When it comes to building wealth, the name of the game is returns. Many people measure their returns based simply on the level of assets involved in the business venture. But the key metric that business people and investors should care about is return on invested capital.
The difference between return on invested capital and return on assets is what is commonly called “OPM,” or other people’s money. Maximizing your return on other people’s money lets you keep more of your own money in your pocket while building wealth fast. Here are seven ways to go about doing just that.
1. Residential Real Estate Investing
Residential real estate is traditionally one of the easiest asset classes to lever up and earn a significant profit on. Many investing experts call it their favorite investment class for exactly this reason.
Residential real estate offers the opportunity to use other people’s money in several ways. First, residential real estate investments historically qualify for long-term, low-cost financing from banks. Almost no other asset class qualifies for 30-year financing terms as easily as residential real estate. In addition, residential real estate also gives investors a ready-made tax break. The mortgage interest deduction is one of the biggest and most lucrative tax deductions in the U.S., and it lets real estate investors deduct all of the money they pay in interest on their home loan.
Residential real estate returns have historically fallen between the higher returns on stocks and the lower bonds. But “low correlations with stocks and bonds make real estate a diversification opportunity,” according to economists Roger Ibbotson and Laurence Siegel. For this reason, experts have been citing real estate investment as the tool that the wealthy have used to get rich for many years.
To get started in real estate investing, do a simple property search in your area with a real estate agent and ask about properties that would make good investment choices.
2. Commercial Real Estate Investing
For those who want to go bigger than residential real estate, commercial real estate investment is also a great way to leverage other people’s money. In fact, billionaire Donald Trump’s fortune was built on commercial real estate following his father Fred Trump’s success in residential real estate. Today, thanks to a new breed of investing websites, commercial real estate investing is available to more people than ever.
Commercial real estate might seem risky, but in reality, it can offer attractive returns and can be a great place to invest. Many investors might be concerned about the cyclicality in the business, but it’s not too late to get in.
“The real estate cycle isn’t over,” said Scott Crowe, global portfolio manager of the Resource Real Estate Diversified Income Fund. U.S. accounting and consulting firm Deloitte is telling clients that the market and investment opportunities are on firmer footing now than they have been in some time. Like residential real estate, commercial real estate generally qualifies for attractive long-term bank financing and can offer substantial tax benefits.
3. Business Loans
For people who are willing to do a little more hands-on work, a great way to leverage other people’s money is through small business loans. The Small Business Administration offers loans to people starting small businesses, but the agency does not make the loans directly. The loans are made through existing banks and carry medium-term financing and attractive interest rates — in some cases, up to 10 years with loans that have interest rates as little as 1 percent above mortgage rates. The SBA loans can require as little as 10 percent down, and loans can be up to $5 million in some cases.
The great thing about SBA loans is that you don’t need to be particularly well connected or have any special background to be a success. There are plenty of ordinary people with big success stories as a result of SBA loans.
4. Silent Partners
Another way to leverage other people’s money is to build wealth is by starting a business with a silent partner. Frequently, people with great business ideas are not the same people with money to invest. To solve this problem, many businesses are started as partnerships, with one partner providing funding but staying out of the day-to-day business activities and the other partner acting as the manager and hands-on operator.
Silent partners are distinct from investors in that even if they are not directly involved in the business on a daily basis, they are still consulted for major business decisions and should be there to give advice and background expertise. Silent partners can be used in all sorts of businesses, from flipping houses to manufacturing or retailing.
Silent partnerships can benefit both partners and enable the formation of a company that would never have been started otherwise. To begin finding a silent partner, tell friends and family about your business idea and ask if they know anyone who could act as a mentor and silent partner to help launch it.
5. Angel Investors and Venture Capitalists
Angel investors and venture capitalists are related to silent partners but are distinct. A partner, whether silent or not, is generally consulted on business decisions and has at least some small role in the running of a company. In contrast, venture capitalists and angels are investors who provide a limited amount of advice and mostly financing. They expect to be paid a return on their investment in the company, and unlike a silent partner, they are almost never involved at the time the company is formed.
Yet both angel investors and venture capitalists can offer substantial opportunities to people starting a business with high growth potential. From Tesla to Apple to Facebook, many of today’s biggest and most successful companies were built using venture capital financing, with the company founders investing very little of their own money. Angel investors generally get involved a little earlier than venture capital investors and often take bigger risks than venture capitalists in the hopes of getting a bigger return.
Investing experts tout the benefits of using venture capital, including guidance and support for the company. Venture capitalists “can open doors, create synergies across companies and provide entrepreneurs with access to top talent,” according to Mike Woollatt, CEO of the Canadian Venture Capital & Private Equity Association.
6. Stock Market Margin and Options
For people who want to build wealth using other people’s money but still keep their day jobs, investing in the stock market using leverage can be a good idea. The Standard & Poor’s 500 index returned an average of 11.53 percent annually between 1928 and 2014 according to the Stern School of Business at New York University. That return is pretty good, but it could be even better for investors successfully leveraging other people’s money. That tactic underlies much of the hedge fund world today and has created numerous billionaires, from John Paulson to Ray Dalio.
For the average individual, starting a hedge fund is not feasible, but using options and margin are. Options allow you to leverage money from other investors in the market without having to pay interest while you are raising the funds. Options can be risky if used incorrectly, but they can also be highly lucrative. Economists Amit Goyal and Alessio Saretto found that some options strategies could yield returns of 30 percent annually or higher, representing an excellent return, given the risk involved.
In contrast to options, buying stocks on margin allows investors to essentially borrow for their investments for a monthly interest charge. That charge varies depending on interest rate levels, but it is generally below the expected annual returns on stocks. For that reason, many investment firms tout responsible use of margin as having benefits for investors.
7. Government Small Business Innovation Grants
Finally, for creative people with great ideas, perhaps no other opportunity to use other people’s money and build wealth is as significant as the U.S. government’s Small Business Innovation Research program.
The SBIR program offers grants to individuals and small businesses with a unique idea to solve a challenge faced by a department of the government. The individual can apply for a grant based on his idea, and if the government likes the idea, it will award grants up to several hundred thousand dollars to start a business that will solve the problem. The SBIR program has been responsible for numerous successful businesses and has helped thousands of people build substantial wealth, all without spending a penny on their own.