The 4 Principles Of Becoming Wealthy
In order to be rich, you need to understand how to make money
Everyone understands the basic concept of trading your time for money, as we have done this since our first part job in college. In the UK our time is judged to be £8.21 per hour. In other countries it is less (the American minimum wage is $7.25), and some countries have no minimum.
Trading your time (energy or skills) for money is the most basic way to make money, but it is not the only one. A few fortunate people don’t work, yet make money through passive income, others make money through smart investments, some move country, some climb the corporate ladder, and others still save in order to become rich.
There are lots of different ways to make money, but for the sake of this article I will focus on four different principles that need to be understood and applied to your life in order to increase your bank balance and overall net worth. If you work with these four principles, then you will be in the right mindset to make your money work for you.
Make More Money
While this seems like an obvious point, it is worth stating time and again. The more money you make, the more money you will have to save and invest, which will then make more money over time.
The most likely place to make more money is your job. Where are you in your career and how can you get to the next pay level? Does it mean moving to a different company that pays more, or do you need additional skills? Are you actively improving within your current role, or are you ready to ask for more responsibility (and more money)? Are you working long hours that work out to be less than minimum wage? Where do you expect to be in 3 years? You might not be able to increase your pay that easily, but if you look across a 3, 5, or 10 year scale, where do you expect to be and what do you need to do to get there faster?
If you are already a 40% taxpayer, you may realise that making more money is not as beneficial as it was before as for every £1,000 extra you make (along with the responsibilities, stress and additional time), you only get to keep around £550 of it after tax and national insurance. At this point, you need to find ways to make more money without trading more time, and this is where you should start looking at investing. The tax rates tend to be more preferential on investment profits (20% on gains) and so you stand to make more money. You could also look at increasing the amount you pay into a pension (or 401k), which will lower your take home pay, but will pay off in the future, as that additional pension contribution will not be taxed. Even if you are at a high tax rate, you should still consider moving up the career salary ladder as working is still one of the fastest ways to make money, especially if coupled with tax efficient investments.
Save, save, save
This is the classic advice from parents — save for a rainy day — and unfortunately for us they are right. Money allows us incredible opportunities and a sense of freedom, and yet many of us don’t have enough of it to feel the benefits. 76% of Americans live paycheck to paycheck, and in the UK it’s estimated to be one third of employees. If you have an emergency then money is one of the best things to help you out of a bad situation, but having money also allows you the ability to do what you want — lost your job, had an accident, want to go on a holiday, visit family, study something, invest in a project, earn interest on your savings — everything needs some capital.
Saving always beats investment (unless you have upwards of £500,000 laying around in a current account) because savings are tax free and guaranteed. For example, if you are able to save an extra £100 per month, that makes £1,200 a year. To achieve a similar result with investing you will need to invest £30,000 at a generous 4% interest rate per year. While we may not have 30k to invest outright, saving £100 per month is doable for most of us. Plus money has the positive snowball effect, which means that after a few years of saving, and some compound interest, your savings start to increase exponentially and look like a sizable snowball.
When investing, think in yield
Good investors don’t think in absolute money terms, but rather in yield. Yield is the percentage return on your money or your investment. Yield is an easy but important concept to understand and it is good mental training in order to realise how to best put your money to use, irrespective of the amount in your money pot. For example, you want to get a 10% return on your money, so if you invest £1,000 and get back £1,100 after a year — great! Don’t focus on the fact you only made £100, rather you made a 10% return on your investment, and this is a great yield, even for a seasoned investor.
When you start thinking in yield, and making financial decisions based on returns then you will see your money growing. Maybe making £100 doesn’t sound like much, but you made that money out of nothing, and now you have an extra £100 to invest the following year. Do this repeatedly across a span of 10 years and suddenly you have a considerable amount of money that didn’t come from your initial pay check.
Tax efficiency
While this article won’t dive into this principle in much detail, everyone should be aware of how the tax system works and how to legally retain more of your earnings and profits. Many high net worth individuals and companies save millions a year by moving themselves and their money offshore as a way to reduce the amount of money paid in taxes. I’m not going to comment on whether this is good or bad, but it is a fact of life. If you are lucky enough for this to be a potential problem, read my other article — ‘Why Warren Buffet’s secretary pays more tax than he does’.
There are of course a few different ways to make money that I have left out — winning the lottery, starting a successful business, inheriting from grandparents — but for the majority of individuals, these four principles are going to be the most important concepts to master in order to get ahead financially.
With the exception of winning the lottery, you won’t get rich overnight, but by changing your mindset towards money and focusing your energy on different ways to increase your wealth, you will set your life on course to being comfortable with money and having wise investments that pay you over time.
