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3 Secrets to Building a Great Fortune

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If you are reading the Investing for Beginners site, the odds are pretty good that you are interested in building your finances to enjoy a better life for you and your family. There are plenty of resources we've provided such as 10 Steps to Building a Complete Portfolio, How to Become Wealthy, 7 Rules of Wealth Building, and 5 Ways to Make Saving and Investing Easier. Now, for those nascent titans of industry out there who want to build fortunes that will serve as an admission ticket to the Forbes list, we've amassed some points that may help in your quest.

1. Establish or Acquire a Business that Generates Astronomical Returns on Equity

The surest way to building an enormous fortune is to start or acquire a business that has three characteristics. First, it generates high returns on equity. Second, it is scalable; that means management can continue expanding easily such as McDonald or Wal-Mart's cookie-cutter model. Finally, the enterprise needs to boast endurable competitive advantages of some sort (what Warren Buffett calls "franchise value.") This can take the form of a regulated or de facto monopoly such as a town with a single newspaper back in the mid-twentieth century, patent protection on a key drug or formula, brand name such as Coca-Cola, or a cultural archetype such as Tiffany & Company.

Many of the greatest businesses on Wall Street and owned by private equity firms today were started in just this manner. Think Microsoft, Apple, Wal-Mart, Target, The Limited, Dell, Home Depot, Yankee Candle, The Bank of Granite, and CitiBank. The methods were different; some were retailers started by entrepreneurs while others were companies taken over by intelligent financial engineers who knew how to structure a business. They provided a vehicle that allowed them to earn more money than their labor alone could. That is the key. You cannot build a respectable fortune if you are reliant upon your own work to generate income. The owner of a chain of banks is collecting interest income as he has Christmas dinner with his family or goes fishing. Compare that to a hard-working hotel maid who must show up and scrub toilets to support her family.

The single most important factor when selecting a business is the return on equity capital. Over the long run, even if you were to pick up stocks or companies for far less than they were worth, it's going to be excessively hard to profit more than the long-term rate earned on shareholders' equity. For information on the components that comprise ROE, read about the DuPont analysis and how you can apply it in your own life or business.

2. Don't Dilute Your Equity Position

Sam Walton's family owned over 40% of Wal-Mart. In the early years, Bill Gate had around 44% of Microsoft before he began selling off shares for his foundation and diversification. Warren Buffett owns over 30% of Berkshire Hathaway. Notice a pattern? In order to build a truly epic fortune, it requires that you own as much of the company as possible. Many times, that means not diluting shares through printing more certificates for overpriced acquisitions.

Why are so few people able to do this? Growing a business takes capital. If you're not already wealthy, the only way to avoid issuing stock is to borrow so that debt makes up a large part of the capitalization structure, or own a company that allows you to use other people's money such as an insurance company which generates float from policyholders that is invested in stocks, bonds, and other assets.

3. Take Advantage of Favorable Tax Law

One way to build your wealth is to ensure that you keep as much money as possible. This includes working with ethical and intelligent financial advisers and certified public accountants that can help you structure your affairs so that you have more money compounding for you and your shareholders in the long run.

More Information

This article is part of our How to Get Rich guide for new investors. For more information on how to take control of your finances, generate passive income, control your debt, and become financially independent, read How to Get Rich - A Guide to Getting Rich.

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