How to get rich: The practical guide

[akula]

This theme of how to "become a millionaire" keeps propping up, so I thought to jot down a quick and practical two part guide. Hopefully, this thread might get some feedback!

Part 1: What is rich? To answer the question of "how do I get rich?", it's important to define the objective. Being rich, is a state where the personal balance sheet allows greater than average capacity for risk taking (i.e. you can afford to lose money).

The typical illustration of a rich person is Johnny putting 1mill on black, getting handed red, and then walking away to laugh it off. That's when you know that Johnny is rich - because his greater capacity for risks allows him to take more risks, and when you can do the same then you'll know that you are rich.

Now....lets have a look at some of the lessons from the example above

Part 2: How to get rich From the example above, you've noticed that the secret to getting rich is having the risk capacity which allows you to take more chances to make money. Because Johnny has the risk capacity, he cap afford to make more bets either on startup companies, bonds, real estate, roulette or other gambles. Because he can take more chances, he can expect to have more payoffs than the average person. The question is then, "how do I do the same?"

Method A - Risk Transfer. One way to get rich is risk transfer. For example, what if the original 1mill that Johnny bet wasn't Johnny's? What if he was playing on behalf of his rich uncle Dave, who gave him the capital and a promise of a share in the winnings? That's one way to get rich - by piggybacking on other people's risk capacity to get exposure to returns.

That's what entrepreneurs do when they "look for investors". They are looking for a situation where they'll get a salary and significant capital gains, and if the business fails - then they can just keep the salary. Likewise, that's what happens when you engage affiliates and commissioned sales people: you position your self to get a financial return, without accepting risk. In essence, you get rich by borrowing other people's risk capacity, without paying for it.

Action item: If you wanna get rich, put your self in a position where you get exposure to financial returns by piggybacking on a 3rd party's risk capacity - this might mean using your employer's resources to spin off a new venture, or employing commissioned sales people...but keep in mind, that smart people charge others to piggyback on their risk capacity - and it's your challange to find those who don't!

Method B - Risk Management. The other way to get rich is not by transferring risk to a third party, by taking steps to remove risks from transactions. For example, what if Johnny had bribed the casino staff to make sure that he wins his game? That would be an example of illegal risk management, but there's plenty of examples of legal risk management.

One instance is an entrepreneur securing a contract with a manufacturer where the manufacturer promises to deliver widget at price $x if an entrepreneur finds a customer, whilst simultaneuosly securing a contract with the customer that they'll buy widget at price $x+10% if the entrepreneur can supply it. This is different to the entrepreneur first buying the widget, and then trying to find the customer. In the first instance, the entrepreneur has increased her overall capacity for risk by negating the risk of one particular transaction, where as in the later example, the entrepreneur's risk capacity has remained the same.

Action item: When starting companies make sure you negate as much risk out of transactions as possible. If you don't you will not be increasing your capacity for risk taking, and therefore you will not be taking steps to make your self rich

That's the basics of becoming rich: risk transfer and risk management. Most of the time, entrepreneurs (yes, you!) don't practice either one. They start companies using their own capacity for risk, and launch products without managing the risks of individual transactions.

Most important point: Keep an eye out on when people piggyback on your risk capacity and when they transfer risk to your sorry ass!

[Gberg]

Very nice read, thank you very much for the quality post.

[akula]

yes, your friend tony is a great example of a conscious risk manager. he packed a gatt, made friends with killers and paid off the cops to make sure transactions went through as planned....and if not, there was always plan B to just shoot the place up, grab the dough AND the yeyo

risk management worked for tony, it it'll work for you too! :-)

[New billionaire]

Good info. However, it requires a lot of thinking before we can manage the risk properly. It really makes sense.

[akula]

yes, risk management is difficult because the management of risks often creates new risks (like tony's example shows)

nevertheless, the important point is very simple to remember: with transactions/investments (i.e. startups), attempt to reach zero risk (via transfer or otherwise)

ideally, in becoming rich, what you're trying to achieve is a risk free profit

"risk free" comes in two flavours; either the risk of any given transaction is relatively small in comparison to the entrepreneur's overall risk capacity, or the risk is small in absolute terms because it's been managed

the difference between skilled and unskilled entrepreneurs is that given the same transaction, the skilled entrepreneur will both engineer risk out of the specific transaction, and then place the transaction in such a structure that in case the transaction fails - the consequence is that of either alternative profit or negligible cost to the entrepreneur

skill to create risk free profit - that's an important skill

[The Stealthy One]

That's a great article! I just finished up a risk management class before heading off to break over December. Things become so much easier when you understand risk.

By the way, totally unrelated, but I really like your writing style!

[skyjoe76]

Cool writing about making money.

The last example is what I did few years back when starting out. I found a supplier and before I ordered anything from him, I look around for customers. I made the customers pay first, took the money, purchase from the suppliers.

No capital involved from me.

[keltenison]

Go become a CPA or a fund manager. Get other people to give you money, prove to them that you get profitable returns from the stock market (or whatever the CPA invests in), and you get a cut of the profit! And if the stock market crashes, everyone loses money except you, since you're not liable for it. There's usually some contract to sign with a fine print that says the CPA himself/herself is not liable for others' losses. And if it happens that you are on the receiving side of losses - all is not lost! It becomes a tax write-off.....

[akula]

yes...that's an issue

in america, australia and several other countries - ordinary people involuntarily contribute over a trillion dollars a year to various kinds of legislated retirement schemes like superannuation

this money automatically goes to fund managers who gamble with it, and when they lose (and they almost always do lose because of efficient market hypothesis), the managers are not kept accountable because my dad, your dad and everybody else's dad has no idea as to who actually invests and manages their retirement savings

in other words, yes, one of the most effective ways to get wealthy is to tranfer risk to undeducated, unsuspecting or unempowered public; which is what happens with your retirement savings, or taxes, when they are dolled out to war mongering military contractors

that's why business opportunities involving sales to governments are rather prised. it's a great way to sell overpriced goods, to someone who isn't gonna complain

[keltenison]

Good thing my company allows for me to choose which mutual funds and/or stocks to invest in!

But what I'm really interested is how they obtained this so-called "14% return" for 401Ks over the long run...... and we're talking about decades here....

[akula]

yep, that's called obfuscation: giving needless information to someone for the purpose of avoiding difficult questions

let me show you how it works

you give your hard earned money to some guy who is supposed to manage it for you

what is the first thing a sane person asks when they give money over to a stranger? how much are you gonna give me back!!

institutional investors call this the hurdle rate

notice, however, that you your self, and the other 65 million 401(k) holders, don't bother to ask this question

you give money over without knowing or asking how much you should get in return

for this reason, when the guy gives you back 14% you don't know if that's a good or a bad return, because you've never had an expectation of a return

why would something so fundamental escape the attention of so many people? it's called obfuscation - instead of asking questions about what really matters, the retiree will simply enjoy the fact that they've been given choice of what to nominate

now....back to the 14%

maybe he should have given you back 16%

what happened to the 2%?

it's your money and you don't have it

are you gonna bother asking questions?

obviously not

congratulations, you've just had risk transfered to your sorry ass!

welcome to the global financial services industry

don't feel bad, technically it's impossible to get rip off when everybody else is also ripped off

when that happens, it's just the status quo - another word for obfuscation which answers everything, yet says nothing