, setting up multi-generational trust funds. A small $10,000 investment at 10% for 100 years, for instance, grows to nearly $138,000,000.
The poor and working class see money as a finite commodity; there is only so much and then you spend it until there is none left. The rich members of the capitalist class know the truth: Money is like a seed. The same principles that farmers have been using regarding sewing and reaping to provide food for thousands of years hold fast for money. Each dollar that comes in to your hand has the potential to be planted, grow, and expand into far more money. It's no different than a farmer growing corn. You can either eat your seed, or plant your seed. One gives you satisfaction today; the other can feed your family for generations.

Everyone wants to be a Warren Buffett. Yet, when you consider that an 18 year old today has 61 years to compound to reach the same age as Buffett (currently 79), it becomes clear how easy it would be to grow rich. If our teenager were willing to save $10,000 per year - an easy task for those who start out with that goal and avoid credit card debt - at a 12% annual rate of return, they'd have $83,692,000+ by the time they were Buffett's age! Yet, for most people, they are simply unwilling to do that because three years into the journey, they decide to cash out of their Roth IRA or 401(k) and instead buy new furniture or a new car. They don't realize that by spending their capital today, they are giving up the opportunity to have that $83.692 million and the corresponding $4.2+ million in annual dividends and interest it would generate! That is $350,000 per month before taxes without ever touching the principal, all from only $10,000 per year, or $834 per month. If our teenager utilized 401(k) matching by his employer, he may only have to come up with $5,000 per year in the case of a 100% dollar-for-dollar match. That's $417 per month before taxes, which he or she would get a tax deduction on at the time of contribution!

The capitalist class understands that time is the friend of money. Like a great oak tree from a tiny acorn, the longer capital can be left to grow, the larger the ultimate fortune will be. The capitalist class also understands that rate of return is extremely important. Using our earlier example, if the same teenager could earn 15% on his $10,000 annual investment instead of 12%, that seemingly small difference of 3% per year over 61 years would result in more than $336,000,000 in wealth. Only 3% per annum meant an extra $252,308,000! That's why the truly great investors ruthlessly control costs. Buffett himself tells the story of a man he knew who counted the total sheets of toilet paper on a roll because he thought a supplier was overcharging him (he was correct).

#5: The Capitalist Class Makes Its Own Luck
One of the surest ways to know that someone is doomed to be middle class forever is their staunch belief that stocks, or real estate, or private businesses are as unpredictable as gambling. They don't understand the outcome depends on your knowledge.
The lower and middle class foolishly assume that the capitalist class is merely lucky or cheats to get ahead. What they don't realize is that the capitalist class is constantly working, studying, and creating opportunities.

Think of it this way: The average person very rarely takes risks or chances. They often get up, go to work, and come home. With the capitalist class, they are researching investments, building shopping centers, finding investors, launching new products, or going after big clients every single day. When only one of these activities pays off big, it's enough to be set for life. To the outside world, it looks like mere luck.

I encountered this in my own life. Several of my family members actually asked what I was going to do with myself after I had graduated from college because I didn't get a job. The fact that I had been obsessed with investing since I was ten years old, and had saved nearly every penny to build my investment portfolio, wasn't visible to them, even thought they knew it, the same way a job is because that's how the middle class is trained to think. They didn't see me as a freshman in college buying shares of companies for spin-offs that I thought were undervalued, or trading derivatives through my SEP-IRA. Then, out of nowhere (to them), I bought my starter house for more than $300,000, my first car (an upscale Jaguar), and somewhere north of $30,000 in new furniture. How? Years ago, I set aside a very large percentage of my assets in shares of AutoZone because of the repurchase program that had begun when ESL investments got control of the firm. As I went about starting my company, those shares continued to grow and I was able to use them to pay for the personal side of my life without hurting my companies and taking money out of them. I knew that accounting rules required the reported EPS to be based on weighted average shares outstanding. AutoZone was repurchasing so much stock so quickly that the actual shares outstanding, which could be found in the 10K, were far lower than the reported figure. This let me have a decent idea of how much "safety" was built into the next quarterly earnings release. The shares had an unbelievable run from $25 to more than $150 over an eight year period.
I read several thousand 10K reports each year for companies that most people don't even know exist. I spent years studying accounting. That's what led me to that investment. Yet, there are some members of the middle class who will always believe that those outcomes were due to luck. What they don't seem to realize is the truth in the old saying if you do something once, you're lucky. If you do it twice, it's skill.
Perhaps Oprah Winfrey summed it up best when she said, "What looks like luck to most people is when preparation meets opportunity." The capitalist class is constantly out there looking for, and creating, opportunity.

#6: The Capitalist Class Doesn't Care What the Market Does
The capitalist class credo could best be summed up as, "The market may go up, the market may go down, but there will always be intelligent things to do."
One of the favorite questions of the middle class is, "What is the stock market going to do?" or "Where do you think real estate prices are going?" You'll very rarely hear this asked by a member of the capitalist class. Instead, the questions will be more along the lines of, "What do you think the Burlington Northern Santa Fe deal will do to Berkshire Hathaway's earnings five years from now on a per share basis?" or "Do you think we could get tax credits by purchasing those properties and opening low income housing rentals?"
The middle class is looking for someone to hold its hand and tell them whether to buy or sell. The capitalist class is trying to calculate the value of specific assets and then makes a decision to buy or sell based on that calculation. The former requires total guesswork, whereas the latter is entirely based on conservative mathematics and sound business.

