If you read many financial books or listen to the some investment experts, you’ll come to the conclusion that wealth building is very much complicated. You will think wealth building steps are technical, and cannot be possibly comprehended by an average person. As such, many people don’t really make an attempt to create wealth.
The principles to succeed in managing your money are pretty simple. They are easy to understand and few in number. You don’t have to be MBA holder or business tycoon to succeed financially – anyone with normal intelligence and a bit of self-discipline can build wealth.
Two Equations to Wealth Building
Personal wealth building ultimately comes down to two basic equations, and I can guarantee your financial success, provided you seriously apply these two equations. These equations will help you become wealthier and be far ahead of most people you know:
Income – Spending = Savings
Savings x Time x Rate = Wealth
Yep. It seems pretty simply like the simple interest you learned in Primary 6. In fact, this is so common sense; but it still not common among us.An average person cannot simply build wealth from savings because we have more excuses than these two equations.
If you look at these equations, you’ll notice that all efforts to build wealth come down to two things: increasing your income or decreasing your expense and as time goes on your financial position will improve.
I will be sharing more articles about these equations but let briefly discuss the elements.
Earn More Income
You need to earn at least a minimum amount in other to meet your basic needs. Any amount above the minimum earning qualifies you to start building wealth. Well, the calculation of minimum amount will definitely differ from person to person, however self-discipline is the name of the plan. I have seen people earning less than D48,000 per annum and yet they are able to buy land in the city. How? They planned it. Your saving rate is actually the difference between your income and ego.
The fact that career is the major source of income for most people, all your efforts should be directed to a successful career management. As an employee, you should plan to be productive and develop yourself. These two strategies can offer you opportunities which leads to more income.
In addition to your job, there are whole lots of part time business ideas which can earn you extra money. If you’re industrious enough, the money you make on the side activities can be quite substantial. I used to pay my monthly rent from my part-time weekend lecturing incomes.
Spending Should be Under Control
No matter what amount of money you earns, your expenses have to be less than your earnings if you want build wealth. If you don’t, you cannot financially progress.
Consider two people:
- Alpha who makes D60,000 a year and spends D50,000 a year.
- Fatou makes D100,000 a year and spends D108,000 a year.
Who is doing wealth building ?
Of course, it is Alpha. He added D10,000 to his net worth while Fatou went backwards (by borrowing) D8,000. Yes, Fatou has more potential to become wealthier than Alpha, however unless she gets her financial management together, she will never be able to build wealth.
Let think about the case further – what if they each kept doing this for 20 years? Alpha would have D200,000 even if there is zero growth in his savings (which is not likely to happen). Again, the D200k excludes any interest he may have earned over the period.
How about Fatou? Sorry for her, she would probably be facing financial issues after several years of taking debts.
You see: whiles having a high income can be a great opportunity in wealth building, however it certainly does not guarantee wealth. That’s why we see so many people living pay cheque to pay cheque. They simply spend more than they earn.
Question: Why can’t most people get these two equations to work in their favor? Many would say because they don’t earn enough money. This may be true for a small percentage of the earners. But you know what, we should look for reasons to save instead of hundred reasons why we cannot. Many people are in bad financial shape, because they spend too much. They can’t plan and control their spending habit.
The key to spending less than what you earn is to take self-audit of where your money goes. Then try to save money in areas that are not basic needs.
Wealth Building Start with Savings
The difference between what you earn and what you spend is your savings. Some people like to call it a “gap” or “surplus”. Whatever you call it, this is the residual income that grow your wealth building portfolio.
Obviously, you would love to have a good savings balance. However, doesn’t mean you need to spend like a miser to squeeze every last bututu into your savings account, but you do want a healthy (and growing income) and to keep expenses reasonable and under control. If you do these simple things, you’ll grow your net worth automatically.
Time Allows You to Multiply
Time does a couple of things for you:
- It allows you to do periodic savings which increases your net worth.
- It allows your money to grow upon itself. For instance, if you earn 5% on your money, your D10,000 savings becomes D10,500 in year 2. The next year it becomes D11,025 and D11,576 the next.
See how it’s growing itself? This is called compounding effect. It has a very powerful effect over a long period of time. If you deposit money in an account that earns return, it will multiplied many times by compounding upon itself. This is why time is so important in growing your net worth.
Wealth is a Result
If you put all of the above together, here’s the conclusion: you build wealth (net worth) when you spend less than you earn and saves over time. Yes, it’s that simple.
No matter where your net worth is currently, you can improve it by taking the following steps:
- Grow your sources of income.
- Cut and/or control your spending.
- Start as early as possible and save more frequent over time.
Like I always say: Savings is not a luxury but necessity for the future.
What are your thoughts about these wealth building formulas ? Drop it in the comment box.