on account of market microstructure frictions, transaction prices may deviate from the equilibrium price, generating transaction costs. As we have noted, the bid–ask spread is a frequently used indicator of market liquidity. This differential is an important component of trading costs, often referred to as implicit transaction costs to distinguish them from explicit costs such as brokerage fees and taxes. We will offer different measures of the spread, each one focusing on a different interpretation.

The quoted spread, or the difference between the best ask and best bid prices offered by liquidity suppliers, is an estimate of the costs that a generic investor incurs for a round-trip transaction, i.e. a purchase followed by a sale. On the other hand, the realized spread is an estimate of the gain a market-maker can expect to make from two consecutive transactions. We show that the two definitions coincide when transaction costs consist solely in order-processing costs. We will also show that the difference between the quoted and the realized spread, which is always positive or at least zero, is a positive function of adverse selection and inventory costs. This difference can also be affected by the number of transactions at prices within the spread, as well as by order fragmentation. Furthermore, we will provide a definition of the effective spread, which is twice the difference between the transaction price and the midpoint of the quoted bid–ask spread and is therefore a better proxy of transaction costs when quoted prices are not binding.

You will notice that in this second stage there are no stocks, options, futures, metals, rare coins, or derivatives in the portfolio. And there is a good reason for that. When you have less than $100,000 to invest and less than a long time to get rich, you should focus on only two things:

1. Continuing to increase your income by continuing to perfect a financially valued skill such as selling, marketing, product development, or profit management

2. Investing the surplus in high-return equity ventures If you focus on this for a few years, chances are that you’ll end up with a surfeit of cash—that is, more cash than you need for your side business and real estate ventures. This extra cash should be kept safe. Extra safe. Remember, this is the beginning of your retirement nest egg. So place this surplus cash in bonds, and reinvest the interest in bonds, too. Make it a primary objective to have this safety reserve grow substantially every year. Once your bond savings become significant, you’ll start to appreciate what a valuable, comforting investment bonds can be.

You could, for example, create a side business selling a skill you currently have (accounting, legal, writing, editing, purchasing, etc.) or could develop (graphic design, copywriting, resume writing, etc.). Or you could turn a hobby or passion (stamp collecting, gardening, pets) into a profitable, Internetbased direct-marketing business.

As your side business grows, it will require that you reinvest some of the profits into creating new products, hiring employees, and developing new advertising campaigns. You should allow for growth, but limit it to avoid growing so fast that you end up losing control and getting into trouble.

Equity-building real estate. Buying equity-building real estate means buying rental properties. The trick to making this work for you at this second stage of wealth is to buy conservatively— that is, to make sure that the rent you’ll get will at least meet (but should really exceed) your cost of maintaining the property. I recommend duplexes, triplexes, and quadruplexes to start. They’ll give you the best chance to achieve zero or positive monthly cash flow. How much equity-building real estate should you develop? If you have a net worth of $100,000, I’d recommend a little more than half. Let’s say $60,000.

Fixed-income instruments. The rest of your money should be in Treasuries, municipal bonds, or quality corporate paper. Fixedincome instruments like these don’t provide a high return, but they are safe.

When you get to the next stage—that is, when you have between $25,000 and $100,000 to invest—you can take a multilayered approach to your investing. I like the following simple five-part formula.

1. Cash. The first money you save should be marked for emergencies. This needs to be put someplace that is secure but easy to access, such as a home safe or a safe-deposit box. The amount you should keep for emergencies depends on your personal situation: how much you typically spend, how reliable your income is, and so on. As a rule of thumb, though, I’d recommend about 10 percent of your investable net worth. If you have $100,000, that would be $10,000.

2. Income-generating real estate. I recommend buying and flipping real estate for everyone, even beginners. If you start when you have less than $25,000 to invest and make a few deals, by the time your investable net worth hits $100,000, you should have a pretty active, nicely profitable second stream of income.

3. Side business(es). If you didn’t want to get involved in a side business when you had less than $25,000 to invest, you should consider it at this stage. You don’t have to risk a ton of money. Invest $10,000 conservatively in a business you understand and see where that takes you.

You can invest a small amount of money (and a lot of hard work and well-spent time) in a small business and see it grow into a business that is worth a million in seven years. I’ve done it many times. I’ve coached people who have done it. Stories are published in magazines every month about people who have done it.

But let’s be frank. With only $18,000 to $25,000 to invest, it won’t be easy. That’s why I like to encourage Early to Rise readers who are at this first wealth-building stage to focus most of their time and efforts on building their income. Doubling your income in a year or two is entirely possible if you follow the advice I gave you in previous posts. And if you double your income and don’t double your lifestyle, you’ll have a lot more money left over to ensure the success of your small side business.

Here are five things I recommend if you are in this situation:

1. Find a way to radically increase your salary by making yourself radically more valuable at work.
2. Resist the temptation to spend more money as your income rises.
3. Put some of your savings down on an undervalued, small, single-family house, fix it up fast, and sell it for a profit.
4. Reinvest that original capital plus the profit in another buyand-flip deal. Keep doing this until it becomes a very pleasant habit.
5. Invest another portion of your savings in a part-time, weekend business. Sell a product or service you know and understand.

Make sure you are not a pioneer. Unless there are others actively selling the same thing, you don’t want to be in the market. The idea is to enter an active market with a better/cleverer/cheaper version of what others are selling. Sell only by direct response—print, mail, and Internet. Go carefully and learn from your mistakes.