With all of the recent coverage of the FI/RE community, there are some basic concepts that are getting lost in the noise. Financial independence seekers only need to focus on a few things. Below are three basic steps to build wealth: make money, spend less, and use the money you are saving, to well, save! (Actually, invest!)
So, you bought that new $30 shirt on sale? Saved a whopping $15? Unless you are putting that $15 into savings or investments, you aren’t really saving. Let’s not forget…you also spent $30.
I’ve fallen into the trap of “saving” $15 and using that money to buy something else. What was saved? All I did was spend less on that one item.
Here are the 3 steps to build wealth:
1) Make Money
2) Use that money to make more money
Wealth is the value of what you own and the value of the assets you have. It is not the number of things you own, but the value of your assets. How much is your car worth? Not what was paid to purchase it but how much would it currently sell it for? For example, if the auto-loan balance is $16,000 and it would sell for $11,000, this is a negative asset. In fact, it’s not an asset at all, this car is a $5,000 liability.
Wealth and income are not the same.
Income is the amount of money made in a certain period of time. The amount of your income does not determine your wealth. Folks who have very high incomes are not automatically wealthy. There are high-earners who also live paycheck to paycheck. They are saving minimally, if at all, and spending everything they earn. Wealth and income are not the same.
Another term for liabilites is debt. Assets minus your debt will give you your networth. (Assets – Debt = Net Worth)
We are not minimalists but we are frugal in most areas. We do not feel deprived. But we buy and spend far less than we can afford.
In order to save money, I cook a lot, about four to six times a week. Our cellphone bill is never more than $65. When grocery shopping, I look at the specials for the week and tend to buy items only when on sale and mostly shop at the budget-friendly Trader Joe’s. If we decide to go out to eat, which is about twice a month, we choose to dine during early-bird dining or have very nice lunches.
I’ve never owned an iPhone for personal use and my laptop is almost six years old. (DISCLAIMER: My job gives certain employees iPhones for work purposes. So technically, I have had an iPhone 6 since 2016.)
One of the biggest criticisms of the FI/RE community is that many Americans spend less because they must. Saving is going to be nearly impossible when monthly expenses are at or exceed the monthly income.
Cutting discretionary spending is simple, maybe not easy, but it’s simple. However, we must acknowledge for many people, living paycheck to paycheck is not simply a choice, it’s the only way. I don’t believe it has to be the only way forever, but for certain circumstances and for a certain time, it’s just the way it is. Their income doesn’t allow for discretionary spending so where should they cut?
One of our relatives, a family of four, live in a rural small town. They could move two hours away to a nearby city. Their housing costs would increase some but their earning potential could increase by 50%. The dilemma is, they have two young children and their parents also live in the same small town. and help with childcare. Moving two hours away would increase their childcare expenses by 100%. We cannot minimize the benefit of having the help and support of their families in close proximity. Before we say, anyone can FI/RE, let’s take a step back. Everyone can make smarter financial decisions. Most people can decrease expenses a little more. But the reality is, unfortunately, for many, extreme early retirement is simply not an option.
What I hope to share is that saving is possible for you. It may not be 70% of your income but there are things we can choose to let go of to reach a savings goal. Regrettably, what tends to happen is that as salary and household income increases, so do expenses. This my friend, is lifestyle inflation. Getting a raise should not automatically equal spending more.
Lifestyle inflation can creep up on you. Lifestyle creep, happens when we are not intentional with our money. Every dollar should have a job, a purpose.
Just got a raise? Perhaps an upgrade in a vehicle or housing. Then discretionary expenses increase. A few more meals out, upgrade the cable package, upgrade electronics including the latest headphones and cellphone accessories. I just got a raise, time to have more weekend getaways. This is lifestyle inflation.
I justified my upgraded wardrobe as a reward for my increase in salary. My packed lunches weren’t cutting it anymore. And why do I need to meal plan I can just buy whatever is convenient. This was me…I wanted to reward myself now by stealing from my future self.
Making the most out of the money you earn will depend on your expenses. The amount of money that remains after expenses should be saved or invested. Your money won’t appreciate in value if you purchase depreciating items. A car, for example, is a depreciating asset.
When you invest in a business, real estate or in the stock market (for the long-term), you are giving your money the opportunity to grow in value. This is true wealth building.
This may sound ridiculous but you need money to make money. You have some money? Find ways to earn more. Are you due for a raise? Ask for one. Haven’t yet received that promotion? Be the best employee you can be. Go above and beyond and prove you’re irreplaceable and indispensable.
So many people will pay for convenience, so capitalize on that. How can you make someone else’s life easier? What task can you perform and get paid for? Have a unique skill like cutting hair? Sounds like a side hustle to me. Think of ways you can share your time and skills by providing a product or service someone else may need.
Often making extra income requires money. For example, you’ll need inventory if you plan on selling products. Plan to invest in the stock market or real estate? Yup, money is needed.
Use that extra money, to make money.
Use that extra income that new raise and from side hustles to establish an emergency fund. Once that emergency fund is created time to invest! Don’t underestimate the extra cash flow you could gain by also cutting out those unnecessary expenses. Reducing your expenses can increase your investing and savings potential.
New York City is a bustling and hustling city. In the summer, there are people selling ice cold bottles of water on the corner to all the hot, sweaty, dehydrated New Yorkers walking out the air-condition-less subways.
Rain in the forecast? There are folks with folding tables and an array of one-time-use umbrellas for your convenience.
I wrote an entire post about the magic of compound interest and how investing will grow your money. But perhaps entrepreneurship is your path. Whatever you choose. Be sure that your money is making you money in order to build your wealth.
Income can be divided into two categories, earned income and unearned income. Earned income is…July 16, 2020