From: alexhormozi
Achieving significant wealth often comes not from income, but from the appreciation of equities one owns [11:04:00]. This principle helps explain why many of the world’s wealthiest individuals reside in high-tax areas like California and New York [08:40:40], as they leverage methods of wealth creation that transcend income-based taxation.
The Source of Fortune: Appreciation, Not Income
Analysis of the Forbes 100 reveals that 94% of their growth originated from the appreciation of assets, not from earned income [11:11:00]. This highlights a fundamental distinction in wealth creation: what is built, rather than what is merely made, is the primary driver of net worth [11:19:00], [13:33:00].
A core tenet for building wealth is to:
- “Make fortunes by taking a lot of risk with a little bit of money” [10:51:00].
- “Maintain fortunes by taking small amounts of risk with a lot of money” [10:54:00].
This implies focusing on significant, transformative gains rather than incremental savings [10:03:00].
The Power of Multipliers
Consider a business example to illustrate the impact of appreciation:
Assume a business that generated 50 million business [11:48:00], [11:53:00]. After a 37% tax rate on dividends, the owner receives $6.3 million after-tax [12:02:00].
Now, imagine the business grows to 60 million [12:28:00], [12:30:00]. After-tax dividends would be $7.6 million [12:35:00].
In this scenario, the total net worth increase for the year is 10 million from business appreciation + $7.6 million from after-tax income) [12:45:00]. The effective tax rate on this total increase is approximately 21% [13:17:00], because 56% of the net worth increase came from tax-free appreciation of the business’s equity [13:25:00], [13:28:00].
The income derived from the business is not its primary value contributor; rather, it is the increased value of the business itself [13:41:00], [13:43:00]. If a business’s profit doubles with a 5x multiple, this creates a double multiplier on something owned, leading to significant compounding of wealth [13:51:00], [13:53:00].
The true power of this principle is evident in publicly traded companies, where a slight increase in profit can result in massive gains in net worth due to high valuation multiples (e.g., a 40x multiple on a 80 million net worth increase) [14:10:00], [14:21:00]. This is how billionaires “manufacture” their fortunes: through the massive multipliers on equities, not primarily through income [14:33:00].
Therefore, the focus should be on making the business more valuable, allowing the value of the business to compound [13:57:00], [14:04:00]. This approach generates far more wealth than tax savings alone [14:47:00].
Tax Shelters vs. Equity Appreciation
While tax shelters might offer marginal savings, they often cost more in other resources (time, attention, legal fees) than they save in taxes [02:11:00]. This is because tax shelters come with three primary hidden costs:
- Cost of Discovery and Conversion: Sifting through numerous illegitimate schemes and the significant time and effort required to implement the legitimate ones (e.g., creating new entities, transferring assets, updating contracts and banking relationships) [02:30:00], [03:33:00]. Charlie Munger noted that 95% of tax solutions are “swampland” [02:42:00], meaning they are not legitimate and could lead to trouble [03:00:00].
- Cost of Upkeep: Ongoing attention and effort required to maintain compliance with tax rules (e.g., frequent travel to meet residency requirements, constant allocation of funds for captive insurance) [04:05:00], [04:07:00], [04:50:00], [05:31:00]. This trades valuable attention for less valuable money by percentage [04:08:00], [04:45:00].
- Cost of Unwinding and Fines: Many “big tips and tricks” are often unwound by the IRS years later (due to their 3-5 year lag), leading to fines, interest, and the significant cost of legal and accounting fees to reverse the structure [06:01:00], [06:11:00], [06:26:00]. Tax clauses are intended as incentive systems, not loopholes [07:18:00], [07:20:00].
Obsessing over small tax savings (thinking in increments) distracts from the larger goal of increasing net worth through growth (thinking in orders of magnitude) [09:21:00], [10:21:00]. Wealth creation strategies should prioritize generating and compounding value over minor tax advantages [09:47:00], [10:05:00].
Focus on Building, Not Evading
The wealthiest individuals prioritize wealth creation through appreciation, often paying their taxes, rather than focusing excessively on tax avoidance [08:51:00], [08:55:00]. The tax code is an incentive system designed to guide economic behavior [07:18:00]. For example, real estate offers many tax incentives because the government wants to encourage investment in infrastructure and property development [07:27:00].
True tax savings typically occur in three scenarios [02:58:00]:
- Giving up ownership or control: As seen in charitable giving or trusts, where ownership is legally transferred [02:02:00], [25:14:00].
- Depreciation: The government allows assets to be depreciated (treated as losses) to encourage investment [25:33:00]. This is how some real estate investors significantly reduce their tax burden [25:52:00], [26:14:00].
- Deferral over elimination: Many structures merely defer taxes until a later date, rather than eliminating them entirely [26:19:00], [26:29:00].
Key Beliefs for Wealth Growth
- Attention is the most valuable asset: Avoid anything that demands disproportionate attention without a significant return [31:36:00].
- Focus on making, not saving: Prioritize revenue generation and business growth over chasing tax-saving schemes [31:42:00].
- Think in orders of magnitude: Instead of incremental savings (e.g., 10%), aim for exponential growth (e.g., 10x) [31:50:00].
- Don’t regret past financial decisions: Once a decision is made (e.g., living in a high-tax state), move forward without dwelling on “roads untaken” [32:01:00].
- Money is a means, not an end: Money exists to buy options and freedom; do not trade optionality for it [34:30:00]. At the end of life, all “chips” (wealth) are left on the table [33:33:00].
- Avoid spending money to save taxes: Do not buy unnecessary items just to expense them, as this is counterproductive to building wealth [30:23:00], [30:31:00]. Reinvesting in assets that build value within the company is prudent [30:56:00].
Ultimately, the focus on building and increasing the value of one’s equity is a far more effective and less complicated path to significant wealth than an obsessive pursuit of tax shelters [10:05:00].