LESSONS ON BECOMING RICH — PART ONE
The rules for becoming rich aren’t complicated. In fact, they are well known and can be found in hundreds of books. Understanding the rules are easy, following the rules are hard, and therein lies the problem. They require discipline, sacrifice, planning and making wise choices.
WHAT IS WEALTH?
Wealth is created through mutually beneficial trade. If you hand over a $100 bill to a thief at gunpoint, then you are $100 poorer and the thief is $100 richer, the net gain in wealth is zero. On the other hand, if you purchase $100 worth of groceries at the supermarket, then in aggregate the items in your shopping cart are more valuable to you than the $100 that you give to the cashier. The economy and society gain from the excess value over cost because, not only did you gain from the transaction, but so did the growers, the manufacturers, the distributors, and the retail store.
Wealth can be viewed as an extension of, and a return on, a person’s investment in labor. In the free-enterprise system, a worker is willing to commit to your company a certain number of hours per day of her time, energy and talent (labor) to further your company’s goals. In exchange, you will pay her an agreed upon amount of money that can be used to further her goals. The more perceived value a person has to her employer, the higher her wages. Of course, however, this is relative to the supply of comparable labor in a given market. If the money that results from this wage is invested wisely, wealth will increase. This can be compared to a product, in that the more perceived value a product has to a consumer, the higher the price (again relative to supply); and the higher the price relative to the costs of production, the higher the profits. If the profits are invested wisely, the company becomes wealthier. And if you replace the word society with the words company and employee, then you can begin to see that all of the combined work and productive processes only benefit the worker and employer because society has placed a higher value on the services and products than their costs to society.
The fact that the builder, the butcher or the plumber is working for personal financial gain or that the corporate executive is working to further his company’s profitability does not diminish the value that each has provided their employers, employees or customers. Otherwise they would be either unemployed or out of business. In essence, this is Adam Smith’s Invisible Hand Theory.
I used labor as an example of mutually beneficial trade. Instead, let’s look at a used dresser that, when new, may have cost $800 at a retail store. To the purchaser the dresser was worth more to him than $800 and the $800 in cash was worth more to the store owner than the dresser. Fast forward 20 years and our customer sells the same dresser for $20 at a garage sale. The buyer, who owns an antique shop, then sells it for $200. All were mutually beneficial transactions. Other examples might include the stock market, collectibles or Miley Cyrus records.
The value of any item is subjective and is only relevant when we interject a willing buyer and a willing seller.
Therefore, to create wealth, a person must provide more value to either his customers or employers than he charges them in either labor, products or services. The greater the excess value over his time and/or costs, the greater will be the persons wage or profit. If invested wisely, then wealth will grow.
Lesson Number 1: Planning
What Can I Do, What Do I Want to Do and What Should I Do?
Regardless whether you are young and just starting out in life or in the middle of your career, you should take some time to take stock of yourself. We all have personal strengths and weaknesses. These include physical, mental and emotional characteristics that make up who we are as humans. We also have dreams, aptitudes and abilities. I recommend that everyone take a career interest test and a career aptitude test. Do you like, and are good at, working with your hands? Do you have a strong desire to help others? Are you good with numbers and figures? Do you love reading, history, politics, money? Once you have a good idea as to your interests and aptitudes, then you can plan and/or change your career to something that you both love and are good at.
This next step requires a little daydreaming. Look ten years into the future and imagine your ideal life. Be very specific and write everything down. Where you live, the kind of home you live in, the car you drive, the vacations and travels that you experience, your ideal job. Are you working for yourself, in a profession, or a specific trade? Maybe you’re a corporate executive or a successful investor? Once you have completed this step, establish reasonable annual goals starting with year one and ending with year ten. Structure your annual goals in incremental steps that ultimately lead you to the life envisioned back in year one. (Of course, over time you may need or want to revise your ultimate dream, which will affect all of your intermediate goals.) Once you have established all ten of your annual goals, then flush out an action plan for year one. Ask yourself: this is where I am today, what action steps do I need to take to meet my goal by the end of the year. Your action plan for years two through ten will be less specific, but at least think them through. The final step is to actually follow your plan day by day, week by week and month by month. At any point along the way, you may get discouraged and want to give up. Don’t! Keep the dreams alive and accept disappointments and setbacks along the way. I guarantee, that you will be much closer to your dream, by staying the course than if you let life carry you aimlessly through the years.
