Do you ever wonder why many people are still living on salary to salary even after working for a number of years? Well, the common answer is the number of dependents. However, I disagree in most cases, because most of these peoples have no proper financial or wealth creation plan. Again, some people think that wealth creation requires some special magical formula which is beyond their own imagination. In fact, in some societies, wealthy people are either accused of dealing with politicians or one kind of devil’s money.
Success in wealth creation requires sound strategies, hard work and timely execution. It is important to understand that wealth cannot be created by just wishing or hoping. You need to take advantage of the basic wealth creation equation, which is the relationship between one’s spending to incomes. In this article, we will discuss the influence of expenses and savings on wealth creation. Wealth here can simply be explained as your net worth ( total assets less Owings).
Let assumed that you have no asset or liabilities (owing someone) and you have just received your first salary of D1,000, your wealth will jump from zero to D1,000. If you spent D750 and deposit D250 into your savings account, then your new wealth position is D250. This is a good start because you have saved 25% of your salary for any future use. Of course, some people are saving 40%, 5% or even 0% of their income. Therefore, a person of the same salary, who saved 50% will be wealthier than you but you are also better than someone who saved nothing.
The concept is very simple – the more you save, the more you create wealth for yourself. It does not matter, whether you are an entrepreneur, employee or a consultant, in long run, it is savings that differentiate the wealthy from the rest. The same principle work for companies and even for countries. If a firm earns revenue and spends the whole amount, then there will be no profit to be reinvested in the growth of the company. In fact, loss-making companies do not last long. So, if an individual received salary and spend everything, then there will be no fund for investment which leads to a strong financial independence.
Relationship between Savings and Wealth Creation
In other to show the relationship between savings and wealth creation, we will categorise people into four group based on their expense to income ratio:
1. High income and low expenses – Financial Planners
I called then the financial planners because these people save a large chunk of their income for the future. Their wealth keeps on growing year on year due to a higher level of savings. They keep their expenses under control usually with a personal budget. Their higher accumulated savings are usually turned into a good investment portfolio. Imagine of Omar earning D40,000 per month and saves D10,000 per month. If he continues saving the same amount for 5 years, his savings account will be D600,000 without considering the compounding of the earned interest. This amount can be used to start a business, develop himself, pay for school fees or for many other reasons why people save money. Many people want to be part of this group but only a few are working towards it.
Tips: If you are in this group, you should continue to save more money and keep on creating wealth but never abandon your basic needs. I am sure you are building the wealth for a purpose. Also, give your time and money to causes that can better our society and the world.
2. High income and high expenses – Enjoyment Group
This is not a bad group but also not the best practice for one to follow. These people earn higher income but they also spend almost everything. They usually spend it on expensive lifestyles such as food away from home, frequent travel, rent and entertainments. An increase in the number of peoples in this group is a positive development for most industries. Yes, because the more they spend, the more the business make sales.
People in this group enjoys their money with very little consideration for the future. Which means that they are also not good at wealth creation. An example says Doyin who earns D40,000 per month but she spends at least D39,000 in a month. In 5 years, her savings should be D60,000 again without the interest. This is not encouraging at all. So if Doyin is laid off today or her business collapsed, this D60,000 will be the only asset for her normal lifestyle?
Again their net worth’s are usually very low or sometimes negative because they can easily spend more than their income by taking temporal overdrafts in banks. They have potential to create wealth and most times when you meet them, you will think they are very rich.
Tips: Control your cost and be yourself. You need to set financial goals and start working on them. A well managed personal budget could improve your financial condition. Remember, this condition and environment may change tomorrow and your financial independence might be threatened.
Dry your clothes whiles the sun is shining – An African quote
3. Low income and low expenses – Simple life:
Due to their income level, many people in developing countries found themselves in this group. They are the lower income earners but also manage to stay within their means. That is the simplicity. They almost spend all their income on necessity such as food, clothing, shelter and health. They have very little or no surplus for wealth creation purpose. With some empowerment and financial education, they have the potential to be in group 1 ( the financial planners).
Tips: Your best option is to look for additional sources of income through self-development, small business or part-time job. Learn about personal finance and set a clear goal on how to increase your income. If you are working, then think about education for better job package or to grow your business. If you cannot increase the family wealth, then work harder and educate your kids.
4. Low income and higher expenses – Keeping up:
The worst are the people who spend the money they have not earned.
These people are usually living their life with competition, fear and emotional issues. They either have periodic overdrafts in their bank accounts or with non-value adding personal loans. For example – taking a loan to buy an old car which will suck their bank accounts through periodic repair bills. If they cannot get the bank loans, they usually move to their families and friends to maintain the lifestyle. If you do a background check on them, in most cases, they try to keep up with their co-workers, neighbours, or peers spending patterns.
You should not be earning D5,000 a month and you want to live in a D8,000 lifestyle. Instead of creating value for the future, you are destroying it now. Staying within one’s income level is a sign of financial discipline.
Tips: Identify your needs from wants and control your desires. Be prepare to change and understand that improving your financial situation could lead to lower emotional stress. Borrowing a loan for consumption, means you are spending your future income.
Question – Which wealth creation group do you belongs to?
Where are you as at now and where do want to be? Group 1 or 4. No matter where you find yourself in the above quadrants, you have two choices to improve your financial health:
- Increase your sources of income and
- Control your expenses, which leads to more savings.
At your best, rather than looking for one hundred reasons why you cannot save, you should look for one reason why should start saving from today and I have already compiled ten reasons why we should all save.