Understand the cycles to put your mind at ease
What are the most effective real wealth creation strategies? Wealth creation is a misused and very poorly understood term. Many people believe wealth creation is about making more money.
This is part of the process, but wealth creation strategies cover a lot more ground.
There are five aspects of wealth creation to consider:
- Generate Income
- Manage Expenses
- Maintain and Increase Assets
- Manage Liabilities
- Manage Risks
If you were to ask 100 people what wealth creation strategies provide, a good majority would use terms like:
Wealth creation is about improving your lifestyle by having the financial means to do this.
Some of the top financial mentors in the world often suggest being wealthy is being able to do what you want, when you want with whoever you want.
Let’s take a closer look at the five key aspects that should be part of your wealth creation strategies (updated for 2018).
1. Generate Income
Notice we didn’t say generate more income. The fact of wealth creation is you do need to generate some income, but many very wealthy people have had a standard salary their entire working life.
Increasing your income is often seen as the way to having more money.
While this can be true, an increase in income for many people does not solve their problems.
Help. I can’t save a cent on $100,000 a year
I am sure you know someone earning over $100,000 per year, and they say it is hard to save on their income.
Often what happens is as their income increases their expenses increase. It is of no advantage to earn $1 million dollars a year if you are spending $1.1 million.
The best way to increase your income is to generate multiple streams of income or to have money coming in from several different areas.
The ‘average’ millionaire
James Althucher, one of the most prolific finance writers, stresses that the average millionaire has seven sources of income.
If one of your income streams stops for any reason, you still have other income to rely on. If you are looking at retirement planning, then creating multiple sources of passive income is the way to go.
Many households, however, have one source of income. Their job.
If something were to happen to this income stream, the financial stress can be overwhelming. That’s when the ‘financial plan’ goes out the window.
Wealthy people do not rely on income from one area as a successful business does not rely on income from selling only one product.
Make a start via investments, property or business
Start investing in shares in the stock market, property or cash to increase your sources of income.
Nowadays, the cost to build an online business is quite low. Consider the options of creating additional income streams via a business.
Here are 10 ‘side business’ ideas which are popular in 2018 to get you thinking
- Become an Uber driver
- Put your skills to use via freelancing
- Turn your spare room into an AirBnB opportunity and earn additional income
- Start an eCommerce store using Shopify, WooCommerce or BigCommerce platforms
- Put your skills up on AirTasker
- Start blogging for a living in an area you are an expert in
- Create an online course and promote it via Udemy, Coursera or Teachable
- Good at English? Become an editor and edit all the new eBooks published on Kindle
- Start writing books to sell via Kindle and Amazon
- Build websites for friends and family and turn it into a serious side income
The idea is to start. Don’t wait for everything to be in place. You will pick up the skills along the way.
2. Manage Expenses
While focusing on increasing your income, it is also important to manage your expenses. There is a very simple rule for creating wealth.
Spend less than you earn and invest the rest.
This is easy to say but not so easy to do.
Don’t love budgeting?
If you had 10 minutes to calculate how much you earned last year, it is very likely that you could do this very accurately.
However, if you were given 10 minutes to calculate how much you spent last year, you will struggle.
How do you know if you are spending more than you are earning?
There is a great book called the Richest Man in Babylon (link to Amazon on the right) which details the process of accumulating wealth.
Your biggest expense in life
What is the biggest expense that you will face in your lifetime? Many people respond that it is their house, their children or their partner.
All of these are expensive items, but it is not the biggest expense you will face.
The biggest expense you will face living in the developed world is tax.
If you are paying the highest tax rate in Australia, then almost half of your money disappears before you see a cent. That is before you pay GST, petrol or alcohol taxes.
Tax is by far the largest expense you will face during your lifetime. It is important you spend time focusing on reducing your tax.
Don’t make this wealth limiting mistake
Many people will drive across town to save one cent on their petrol or visit many different supermarkets to save a few dollars on groceries.
If they spent as much time focusing on legally reducing their tax, then they would be in a much better financial position than saving a few dollars here or there. Don’t get me wrong, saving accounts are excellent but there is a bigger focus.
We will take a look at different structures you can invest in to minimise your tax.
Maintain and increase your assets
The goal of a person seeking to create wealth is to increase their assets so that they can generate an income from them.
The starting point is to recognise what is an asset. The real definition of an asset is something that puts money in your pocket.
Anything that takes money out of your pocket is considered a liability. Many of the things you consider to be assets are in fact liabilities as they cost you money.
Assets can be classified into two categories:
- Lifestyle assets; and
- Investment assets.
The car the house and the boat are all lifestyle assets. Rental property, shares and cash are considered investment assets.
People who struggle to become wealthy make a critical error throughout their best income producing years.
They strive to have:
- the beautiful house (you must have the McMansion in 2018, right?)
- a modern car with all the accessories or even multiple cards
- a boat to cruise around the oceans (real freedom, yeah)
The critical missing wealth creation strategy
But they miss a crucial link on the path to creating wealth.
They get a high paying job and buy the house, the boat and the car the wealthy drive. The link they missed was the rich person bought investment assets to pay for the house, the boat and the car.
