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one loafer foot, one homeless foot, representing the concept of creating wealth creation

Creating Wealth 101: Use It (Or Not), You Will Lose It

Like Life Itself, Your Wealth is Entropic

The hard truth about life is that the moment we are born, a process begins that ultimately leads to our death. While some days are better than others, our cells and bodies are on a constant path of growth and decline that inevitably ends in, well, you know. Physicists refer to this process of gradual decline as “entropy.”

Entropy’s Relationship With Wealth

The idea of entropy is enshrined in the Second Law of Thermodynamics, which states that there is a natural tendency of any isolated system to degenerate into a more disordered state. Wish as you might, exceptions to this law have never been found.

Because humans are entropic, so are the things we create, including wealth. Then, it should come as no surprise that every force of nature resists the expansion and perpetuation of wealth, including taxes, spending, inflation, philanthropy, investment losses, theft, divorce, and an expansion in family members.

The list is long, and these examples are just the start.

There is no way to prevent the entropic dissipation of wealth. If you have a pool of capital (an “isolated system”), that pool will eventually dissipate regardless of the steps you take to slow the tide. The best one can do is to make more wealth so that the entropic process can be extended or repeated.

Can We Stop the Loss of Wealth?

Some investors see “wealth preservation” as a middle ground between entropy and new wealth creation. This is a misnomer at best and a myth at worst; wealth is entropic and cannot be preserved any more than life can — it can only be cut short or extended a bit.

Creating wealth at the same rate it dissipates sounds like a way out of this trap, but it is not.

Wealth dissipation scales perfectly in a linear way, while wealth creation faces diseconomies of scale. It is infinitely easy to dissipate 20% (or more) of every new dollar created, but it is even more challenging to grow an expanding pool of wealth by the dissipation rate.

Grow $1,000 by 20%? Not too hard. Grow $1,000,000 by 20%? Not as easy. Grow $1,000,000,000 by 20%? There is a point at which you simply cannot make money at the same rate as you can dissipate it. This “point of decline” differs for everyone, but we each have such a point.

In the following illustration, an owner of wealth can outpace dissipation for a time by minimizing spending and taxes, earning income, and generating investment income at or above the inflation rate. But this trick of the eye makes losing more slowly look like winning.

More, More, And More

But before you rethink your philanthropy, move to a one-bedroom apartment, and revoke your child’s trust, rest assured that all is not lost. You can be sure that, while wealth is entropic, it will grow in an absolute sense (or last over more than one generation) despite entropy by doing two things (neither of which is easy):

  1. Accept emotionally and intellectually that your wealth is entropic.
  2. Make more wealth.

If the dissipation of your wealth is not a concern of yours, the good news is that you don’t have to do anything to see that happen. But if you want to outrun entropy, create you must.

Options for Creating Wealth and Outrunning Entropy

Here are your primary options for making more wealth:

Earn Money

Earning income is a form of wealth creation, but spending less money is not. Spending less money delays, but does not avoid, the inevitable, not least because there will come a time when you can no longer earn income. While earning money helps, it is only a temporary patch on the problem of creating wealth.

Stock Market

Despite its appeal as a long-term investment, public shares and stock indices won’t remedy (and may even exacerbate) the issue. The only historical correlation between stock market returns and inflation is negative – stocks go down as inflation goes up. In the context of creating wealth, this presents a double-whammy.

At the same time that inflation erodes your buying power (and thus your wealth if your spending stays unchanged), your stock market investments are likely to decline, further dissipating your wealth. If you imagine a world without inflation, the market might be your salvation, but you better have a good imagination.

Private Company Investments

Over centuries, the most reliable way to create more wealth is the same way most families created wealth in the first instance: starting, owning, and investing in private companies. The greatest dynastic fortunes have resulted from starting or investing in private companies, beginning with the Medici and Rothschild families and continuing to Bezos, Walton, and Buffett.

Apart from their demonstrated ability to create wealth, private company investments have added advantages related to taxation and generational wealth transfer, extending the life of the new wealth they create.

Caveats of Wealth Creation

Creating wealth comes at a cost, particularly when one seeks to do so by buying private companies.

Among other things, to create wealth in this way means that you typically take more risk, which sometimes leads to its destruction. Generally, buying and owning private companies consumes more time than most other forms of investing, and time is the most finite and valuable resource yet discovered. These costs associated with risk and time can sometimes be substantial and are almost always unpredictable.

Is Wealth Creation Worth It?

This begs the question – what makes us wealthy? Is it just money, or is it some combination of money (acquired with an acceptable amount of risk) and the time to enjoy the fruits of one’s labor? This is a personal question with no right or wrong answers, only an answer that is right or wrong for you. Before you set out to create more wealth, decide whether the better path is to accept that wealth is entropic and, as they say, die just after finishing the last bottle of wine in your cellar.

We think you’ll also like:

  1. Multi-Generational Taxs Strategy for High Net Worth Families
  2. 6 Ways to Make Your Family Legacy (and Wealth) Bulletproof
  3. 2 Crucial Tips for Preserving Multigenerational Wealth 

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

  1. Estate Planning & Asset Protection in an Hour 
  2. Investing in Residential and Multi-Family Real Estate 
  3. Tech Talk: What’s Next in Green?

This is an updated version of an article originally published on Sept. 13, 2018, and updated on June 29, 2020.]

©2023. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.

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About John Rompon

Over the course of his 25-year career, John has played a leading role in nearly every aspect of private company activity and family office investing. He has structured transactions as a lawyer, improved operations and developed strategy as a management consultant, started companies as an entrepreneur, lead management teams as a CEO and Board Member,…

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