The first and biggest “wealth drain” is taxes.
Our tax system is designed to penalize hourly and salaried workers while rewarding entrepreneurs and business owners. Salaried workers pay taxes based on what they gross, while business owners pay taxes based on what they net. To that end, most people think Fortune 500 companies getting something over on little guys. Keep in mind, you don’t have to be a big business to get great tax advantages. Even startups get huge tax benefits. So rather than complain, maybe you should run a business from your kitchen table.
To qualify for tax deductions in that business, the IRS says you must intend to make a profit. When that standard is met, you automatically qualify for dozens of tax deductions that you don’t get as an individual. Most losses and startup expenses can be written off against other income from your job (limits apply, so get a good business CPA to work with you). Realize that nobody else (not even your CPA or tax preparer) cares how much you pay in taxes, so it’s your job to understand how the system work and how to use it effectively.
Losing the Chance at Compound Growth
Another set of huge wealth drains are market losses on investment capital that you control. When a stock or a piece of real estate drops significantly in value, it could take years for you to get back to even. And, of course, there are no guarantees that it will come back during your investment lifetime. The less capital you have invested, the less you can benefit from the power of compounding growth.
If the compounding curve of your money is broken by market losses or premature withdrawals, it has a massive effect on your final pool of wealth. For example, if you were offered a job that lasted only 36 days and you had two choices on the pay plan, which one would you take? (A) You could be paid $5,000 per day at the end of every day, for a total of $180,000. (2) Your second option is to be paid one cent starting on Day One, but your pay would double each day – be compounded by 100 percent – and payable at the end of those 36 days.
If you jumped at the $180,000, you missed the power of true compounding of money. If your coworker doing the same job chose the compounding penny, he wouldn’t be a millionaire. After 36 days… he’d be a filthy rich multimillionaire with a final check of $343,597,384. Obviously, your investments won’t experience such rapid (or consistent) compound growth, but do the math – the power of the compounding curve is strong over time – if you don’t break it with big losses (which you can’t always control) or withdrawals (which you can).
Money Lost in Fees and Interest to Banks and Financial Companies
The next massive wealth drains we face are interest and fees paid to banks or finance companies. Money-lending has been around for thousands of years, and any business model that’s lasted that long is a winner – for the business. But when you’re on the borrowing side of the transaction, it’s a wealth drain, especially if most of your borrowed money is spent on depreciating assets
Now, people will tell you that if you can borrow money cheap and invest it in something that has a higher rate of return than the interest rate you’re paying, then you’re using leverage properly. That can be true, but those attempting such a move should be aware of the caveats. Try this simple exercise: Add up all the money you’ve paid out over your lifetime in monthly payments. Then compare that total to the amount of money you have saved for retirement and see which one’s bigger. (If you’re willing, we’d love to hear about your results in the comments section below.) Then think about how to be a lender, and not a borrower.
Depreciation of Vehicles and Other Large Assets
Another massive wealth drain comes from the depreciation of cars, boats, equipment, appliances and most other large assets we buy. Most people will lose more money on cars during their lifetimes than they’ll ever save for retirement, let alone all the other depreciating assets they’ll buy. But there’s a way to make money on these items.
Think of your financial life as a big pie. Don’t fall for the old magic trick and focus only on what’s happening to your one slice of the pie (i.e., your investment gains or losses). Instead, pay attention to the whole pie and put a stop to your massive wealth drains.