Lesson Number 2: Lifestyle
Live below your means:
Of course, it matters how much money you earn, but there are plenty of people making a million plus dollars a year, who spend a million plus dollars a year. If you earn thirty thousand dollars a year and save 10%; and then invest the $3,000, over time you will accumulate a nice nest egg. My daughters were born in 1980 and 1982. When they were born, their grandfather set aside $10,000 each for college funds. In 1980 he bought ATT stock and in 1982 he purchased Exxon stock. He then reinvested all the dividends. By the time the girls had graduated from high school the accounts were worth over $300,000 each. Therefore, a relatively small amount of money over time can become quite significant.
As consumers, we are faced with thousands of temptations every day. Advertisers spend billions of dollars a year convincing us that we need their products. I admit that some of these products and services we do, in fact, need. In most cases, however we don’t, and should instead, hang on to our money. Think of it as warfare. They want what we have “money”, and they want us to believe that we need or desire their products. Every time we are in a store or on-line shopping we should be aware of this struggle. So, I recommend that you stop — and think: Is this product really worth more to me than the money in my pocket?
The Tax Effect:
We should remember that the cash in our pockets, as well as our checking accounts, savings accounts and investment funds are all after tax. Federal, state and payroll taxes have already been taken out, so every dollar that you don’t spend is like getting a tax-free raise.
You should run your personal finances as if you were running your own business. Make an assessment of your financial strengths and weaknesses. This includes your job, your bills, your debt and your assets. Create a balance sheet listing the dollar value of all your assets, all your debts (liabilities) and your net worth. Assets minus liabilities equals net worth. Once it is completed, your assets will equal your liabilities, plus net worth. Then create an income statement. Start with a monthly breakdown of all your income sources. Next list all of your bills and living expenses for the month. Finally, subtract all of your monthly expenses from your total monthly income. Hopefully, the result will be a positive number. The higher your net income the more of your money that you can keep to save and invest. Every month, your new net income will be added as cash to your assets and your net worth. Analyze these financial statements. You should constantly be looking for ways to increase your net worth through new avenues of income, increasing existing sources of income or by reducing expenses.
Start with your mail. Make time available every day to open all your mail, sort through your bills, bank statements, important communications, solicitations and junk mail. Throw away what you don’t need; then set up a filing system for everything else. Create a spreadsheet showing all your bills. Keep a running tab on credit limits, balances, payment amounts and due dates. Update this monthly. Next keep a calendar that reflects the dates on which you will be paying each bill. If at all possible never be late paying anything. A good credit rating should be a top priority.
Years ago, my wife and I made it a priority to establish excellent credit ratings. In so doing, we have only incurred minor interest charges and normally we don’t pay any interest charges at all. We are constantly receiving 0 interest deals from the major credit card companies. We have one car and the loan against it was paid off a few years ago. I am not against car loans or car leases as long as you are able to easily afford the payments. Remember that cars are depreciating assets. Therefore, over time they decrease your net worth so go easy on both the car loan balances and the payments. Remember, cars have one utilitarian purpose: transportation. Your home, on the other hand, is normally an appreciating asset and you can deduct your mortgage interest from your federal return and, depending on the state, also your property taxes. For these reasons, I recommend that everyone either own their own home or be working toward a home purchase. Still, I caution you against being house poor. Part of living below your means is living in a relatively modest home until you have built up your net worth and income to substantial levels. Once you become wealthy, you can live wherever you want.