Building wealth ultimately comes down to one equation – and it’s simpler than you might think. This one formula is the foundation of how wealthy people like Warren Buffet make financial decisions. If you live your life according to this formula, you are well on your way to being rich.
Checkout this Prime Minister of India List with Photo
One of the best selling personal finance books of all time, Rich Dad Poor Dad by Robert Kiyosaki, illustrates this view well.
In the book, Robert Kiyosaki compares the decisions of his father – his Poor Dad – who made a high income as a government official, yet never really created significant wealth for himself, and his friend’s father – his Rich Dad – who owned several businesses and generated mass wealth over the course of his career.
The difference in how the two fathers made their financial decisions comes down to this formula.
Net Worth = Assets – Liabilities
Rich Dad tries to maximize his net worth, so he minimizes unnecessary liabilities and builds his assets. Meanwhile, Poor Dad spends money keeping up with his many liabilities (car payments, luxurious spending, vacation homes ect.) and has little left to build his assets.
The perfect example of the Rich Dad way of thinking is Warren Buffet. Warren Buffet lives in the same house in the central Dundee neighbourhood of Omaha that he bought in 1958 for $31,500. Now that’s a little extreme, but I think you get the point.
Warren Buffet minimizes spending on ‘things’ like cars, toys, big houses and luxury items and maximizes his spending on assets, which in his case are mostly stocks. Stocks give him even more money via dividends and capital gains, further multiplying his wealth. With more wealth he generates more wealth and with more wealth he generates more wealth and the cycle goes on and on.
See the Most Richest People of the World
Don’t buy things that cost you money. Buy things that give you money. Repeat. Be Rich.
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
You now know the magic formula: Net Worth = Assets – Liabilities.
You’re off to a great start. Use your money to buy assets, not liabilities. The more assets you can buy, the more you will build your wealth. The more wealth you build, the more wealth you can build from that wealth. Its a virtuous cycle.
So how can we start to put this concept into practice?
If you don’t have spare cash or you are living paycheque to paycheque (which happens even to those with a very high income), then you should listen up.
Make a budget. Easiest way to do it is via Mint.com. There are others like it, but Mint is free and its great – it’s what I use and I’m awesome. Mint is an online and mobile app that makes budgeting basically automatic. At first I wouldn’t even worry about making the budget, just make sure you link up all of your accounts and that all of your spending is properly categorized. After a couple months you will see where your money is going and you can start making budget categories that make sense based on your unique circumstances. I spend maybe 30 minutes per month on budgeting. It’s easy and it’s worth it, I promise, it just takes some time up-front to set-up.
The key here is that your total spending should be as small as possible in comparison to your income. That doesn’t mean you can’t enjoy your life. It doesn’t mean you can’t have that daily Starbucks. You’ll quickly realize its not that daily premium java that gets you. Its that shopping spree or splurge that smokes your budget.
Check out the List of Billionaires in India
If you start saving well, you are laying the grounds to getting rich. Once you have money, the fun starts.
Saving well won’t make you rich though, unless you’re making a very high income and you’re very frugal. Cash is not king – despite the way the saying goes. Cash gets eaten by inflation (and bank fees). You are slowly losing money by holding cash in your bank account. However, cash is what your going to use to buy assets that you’ll be using to get rich. So its a great way to start.
You now know the magic formula and your setting yourself up to use it to get rich by properly budgeting.
“Risk comes from not knowing what you’re doing.”
You have a budget and you’ve been sticking to it. You’ve happily watched your bank account move on up, slowly but surely.
What you end up doing with your savings is often the most important factor in determining how rich you will get. There is however, a few more things we need to decide before you finally make some investments. The answers to these questions will guide you into what investments you should be considering.
How long before you will be spending the money and how much will you need?
To answer this question you should understand what you are saving for. There is no point in investing unless you have a goal in mind. You should put some solid numbers to it.
Example: ”I want $3 million when I am 65 (40 years from now) so I can retire comfortably and $60,000 for each of my children (in 25 years) to go through university.”
Each person will have a different time horizon and a different set of goals. To find out how much you need for your goals, do some research. Check how much you need for retirement using one of the many retirement savings calculators (search on Google). Check how much you will need for a downpayment on the house or car you want. The key here is that you have a dollar amount that you will need and the time horizon (in years and/or months) for when you will need to spend the money.
How risk tolerant are you? (Do you embrace risk, are you generally risk averse or are you somewhere in between?)
Understanding your risk tolerance will have an affect on which investments you are capable of investing in. There is nothing wrong with wanting to avoid risk, however, if you are capable of handling swings in the value of your investments, then you can expect greater returns. Embracing risk can often be a good thing.
How much time and energy are you willing to put into your investments?
If you don’t have time, then your investable universe will shrink. Nothing wrong with that, but if you want a passive portfolio that you never have to touch (because you can’t be bothered or you are too busy), then you shouldn’t be willing to accept much risk. If you are willing to put in significant time and energy and are willing to learn and understand your investments, then you are likely capable of taking on more risk, and, in turn, you can expect a greater return.
