Marissa Mayer retired from Yahoo after 5 years as CEO with over $200 million. According to SEC filings, Mayer owned 4.5 million shares of Yahoo on exit. She was also given a $23 million severance for walking away. In today’s day and age those who take risks and have equity get to retire like a boss.
Capitalism Rewards Owners and Top Talent
Capitalism is an interesting system. Owners and those with very unique talent are rewarded financially in our society. Meanwhile hard-working folks at W2 jobs struggle to get by unless they’re janitors in San Francisco. This is due to how our tax system is set up. The proof is right here in the way different income and capital is taxed.
Self-Employed Earned Income:
$30,000 taxed at 12.4% for Social Security, 2.9% for Medicare, 28% Federal tax bracket, and 8% state tax bracket = $15,390 tax due
Employee Earned income:
$30,000 taxed at 6.2% for Social Security, 1.45% for Medicare, 28% Federal tax bracket, and 8% state tax bracket = $13,095 tax due
2017 Federal Tax Rates
$30,000 taxed at 15% if you’re in the 25 – 39.6% tax brackets = $4,500 tax due
Capital Appreciation / Business Equity:
$30,000 invested in a business is NEVER taxed. Not until you sell. The key here is that you can continue to generate money on the amount invested (tax free growth too!).
For example, let’s say I own 1,000 shares of Berkshire Hathaway Class B stock worth $250,000. Let’s assume then that the P/E ratio expands because Buffett kicks the bucket and a new brilliant messiah takes the reigns. The shares are immediately bid up making your share now worth $500,000. You pay zero on the gain because you didn’t sell anything. You could borrow against this amount if you needed money and you’d still pay zero tax.
Same thing for a business owner. Let’s say you have $1,000,000 in capital invested in the business. You can continue to grow this amount by investing in the company. As long as you invest in projects that have a positive net present value, you’ll continue to grow your capital. You’ll have to pay tax on earnings of course, but if you invest in the company, you’ll be able to snowball your capital. Look what Amazon did over the past 20 years. Their goal was not to make a profit but to grow, grow, grow. They care about revenue and market share, not GAAP earnings.
This is also why it sometimes makes sense for companies to either invest in themselves by either expanding operations or buying back shares instead of issuing dividends. There are tax benefits to continuing to invest back into the business. Warren Buffett explains this in depth in his 2012 letter to shareholders. If you hold equity as common stock, it can be better to sell off shares of the business as you need to instead of having the business issue you dividends. See the “Dividends” Section of Buffett’s 2012 letter to shareholders why it may be better to sell shares in a business instead of get dividends.
Starting to see why it’s so much easier to get rich off of being an owner versus W2 employee? Owners get to compound their equity without being taxed. Employees get taxed every year regardless. It’s much harder to save up a large nest egg when you have to pay ever-increasing taxes on earned income.
Getting Your Equity
I’ll never forget what one of my professor’s said during an entry level economics class. To paraphrase she said that the world is full of economic opportunity and I challenge you to go out and achieve prosperity. I couldn’t believe what I was hearing. A college professor was telling me to go out and succeed in the world. Usually college professors want you to get a job but to actually say go out and take your share of the pie is pretty incredible.
I think everyone should have equity ownership in something. This would even include your house, which is generally not thought of as an investment. Here’s a list of equity positions:
1) Home Equity – While it’s not a great investment, it’s good to have some home equity. The reason it’s not a good investment is two-fold: 1 – it’s just sitting there earning a negative yield, and 2 – you can make so much more money elsewhere.
2) Rental Equity – Building equity in rental homes is a great way to build wealth as long as you have some competitive advantage. I’m a fan of Jason Hartman’s refi-til-ya-die strategy for reinvesting your equity into other properties. As far as I can tell, there are three ways to invest in real estate and make money: bargain purchase (buying below market value), high cap rate (renting for at least a 10% cap rate), and appreciation (buying in up-and-coming neighborhoods). If you know where I can find any good deals, please let me know (east coast preferable).
3) Stock Equity – Stocks offer the kind of equity that most folks can accumulate. You can own outright through direct ownership in individual stocks or through funds. Fees can be a problem when you’re investing in stock funds. You want to make sure you’re not over-paying for fees.
4) Business Equity – Equity in a business is yet another kind of equity. Whether you’re a LLC, LLP, S-Corp, or C-Corp, having ownership in a business can make you very wealthy. The business has to do well of course. Or even do poorly but someone has to be willing to pay up for it. Good luck with that.
You can get equity through various ways. You can be bequeathed it, earn it, or be awarded equity. Wait, isn’t being awarded equity the same as earning it? I’ll let you decide. What some people don’t expect or can’t comprehend is that sometimes there’s a bit of luck involved. You don’t always have to be super smart to be rich.
Retiring With Tons of Dough
Maybe you won’t make it to $200 million like Marissa. That’s okay. She’s an outlier and you shouldn’t compare your retirement funds to hers. What you can do is make sure you’re set up with some type of equity so that you can have a better chance of retiring wealthy.
Regular W2 employees can accumulate multi-millionaire dollar portfolios by the time they retire with discipline and strong earnings. But if you want to retire like a boss or have some catching up to do, you have to build some sort of equity. And then make sure you compound that equity by reinvesting it. One of my main goals is to continuously buy assets and reinvest the proceeds without being taxed.
“What gets measured gets improved” – Peter Drucker
The best way I know to track your nest egg building is through Personal Capital. I use this completely free tool to make sure my net worth is going up and to the right. I also like their retirement tool planner which shows you if you’re on track to cover your expenses in retirement. Give it a try and let me know what you think.