Six secrets wealthy people know

If you want to become seriously rich, then learn these six lessons for life.

After turning 18, I set myself some goals to achieve before I reached 40. These included learning to drive, writing a book, and being worth £1 million.

Although I met most of my life goals, some happened in a roundabout way. For example, I passed my driving test first time in 1996, but stopped driving in 1999. Likewise, I had always intended to write a work of fiction, but my Financial Times book was published nine months after I turned 40.

As for becoming a millionaire, my household wealth first reached £1 million on the day of my 40th birthday, just over two years ago. Given that I was heavily in debt at 30, this was a remarkable turnaround.

Six lessons for life

Somewhat peculiarly, I’ve discovered that I’m much better at making money in ‘bad’ times than ‘good’. For example, the vast majority of my wealth was made in the stock-market crashes of 2000/03 and 2007/09. This may be because, as a ‘contrarian’ investor, I prefer to go against the herd.

Anyway, here are six ‘life secrets’ that I’ve collected along the way. Some come from my own experiences, others from far wiser -- and richer -- individuals:

1.     Be your own boss

Although I’ve spent 23 years investing in the shares of other companies, I sincerely believe that the best business to own is your own. Sure, the red tape, paperwork and general bureaucracy can be stifling, but the benefits more than outweigh the burdens.

Having run my own one-man company since late 2005, I know that when I work twice as hard, I can earn twice as much. Likewise, working at home gives me a level of personal freedom and flexibility that I never had as an employee. In addition, after the taxman’s had his cut, all of the fruits of my labour go to me. When all’s said and done, you can’t beat being your own boss.

2.     Debt can be good or bad

One crucial lesson which rich people learn is that there is ‘good’ debt and ‘bad’ debt. Debt run up from shopping sprees, foreign holidays, flashy cars and high living is bad debt, because it drains your wealth. On the other hand, debt used to further your education, build a business or buy a home is good debt, because it usually builds long-term wealth.

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Likewise, interest-free debt -- such as a 0% credit card -- is infinitely preferable to, say, a store card charging 30% APR. At this sky-high rate of interest, your debt will more than double every three years, thanks to interest alone.

So, treat debt wisely: use it to buy assets which go up in value over time, and don’t spend money you don’t have on depreciating assets, consumer disposables and needless luxuries.

3.     Property is often a good buy

One oft-quoted rule of thumb is that ‘property prices double every seven years’. While this may be the case during house-price booms, it’s simply not true over the long-term. Indeed, I crushed this myth in this article from January 2008. That said, house prices rarely go down over the course of a decade -- the last time this happened was between 1989 and 1999.

So, buying your own home with a Best Buy mortgage usually makes good sense -- unless you overstretch your finances or buy at the top of a bubble, of course. Similarly, buying premises for a business adds up (although commercial property prices plunged 45% from their peak before starting to bounce back in 2009).

4.     Pensions still make sense

On 6 April 2006, known as ‘Pensions A-Day’, the government scrapped a heap of existing pension legislation, replacing it with a simpler, more attractive and more flexible regime. This led to a boom in contributions to personal, stakeholder and self-invested personal pensions.

Alas, the previous Labour government couldn't resist meddling with this simplified regime. First, it introduced a new 50% tax band which applied to those earning over £150,000 a year. And from this April, it would have introduced tapered tax relief, restricting the amount of tax relief that higher earners could claim, aimed at anyone earning £130,000 or more a year.

However, the coalition government has simplified matters and instead of reducing rates of tax relief for higher earners, the overall contribution limit will be dramatically reduced from £255,000 a year to just £50,000 from 6 April 2011.

The £50,000 allowance is the limit you can pay annually into your pension and still qualify for tax relief. Although this sounds like a huge reduction, the number of savers likely to put away more £50,000 a year into their pension is relatively small.

So for many workers, pensions still make a lot of sense, as they will still enjoy tax relief on their pension contributions in the same way they do now. All savers still get tax relief at their highest rate of tax, so those who are paying the 50% additional tax rate will still qualify for a 50% tax break on their pension payments. You can find out more in Government cuts will hit your pension.

5.     Diversification sometimes fails

Diversification is a simple concept: in order to avoid losing your shirt when one asset takes a tumble, you spread your money around between different asset classes. For example, using ‘asset allocation’, you choose a mixture of shares, bonds, property, commodities and so on.

Alas, when asset classes become highly correlated (follow similar patterns), diversification can become ‘diworseification’. Notably, this happened during the credit crunch and economic downturn of 2007/09, when the prices of property, stocks and shares, commodities and credit all plunged steeply, more or less as one.

So, don’t assume that spreading your money around automatically makes it safer. When asset prices become strongly correlated -- for example, during global bubbles -- then diversification can fail. Indeed, the only guaranteed way to diversify is to hold good old-fashioned cash. Only during times of trouble do some investors learn that ‘cash is king’.

6.     Inherited wealth can be a problem

You may have got rich slowly or quickly. You may have found building wealth to be easy or hard. Regardless of how you made it, you’re going to have to part with it someday.

One way to wave goodbye to your wealth is to go SKIing: Spending the Kids’ Inheritance. After all, if you die leaving nothing of value behind, then you don’t have to worry about inheritance tax (which can gobble up 40% of your wealth above £325,000 on death). Alternatively, if you want to pass on a sizeable sum after you pass on, then you’ll need to do some inheritance-tax planning.

Then again, leaving a fortune to your children or other relatives could cause more harm than good. This is particularly the case when dynastic wealth is at stake. It’s worth noting that Warren Buffett -- the world’s greatest investor and the third-richest person on Earth -- will leave almost none of his $47 billion fortune to his offspring.

Instead, Buffett’s great fortune will go to charity. A wise move from a super-smart man!

This is a classic article that has been updated for 2011.

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