How to build wealth?

Without giving you any BS i'll dive right into the content. Building wealth requires patience and determination and a never ending thirst for success. If you think you can muster all these three characteristics to build a 'new you' i can guarantee that you will be successful at building your wealth.

Complete financial independence can only be achieved gradually. It cannot happen in one day or one year. What is the starting point of financial independence? The starting point is to realize that something like a ‘wealth formula’ exists. In this article we will get introduced to this wealth formula

                            

How to realize ones dependency on paycheck

It is not so difficult. The realization can be achieved easily by doing a small experiment. Take a conscious decision of not using one months salary. That month, use only savings to pay for all expenses. Repeat this experiment for at least two months.

The longer one can survive without using paycheck, the better. A completely financially independent person will survive all his life without a paycheque. But for us, we will have to experiment it for only 60 days. The closer to 60 days one can get, the more likely he/she will achieve financial independence in life. How? People who has a habit of saving and investing money can only achieve financial freedom.

Majority cannot pass the first 10 days of the month. Its true that this experiment will make you very uncomfortable. But once you come out of it, you will be a changed person.

You will start asking difficult questions to yourself. What happens if I loose my job? How will my child continue education? How will I pay my EMI’s? This realization about how dependent we are on salary, is one big step towards building wealth. Everything after that will start happening automatically.

Asset-Liability and Wealth Building

Establishment of financial goals in life is a must. Goals gives direction to our spending habits. People spend money to buy assets. But more people spend money to accumulate liabilities. If goal is to accumulate wealth for future education of child, it is less likely that the fund get spend elsewhere (to buy a liability like a car). In general we can say the goals helps us to buy more of asset and less of liability.

For financial freedom, one must buy more of assets and less of liability. But confusion exists between what are assets and what are liabilities.

To know the difference between asset and liability, we can use simple mathematics. We know that 1+1 = 2, & 1-1 = 0. Asset is +1 and Liability is -1. Our effort shall be to accumulate more of +1’s. In parallel, we must also try to accumulate minimum of -1’s. In the process of building wealth, important is to realize, which items are +1 (asset) and which is -1 (liability).

Wealth formula # 1

Don’t Confuse Liability with Asset

There is difference between asset and liability. Assets adds money to pocket. Liabilities takes money out of pocket.

Asset accumulation does not mean buying a house, fast car etc. Anything which generate net expense is a liability. Only thing which generates net income is a asset.

Example of assets:

– Cash reserve in saving account.

– Dividend paying stocks.

– Dividend paying mutual funds.

– Value Blue Chip Stocks

– Zero debt rental property etc.

Ones financial goal should be to accumulate such income generating assets.

Asset focused financial goal will eliminate confusion between asset and liability. One such goal can be like “In next 10 years time I shall be earning at least Rs 50,000 in form of dividend income from stocks”. Here, dividend paying stock is an assets.

The concept of Return on Investment

Dividend income from stocks is the return on investment. If one wants to build wealth, ‘assets’ and ‘return on investment (ROI)’ is the key.

ROI is a litmus test for any asset. It helps to differentiate asset from liabilities. We consider many item as asset. But if it is not generating ROI, it cannot be an asset. A combination of asset and ROI has potential to build wealth over time.

Wealth Formula # 2

How to Simply Build Wealth

Accumulate assets and minimizing liabilities.

But if building wealth is so simple then why everybody is not a millionaire?

Accumulating assets is easier said than done. This is because, to buy an asset one needs to compromise a liability purchase. Liability is like a ‘Cheese Burger’ which is very tempting and hard to resist. Asset is like a ‘Vegetable Soup’ whose benefit can be seen only in long term.

Majority gets tempted to buy liability before an asset. This is what makes people poor. Selection of asset over liability can make people very rich. But its not easy to fight ones own temptations.

Our education system has also not taught us the difference between asset and liability. Instead, we got wrong examples of assets. In our endeavor to master the wealth formula, we must also remember this:

Assets adds to net worth. Liability eats away net worth

Starting Point of Wealth Building…

A man was driving a luxury car on a highway. He was enjoying the drive. But he had no destination. Ultimately he took a U-turn and head back from where he started.

In the same way, building wealth cannot happen without clear goal. In absence of goal there is 99% probability that one will not travel long.

Financial goal is like a compass that gives direction to person. Identifying clear financial goals is the best starting point for wealth building.

Quantifying & scheduling money-requirements further helps to build wealth.

A typical financial goals is shown in a below table. Please note the last row. Creating a goal of becoming financially independent is essential.

Path to building substantial wealth passes through ‘achievement of financial independence’. If one is not financially independent it means wealth building has still long way to go.

Magic Formula to Build Wealth

This is a magic formula that can guide anybody build wealth.

This formula is a result of excellent research work done by experts in the past. With the introduction we already had here, lets use this magic formula for best results.

This is Wealth Formula 3

INA = Income from Assets

INJ = Income from Job

FI = Money required for Financial Independence

EX = Expenses

In order to understand this formula lets take an EXAMPLE 1:

INA (Income from Assets) = $0 / month

INJ (Income from Job) = $1,500 / month

FI (Money required for Financial Independence) = $2,000/ month**

EX (Expenses) = $ 1,000/ month

Applying this on Magic Formula:

$0 + $1,500 < 2,000 + 1,000

INA + INJ < FI + EX.

Income from asset (INA) is zero. Income from job (INJ) is $1,500 against expense (Ex) of $1,000. But in order to become financially independent one requires $2,000 each month which is unavailable. Hence person is not on right way to become wealthy. Income from Asset (INA) must be increase to support income from job (INJ). A stage must come where INA > EX. This is a condition of financial independence.

EXAMPLE 2:

INA (Income from Assets) = $2,000 / month [return on investment]

INJ (Income from Job) = $1,500 / month

FI (Money required for Financial Independence) = $2,000/ month (money invested will strengthen INA)

EX (Expenses) = $ 1,000/ month

Applying this on above formula of wealth:

$2,000 + $1,500 > 2,000 + 1,000 

Income from asset (INA) is $2,000 against expense (EX) of $1,000. It means the person is financially independent. He is already making $1,000 more from Asset income, above EX. Hence the additional $1,000 goes to fund FI. As he is already financially independent, money diverted to FI is only making the person more and more wealthy.

INA + INJ > FI + EX