22: How the Rich Keep Getting Richer

0:00Hi, everyone, and welcome back to the Rich Habits Podcast, a top 10 business podcast on Spotify. My name is Austin Hankwitz, and as always, I'm joined by my co-host, Robert Croak. Robert is a seasoned entrepreneur in his 50s with more than 200 million in company exits under his belt, and I'm an entrepreneur in my late 20s with a background in finance and economics. Since quitting my full-time job in corporate finance a few years ago, I've built a seven-figure media business and actively advised some of the most well-known fintech companies around the world. As the show name might suggest, every episode we talk about rich habits as they relate to business, finance, and mindset.

0:38However, we try and bring you two unique perspectives along the way. One from an industry veteran, which is Robert, and the other, myself. Someone who's still in the process of building wealth and figuring it all out. Robert, what are we going to be talking about in today's episode? In this episode of the Rich Habits Podcast, we're going to be discussing the top three reasons why the rich keep getting richer. as well as how you can implement these same strategies. Specifically, we'll be talking about how the rich use leverage good debt to build their portfolios of cash flowing and appreciating assets.

1:10We will also cover the most common real estate strategies of the wealthy as well as how they get away with paying little to no taxes. It seems like almost every day we hear people say the phrase eat the rich or something of that nature. Let's be clear here. It's okay to be rich. It's okay to be a millionaire. It's actually encouraged. I think people see the ultra wealthy billionaires like Elon Musk or Jeff Bezos, and they associate them with everyday millionaires as if there should not be a separation of what their tax liability should be versus the everyday millionaire. We want everyone to be an everyday millionaire.

1:47And we've even laid out the step by step playbook in our last episode to help your children achieve that. In my opinion, mindset is one of the critical elements to building wealth and living a financially free life. If seeing or reading about rich people triggers you, then you definitely have a lack mindset and that needs to change. So with that being said, Robert, walk us through the first strategy that we see the rich using to get and stay rich. Leveraging debt to build wealth. Let's dig into that one because this is one that I believe most people on their way up or most people that have this lack mentality mindset don't understand.

2:25Here's what I mean by that. There's good debt and there's bad debt. Bad debt is unfortunately the most common. Think high interest consumer debt like credit cards, used car payments, student loans, hospital bills, and even taxes. That debt is bad and we're not at all suggesting people to keep that kind of bad debt. But there's also good debt. This is the kind of debt we love, the debt that produces cash flow and capital appreciation for the investor. A couple examples of this are real estate and purchasing small businesses. Yeah, a good example of this might even be like a car wash, right? Shaquille O 'Neal has hundreds of car washes in his portfolio.

3:02So I think he's kind of figured out the playbook and we all know that that guy's got money. Think about it like this, right? Let's say you go out and buy a car wash and you borrow a million dollars to do it. Let's now also pretend the car wash generates$40 ,000 in revenue. Because you went in debt, right, good debt to buy this cash flowing and appreciating car wash, you owe the bank$10 ,000 a month principal and interest, leaving you$30 ,000 a month to pay your employees, buy your supplies, and even keep some profits for yourself. This is a form of good debt because one, it cash flows. Two, if you're doing it right, it's likely going to appreciate in value.

3:36So when you sell it to the next person, you're probably going to make a return on your original investment. And also you'll be able to leverage tax strategies to help you depreciate and keep more of that money in your pocket at the end of the day. This is a very, very common way we see the rich get richer is they leverage good debt to buy cash flowing and appreciating assets that also have some sort of tax benefit. Yeah, I love this strategy. I've obviously been implementing it for decades now, buying and taking over underperforming and sometimes really well cash flowing businesses for myself, adding it to my portfolio because then it just gives me more profits monthly, more write-offs yearly, and just it's a great strategy in your wealth building journey.

4:15Okay, so leveraging good debt is a way the rich get richer. What's another way the rich get richer, Robert? Yes, definitely real estate. You know, you look around and all of my wealthiest friends all have real estate portfolios, and it's just a really good way to implement further strategies in your wealth building journey. So let's get started on what that means. Buying real estate is the most common form of leveraging good debt, except you're not taking out a multi-million dollar loan like you might be to buy a business. Instead, you're taking out a loan for maybe a$300 ,000,$400 ,000, or even a$500 ,000 property while also getting utility from the asset.

4:54This is key. I think what's incredibly powerful about real estate is number one is you're able to roll your profits from the sale of one property into the purchase of another property without paying taxes. This is called a 1031 exchange and generally speaking the value of real estate always goes up over time so you're perpetually doing these 1031 exchanges and avoid paying those capital gains taxes on the properties. Real estate comes in many shapes and sizes which means it might not just be buying and living in single family homes. To the rich real estate might mean storage units, RV parks, shopping centers, and even Airbnbs.

