How To Become Rich, Then Wealthy
Every Tuesday Chuck releases a new Trader Tip video on YouTube. This week we will discuss how if we want to become rich, then wealthy, one of the ways that we can accelerate this process is to understand how becoming rich and how becoming wealthy relate to economic cycles. Watch the Trader Tip Episode for more information!
You can read the episode transcript below or watch the video that follows.
If you have any questions, please reach out to us. We look forward to being a continued part of your trading education!
If we want to become rich, then wealthy, one of the ways that we can accelerate this process is to understand how becoming rich and how becoming wealthy relate to economic cycles. When we go through a period of growth, assets appreciate in price, stocks go up, the value of businesses go up, commodities go up, and so as such, one of the core principles we want to understand is that cash flows tend to be more stable. Asset prices go up and asset prices go down, but cash flows tend to be stable, they'll go up some, but cash flows rarely go up, and then come back down.
When was the last time you ever remember having a landlord, decrease your rent? It just doesn't really happen. When do you remember the last time the price of cars went down, or the price of anything really went down? What I want you to think about is that pricing and particularly cash flows, things like rents, mortgages, these sort of things are stable, and if there happens to be a decrease in the cost of input rather than lower the price, what usually happens is a profit margin increases. Then when we go through economic growth, and there's demand, again, cash flow might go up some, but appreciation tends to go up a lot more.
In economic growth, the value of assets goes up. You make money through appreciation, and the thing is this is where most people focus so they do really well when the economic cycle is up or we're in growth, and then they get clobbered when we go into economic contraction or recession. If the asset prices are rapidly increasing, but cash flows are stable, then the ROR, the rate of return, on basis actually goes down and you get people chasing yield. In the effort to find yield, they invest in substandard investments, just to get a little more yield. They buy junk bonds and high yield bonds just trying to get a little more yield. This tends to come back and bite them in the butt, because invariably, the market will go from economic growth to economic contraction. We want to understand is that where the rich really become wealthy is when the economy goes into economic contraction.
When the economy transitions for economic growth to economic contraction, the value of assets start to reverse, and instead of appreciating, they begin to depreciate. Now as they depreciate in value, cash flows remain stable. One of the concerns or one of the things to watch with cash flows is the default rate rises. If we own a 10 unit apartment building, our rents aren't going to go down but people might not pay their rent. The default out rate or the delinquency rates will go up. We get into a situation where a lot of times we end up in economic contraction, we end up with panics. Somebody who is overly invested at the same time loses their job. They ended up having to dump their house, dump their stocks, dump their assets to be able to raise any kind of cash, and at this point, they're no longer thinking about how much they can make, they're thinking about what they can lose.
We get depreciation of prices, while cash flow has remained stable. This is a good example of what we're seeing. This is just a really simple example where we have, let's just say a duplex that is worth $300,000 and has $60,000 a year in rent, with a rate of return on the 300,000 is 20%, but when we go through economic contraction to value, that asset can go from 300 to 150. While the rents stay constant, this takes the rate of return to 40% from 20%. We're able to buy cashflow. If we step back for a second, we become rich through appreciation, we become rich through economic growth. What does that mean? What does rich mean? Rich means we have cash. Everybody wants to be rich. Well, rich is not the end goal. The end goal is to be wealthy, Rich is about having cash. Wealthy is about having cash flow.
The way we transition from rich to wealthy is by converting our cash to cash flow. We get appreciation and economic growth, that gives us cash, especially if we can get out then assets depreciate in value, causing the cash flow to rise. What we do is we buy distressed assets, in recession, in depreciating economic contraction type markets or environments, and when we do that, our rate of return goes up, then eventually the economy will stabilize, it always does. When it stabilizes, well, what will happen is the default rate will start to rise. Now, cash flows tend to be constant, but the default rate will decline, the delinquency rate will decline, increasing the stability of the cash flow, and when the stability the cash flow increases, you're set, you're really set. Because now that 40% rate of return is real, and now you're taking $150,000 and kicking out $60,000 every year, or putting in 15 million, and kicking out 6 million every year. You don't have to worry about it, it's just more of it comes in month after month. That's when you know you're wealthy.
When you're rich, you have a bunch of cash, but if you don't do anything with it, you just become poor, because you spend it. When you become wealthy, and we talk about Infinite Wealth. Infinite Wealth is where a passive cash flow is greater than our monthly expenses. This is where the passive cash flow keeps coming in, and is fast as you can spend it more of it comes in, that's when you can really raise your lifestyle. When the economy goes into recession or contraction, this is the chance to buy distressed assets at really great rates of return. When the default rates or delinquency rates stabilize, that rate of return becomes real and you become wealthy. Then through time, you could gradually increase your cash flow, and as you gradually increase your cash flow, it's always against your basis. Now we paid 150,000 for this duplex, it might be worth 300,000 now, but our rate of return is always going to be on what we paid for it. Now if we raise our rents from 60,000 to 84,000, our rate of return now jumps to 56%. This is what the wealthy do. They buy assets in distress. Now when the economy turns around, they hold them and they pay for everything for years and years to come. This is an incredibly powerful model. You want to take time, watch this Trader Tip Tuesday again, really internalize what I'm telling you and start thinking about how you can get ready because we're nearing a phase where these types of investments are going to be happening. We are close. You want to be ready because if you get it right, it'll set you up for the next 10 to 20 years.
That's Trader Tip Tuesday for this week. Stay tuned every Tuesday, where we'll have additional webinars where we teach you different ways to think about trading and investing that will take your performance to an elite level. Have a great week. God Bless. Bye.
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