That is one of the major reasons its rare to see capitalist class investors panicking when the market collapses. Through the credit crisis that started in 2007 and extended into 2009, as the Dow Jones Industrial Average plunged from 14,000 to nearly 6,000, the news was filled every day with stories of Warren Buffett, Goldman Sachs, or JP Morgan buying up everything it could afford.
The capitalist class credo could best be summed up as, "The market may go up, the market may go down, but there will always be intelligent things to do."

#7: The Capitalist Class Understands Taxes
A basic understanding of tax regulations can make building wealth much easier. The capitalist class understands this and studies the rules themselves, as well as hires good tax accountants.
The average person doesn't bother to read the tax rules or pay to have good accountants. It is more than possible to save substantially on taxes by learning the regulations the IRS makes available in easy to download documents on the official website.

Imagine you know a member of the capitalist class who invested $10,000 in Wal-Mart Stores, Inc. back in the 1970's. Today, those shares, with dividends reinvested, are worth more than $10,000,000 and pay out cash dividends of approximately $210,000 each year. If he wanted to come up with money without selling any shares, he'd likely know his options included:
Depositing the stock into a brokerage account and borrowing small amounts on margin against the underlying shares. The debt could be withdrawn without triggering the capital gains taxes. As the dividends were received into the account, they would lower the margin balance.
Using the shares to fund a limited liability company or a limited partnership and then gifting equity in this partnership below the gift tax levels to children and grandchildren. If he is married, between him and his spouse, he could give up to $26,000 per year to each person without triggering taxes. If he had 4 children and 16 grandchildren, this could result in a transfer of $520,000 annually. Over time, he'd be able to get a lot of wealth into the hands of his family without capital gains tax consequences.
He can setup a charitable remainder trust funded with the shares. The trust document will call for a certain percentage, say, 5% annually, to be paid out to a beneficiary of his choice (a child or grandchild), with instructions that when that person passes away, the remaining money in the trust will go to a charity he has defined as the death beneficiary. He gets a tax write-off for donating the shares, his child or grandchild gets a regular "paycheck" to help them build their life or purchase a home, and later, the charity benefits from a large donation because it's possible the account has grown in value through compounding.

These are just a few examples of how the capitalist class is able to achieve its objectives, support charity, and still end up with more money in its pockets by knowing the tax rules.

#8: The Capitalist Class Realizes Money is a Fungible Commodity
The capitalist class understands that money is money. A dollar generated from a hot dog stand has the same value as one generated from a high end Parisian fashion house. The middle class seems concerned with how, or where, the money was generated.
A defining characteristic of the capitalist class is that they treat money as a fungible commodity. This manifests itself in several ways.
Members of the capitalist class don't care if they earn their profits from non-sexy businesses such as trash hauling, storage units, or plumbing services. The middle class often does care by treating family members that are lawyers or doctors with more respect because of how they earn their money.
When raising capital to start or expand a business, members of the capitalist class don't care where the money comes from, only the terms and cost of the funds. They will often approach banks, private equity groups, or even insurance companies! The middle class heads to one, or maybe two, local banks and if the answer is "no", simply stops trying.
The capitalist class doesn't compartmentalize money like the middle class does. Members of the middle class who are drowning in credit card debt will often use unexpected bonuses or tax rebates for vacations or other perks. The capitalist class sees every dollar as a dollar and puts it toward its greatest use.

#9: Profile of the Capitalist Class
The best word to describe members of the capitalist class would be stability. They have been married to the same spouse, lived in the same house, and been in the same business for decades. They've diligently invested and built their assets over time.
So, now that you know some of the secrets of the capitalist class, it might be useful to see who the average member of the capitalist class. According to government and private research data, the capitalist class:
More than 90% of capitalist class households consist of a Caucasian married couple where both spouses work and have children.
More than 90% did not inherit their money - they are entirely self-made.
Most own their own business and have lived in the same town for more than a decade. These businesses are unglamorous and include things such as HVAC, commercial plumbing, self-employed lawyers, accountants, and real estate investors.
More than 90% own their own home and have lived in it for years. Fewer than 7% rent or lease.
More than 90% graduated from college, but grades had no correlation with their financial success. In other words, students with a C- average were just as successful as those with an A average.

#10: The Capitalist Class Thinks of Business as a Game
The capitalist class thinks of business as a game. For most business owners, it really isn't about the money at all. The motivation is to build something and to win; whether it's beating competitors, or competing with themselves.
The middle class often has an almost perverse relationship with money. From the time students leave college, they are told to get a good, "secure" job with benefits, fear stock market fluctuations, and spend their money on assets that depreciate such as cars and consumer electronics. For the capitalist class, business and money are merely tokens - tangible proof that they have succeeded. Some capitalist class members have described the balance sheet as the "score card" by which they can compare themselves to their competitors.
My own office is filled with framed Carl Barks artwork of Scrooge McDuck, reproduction Monopoly properties, and hundreds of books including some as old as 80+ years. The walls are lined with stock certificates and my first dividend checks. The Wal-Mart stock, for instance, has a collectible die-cast Wal-Mart truck next to it in the display. This is because I love playing the game of business. I want to see how large I can grow the company. For my retail subsidiaries, I want to see just how many sales we can generate. I love turning on television or going to the movies and seeing products that we sold to the movie studio on the screen.
This approach to business, and life, makes it easier to take risks. It removes a lot of the fear because you know that if you lose money (which, of course, you always avoid at all costs), you're only one idea away from rebuilding the asset.

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