You’ve answered some important questions – now the fun starts.
You now understand that becoming wealthy is a pretty simple concept. Buy assets (things that give you more money) and minimize liabilities (things that take your money). How? Spend less than you make so that you have some savings. You also now have some financial goals, a time horizon for when you will be spending your savings , a risk tolerance level and finally, you know how much time and energy you are willing to put into your investments. These will all guide where you will be putting that hard earned cash.
So what are your options?
The investment universe has vastly expanded over the past several decades. It can be dizzying for the amateur to figure out where to start. Luckily, it’s simpler than you might think. I use the KISS method – keep it simple, stupid. That’s why I have three main assets, in my opinion, that you can consider for purchase.
Equities are traditionally thought of to possess high risk. I won’t debate how I actually feel about this, but no doubt, if you want to purchase public equities, you should possess a longer time horizon and be prepared for more volatile swings in the value of your portfolio. However, over the long term, if you are not dancing in and out of the stock market, you can expect strong returns.
“No matter how great the talent or efforts, some things just take time. You can’t produce a baby in one month by getting nine women pregnant.” – Warren Buffett
If you are a rookie, you don’t have time to learn about your investments and are perhaps a little less risk tolerant, I strongly urge you to buy an Exchange Traded Fund (ETF) of a major stock market index. Sounds fancy, but all it does is track the value of the overall stock market. If you open a Questrade account, you can buy them for free. Buy them every time you get a paycheque, that way you don’t have to worry about timing the market. Over the long term, you can expect a strong return by investing in major stock market ETFs. Pick two or three ETFs. Maybe one from Canada, one from the US and if your feeling up for it, maybe one from a developed market in Europe. You now own a piece of the world.
You can also invest in reputable and low fee mutual funds if you like, but I prefer ETFs. If you don’t have time to research investment managers and are not sure why one is better than another, ETFs are the way to go. They are cheaper to own and study after study has proven that after fees are included, they perform just as good if not better than mutual funds. So stick to ETFs.
Individual stock picking is not for the faint of heart. It is also not for amateurs unless you are restricting yourself to a diversified portfolio of large, global, high quality businesses. If you insist on picking your own stocks, I would first suggest before buying anything that you read The Intelligent Investor by Benjamin Graham. If after you read the book you still think you want to pick your own stocks, start small and practice, practice, practice. With plenty of time and effort, maybe you will be the next Warren Buffet.
The safest of these assets, bonds of credit worthy companies are protected and secured buy the assets of the business, are first in priority in the case that the business goes bankrupt and the company is contractually obligated to continue to make its interest payments. Bonds are an essential part of almost any investment portfolio.
I wouldn’t suggest buying individual bonds if you are an amateur or have relatively little capital (since a minimum order is often $10,000 a pop). So you should buy a respectable corporate bond mutual fund or a municipal bond fund. Make sure they have low fees and are offered by a very respectable and experienced investment manager. Just like equities, you should buy them over time, so you don’t have to worry about timing the market. Bonds are the core of your investment portfolio, they will hold up much better during recessions than most other assets.
3) Real Estate
Somewhere in between in terms of risk level, real estate is often the largest investment in most people’s lives. Though it is also subject to swings in value like equities, home owners possess the piece of mind that they have a hard asset that they own and can see, touch and feel. Perhaps more importantly, they don’t get an appraised price everyday like equities. In my opinion this is part of the reason real estate values are generally less volatile than equities.
I only consider real estate to be an asset however, if you are not living in it, but are instead renting it out and generating positive cash flow from owning it. Real estate is often a liability if you live in it, because it takes your money. You pay for your mortgage and you pay for repairs and maintenance. Over time, many owners put more time, energy and money into their homes than they receive via the appreciation of the property over time. An investment property, however, where the rent you are generating is greater than all the expenses of owning the home (mortgage, repairs, maintenance, taxes etc.), is an asset, and many people have become very rich from buying investment property.
It takes more time, energy and know-how to buy an investment property. But there are several advantages including not having to use your own money (via using a mortgage), and the direct control you have over the value of the property. This is not the case with equities, as you can’t use margin (a mortgage for equity purchases), and you don’t have control over the value of the investment.
Real estate is often a good option for do-it-yourselfers and people that are willing to put in the time to make sure they can generate a positive return from investing in the property.
That was a lot, but now you have some options. There is also the question of how much of one asset class to buy vs the other.
The general rule of thumb is that the more risk tolerant and the longer your time horizon, the more of the risky assets you are capable of owning. But under all circumstances you probably shouldn’t own 100% equities and real estate. Something like 75% makes sense if you can handle the risk. Otherwise, a 50%-50% split between bonds and equities is a good option.
As always, consulting with an investment professional is never a bad idea. In fact, even those of us with solid investment acumen should have a sounding board for their ideas.
All you have left is to get started.
Good luck and happy investing.