5:32Each form of real estate has its own respective tax optimization strategies. For example, with Airbnbs, a common tax strategy is called a cost segregation study. And what is great about this analysis is that the owner can depreciate 40 to 50 % of the purchase value of the property in the first year. A huge tax write-off allowing you to reinvest these profits elsewhere. The pro tip here is to understand and utilize all of the tax strategies available to you when building your portfolio. So read up and find the best real estate tax attorney in your area and strategize when first getting started on your way up and don't wait until you have multiple properties to get your structure in order.

6:18This is probably the most important to consider when you do have more than one property. I mean, I know a bunch of Airbnb investors, they've got four or five properties in Nashville. They do these cost segregation analyses. They're able to write off 40 or 50%, but without having the specific holding companies or LLCs or things of that nature already in place, it's a recipe for disaster. So I highly recommend if you're getting into real estate investing in general, make sure you have a really good tax accountant in your corner. With that being said, Robert, we've talked about real estate. We've talked about leveraging good debt.

6:53What's our last rich get richer strategy here? Yes, this is proper tax strategies. Now, this one is nuanced. So definitely make sure you're consulting with a tax professional and not just listening to two fellows on the Internet. My favorite tax optimization strategy that the rich use is the buy, borrow and die strategy. Elon Musk is notorious for this one. Here's how it works. Buy. Use your wealth to purchase appreciating assets like stocks, real estate, artwork, or anything in between. For example, Elon Musk is both awarded and purchases stock in his electric vehicle company Tesla. Next, borrow.

7:32You've purchased your appreciating asset. Now you're going to borrow against them by using them as collateral at a favorable interest rate. Historically, the interest rate is in the low single digits, far below how much the asset would annually appreciate. In Elon Musk's example, he borrowed against his Tesla stock to fund the$44 billion purchase of Twitter. Finally, die. This is pretty self-explanatory as long as you have all of your estate planning in order. This is definitely something the rich do. Before dying, you've purchased an appreciating asset, borrowed against it in the form of debt, spent and enjoyed the borrowed money on who knows what, and now you've died without paying a dime in taxes.

8:12Now, one of my favorite strategies that I think a lot of people forget about is long-term capital gains and qualified dividend income. As we might remember, there are two types of income. There's earned income and there's portfolio income. Earned income is your 9-to-5 job. It's your hourly wage. It's your salary. But more importantly and unfortunately, it's taxed at 25%, 30%, and sometimes 35%. 5%. However, your portfolio income, aka the profits you make when you sell a stock for more than you bought it for, or the qualified dividends you earn paid to you from owning that stock, are taxed at a much more favorable rate.

8:50In most cases, only 10 % to 15%, and in some cases, even 0%. If you're married and your combined taxable income was less than$83 ,000 in 2023, you're not going to pay a diamond taxes on your qualified dividends. This is how the rich get richer. Now here's the pro tip. Consider investing into equities that leverage section 1256 contracts. According to section 1256 of the Internal Revenue Code, these specific contracts allow their investors to only pay short-term capital gains on 40 % of the profits while the other 60 % of the profits are taxed at the more favorable long-term capital gains, right?

9:30Zero, 15, 20 % versus 25, 30, 35 % with short-term. My favorite ETF that takes advantage of these section 1256 contracts is called SPYI. It's an ETF that aims to track the price performance of the S &P 500 while also paying a double-digit annual distribution yield in the form of cash dividends. Very, very interesting to me, especially as someone who's looking for continual passive income through dividends. I have never really did a deep dive into the 1256 contracts. I love SPYI, so this was a great tip, Austin. Love it. This episode of the Rich Habits podcast is brought to you by NEOS Investments.

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11:27A fund's income may decline when yields fall. Fixed income securities will decline in value because of an increase in interest rates. And I know we say it every time, but thank you again for sticking around with the scripted advertisement throughout the middle of the episode. It helps us pay our video editors and our social media managers and everyone to keep this podcast moving in the right direction. So again, thanks so much and definitely go check out neosfunds.com. Now, Robert, with that being said, let's jump in to question and answer. We received 12 questions in a 24-hour period last week after our last episode about how to make your child a millionaire.

12:02So keep the questions coming. We're trying to get back to every single one of them as they come in, while also selecting some of the most interesting and important ones to display for you all here. Our theme for this episode is actually women. We decided to take three questions from awesome women that listen to the podcast, starting with Anna. Anna asks, you all always talk about earning extra income, for example, laundromats, car washes, and real estate. That's actually pretty timely here, Robert. But as someone who works full time and makes less than$100 ,000 per year, how do I do these things without taking out millions of dollars in debt?

12:34Anna, this is an amazing question, and I'm going to take this. It really starts out, Anna, by you building your base. You're working hard. You're making your money. You're getting your Roth set up. You've got the IRA going and you've got that, let's say,$100 ,000 base in traditional investments. You can get your base built, then maybe start looking at taking these investments on$10 ,000,$25 ,000 or$50 ,000 at a time to own pieces of these larger projects. You don't have to take on big debt to get started. I think a really cool follow-up there from a personal experience myself is I purchased a vending machine business on one of these biz buy sell websites a couple, about a year or two ago now.

13:17I paid$40 ,000 for it and it cash flows about$2 ,500 a month. This is something you could do as well, Anna. Maybe you start with vending machines. You go to, I don't know, maybe a different small business or something around you that's more local and pertinent. Maybe you buy up some food trucks or who knows, right? Everyone's sort of background and strategies and interests are different. For me, it was vending machines, but there are tons of different ways to increase your income. Now, I will say, you don't always have to go out and invest or buy a small business. There are tons of, if it's a REIT, if it's a publicly traded ETF like the SPYI ETF that distributes 12 % annually to its investors, there's a ton of different ways that you can take money right now in your brokerage account and earn 8, 10, 12 % on it in a consistent manner going forward without having the stress of a car wash or a vending machine business or a laundromat.

14:04And this doesn't happen overnight, right? This happens over 5, 7, 10, 12 years, not 5, 7, 10, 12 months. Okay, Lexi W, I'm going to take this one. I have 5K in high interest credit card debt on my Discover card. Is it smart to take out a 5K personal loan through SoFi with a lower interest rate to pay off that debt, then eventually pay down the SoFi loan? I love this thinking, Lexi W. I think it's smart because at the end of the day, you can't out-invest high interest debt. And if you can positive arbitrage your money, let's say that the high interest debt on the Discover card is 24 % and the SoFi loan is 12%, you are then 12 % to the good in getting yourself cash flow positive.

14:45I think it's a great strategy. More people should think like this because at the end of the day, you have to get positive arbitrage on your money to build wealth. I think it's a great question. This is called a debt consolidation loan, right? This is a very common way for people to say, I've got$10 ,000,$20 ,000,$30 ,000,$50 ,000 in high-interest consumer debt at 24%, 26%, 28 % interest. How do I still pay that debt off? The goal is to certainly get debt free from these things, but not have to pay it at 30%, maybe pay it at 12 % or 14%. Like Robert said, moving that money back into the good versus so, so much in this high-interest debt.

15:21There's actually going to be a link in the show notes below for not just you, Lexi, but other listeners right now to explore their debt consolidation options. We've teamed up with a company called Engine. What they've done is they've built a marketplace of debt consolidation offers that rank from interest rate, credit score, all the fun stuff that makes a lot of sense. So check that out in the show notes below, and we're going to show you a great way to find a debt consolidation loan that actually meets your needs. Now, our last question, Robert, comes from a woman named Taylor G. Taylor says, you all talk about credit card debt, but what about student loan debt?

15:53Is there a specific strategy I should be using to pay these off? Now, generally speaking, Taylor G, the answer here is there are two strategies I think everyone should always use to pay off their debt. One is called the debt snowball, and one is called the avalanche method. Look up at both of these. They're very simple to understand. I think the debt snowball is something that people tend to gravitate toward. However, since we're math nerds, we like the avalanche method because it's going to save you the most money in the long term. Now, with that being said, you can use either of these debt payoff strategies going forward to attack your student loans.

16:23But something I want to warn you about is I think we've seen in the headlines here recently, all this chatter about, you know, student loan forgiveness, if it's paid back over 15 or 20 years with an income-based repayment model and all these different things. Please stay away from that. That is how you have debt for the next 15 or 20 years and you pay every single month some sort of student loan payment. But for whatever reason, your student loan balance keeps climbing, right? That's because you're not actually paying anything down. You want to get out of the student loans, use the snowball method or the avalanche method.

16:51I think it's the best way and you want to get rid of this debt as soon as possible, Taylor. I love the avalanche method because it takes interest rates into account. Austin, what a great takeaway. We want to thank everyone for joining and listening and following along on this journey of the Rich Habits podcast. We are forever grateful that you guys have gotten us to the top 10. We love all of your interactions and all of your questions. It seems to be a fan favorite reading some of your questions in each episode. And we appreciate you guys following along. Don't forget, if you have a question for us, go to Rich Habits Podcast on Instagram.

17:24Shoot us a DM and ask it. This is how Taylor, Lexi, and Anna all got their questions answered on the show. And as always, if you've enjoyed listening to this episode of the podcast, be sure to share it with a friend, your yoga instructor, the guy at the Apple store that you just met yesterday because your iPhone broke. Share the episode. Let them know that you're learning Rich Habits. and don't forget to give us a five-star review on Spotify. We'll see you next Monday. Have a great start to your week.