The wealthy aren’t buying these ‘doo-dads’, as Robert Kiyosaki would say, out of their salary. They are purchasing them through their business.
Debt is not right or wrong. It is how the debt is used that will determine whether the debt is of benefit to you or detrimental to your financial well-being.
If you were to borrow $10,000 and spend it on an overseas holiday, how much would it be worth in a year’s time? You would have memories and photographs maybe, but no money. If you were to borrow $10,000 and buy a car how much would it be worth in a year’s time?
The car would possibly be worth $5,000 and certainly less than $10,000. If you were to borrow $10,000 and buy property or shares then how much would it be worth in a year’s time?
The exact amount is unknown however it is likely to be worth more than $10,000. So borrowing to buy an asset makes the debt “good” or of benefit to your financial position and borrowing to spend makes the debt “bad” or detrimental to your financial situation.
Manage your Risk
If you are a proponent of Murphy’s Law, then anything that can go wrong will go wrong.
Managing risk is about reducing the impact on your financial situation when things do go wrong. Risks fall into two categories, insurable risks and uninsurable risks.
Insurance is an important aspect of a solid wealth creation strategy
Most people have insurance for their house, car and contents, but fewer protect the things that can have a huge impact on your financial well-being. Most people’s major asset is their ability to earn income.
This can be protected with income protection insurance which will replace an income if you are unable to work for any length of time.
Life and health insurance
Life insurance becomes important if you have children or a partner that depend on you for their lifestyle. Health insurance may be of benefit to you to cover large medical expenses that could occur.
Insurance can be used to minimise the impact of unforeseen events. However, there are some things you cannot insure against.
Insurance is not as readily available to your business having a severe downturn or being sued because of a traffic accident.
To protect your assets and income in the situation where you are uninsured requires the use of structures to isolate different activities and to hold assets away from creditors.
Wealth Creation-Life Cycle
There are four phases of wealth creation during your life.
- Broke from 0 -20 years old
- Financial Survival from 20 – 40 years old
- Financial Stability from 40 -60; and
- Financial Freedom from 60 years onwards.
Obviously, the ages are a guideline, and this will vary from person to person.
One of the most inspiring things about living in 2018, is the number of opportunities to create wealth. Take a look at YouTube. There are many examples of 20-year-old ‘kids’ making serious income through videos posted to YouTube. Just amazing.
Not only that but the Bitcoin Millionaire craze has really taken hold. It has been one of the most volatile asset classes but has certainly generated a lot of wealth for many people.
Let’s take a look at each phase of wealth creation in more detail:
Phase 1 of building wealth – Broke
Oh, the irony of step number one of building an asset rich, income producing lifestyle. You start at broke. Well, we all have to start somewhere.
Most people are born into this world with nothing. Very few people arrived with a wallet attached when they were delivered, and most people do not have significant income during the early years of their lives.
In this phase of life, income equals expenses as the majority of the money earned is spent. The person has no significant assets or liabilities.
Phase 2 – Financial Survival
Phase 2 is often worse than being broke. The person now has a regular income, and he or she can borrow to buy a car or a house.
At this stage, he or she is also setting up their life by purchasing furniture, appliances and often having children as well. There are many expenses to pay and often the young person borrows to cover these costs.
This can generate a downward spiral when a person’s expenses are greater than their income. The only way this is sustainable is if the person borrows more to pay their debts. If this stays out of control for an extended period, then the person can end up bankrupt as they are no longer in a position to pay their debts.
Phase 3 – Financial Stability
As people get older their income increases and their expenses drop away.
It is during this phase of life that people are in the best position to accumulate assets and boost their super funds.
The assets they own are increasing in value and adding to their income. This allows them to reduce their debt levels and add further to their asset base.
You may want to increase your contribution to your self managed super funds. This can often be an excellent tax strategy as well. But best to talk to a financial planner first.
Phase 4 – Financial Freedom
Financial freedom occurs when a person’s income from their assets is greater than their expenses.
At this point, the person is free to stop work if they choose to and live off the income generated by their assets.
In Robert Kiyosaki’s game, Cashflow, the hardest professions to get out of the rat race are the doctor, the lawyer and the airline pilot. Does anyone even remember this game?
If your expenses are out of control
The spending of high-income earners tends to be very high, so a large income is required from their assets to get out of the rat race.
This is backed up by the book called the Millionaire Next Door, which studies the profiles of millionaires.
The majority of them own their businesses and do not drive expensive cars, or live in expensive houses.
Focus on investing your savings as your key wealth creation strategy
The millionaires focus on investing their money to increase their wealth.
You can view the best investing books to help get the right mindset and wealth management strategies for long-term success.
When it comes to investing books, you will learn from the investment greats such as Warren Buffett, Peter Lynch, Benjamin Graham and more.
In addition, you will learn how to invest in a managed fund, learn about business advisory strategies and understand what an estate plan looks like.
Mark your starting point on the road to your wealth creation strategy
Everyone is at different stages on the path to financial freedom. It is important to identify where you are on the current path.
If you do not know your starting point, it is tough to set out in the right direction to achieve your financial goals.
The best thing you can do now is to start building your wealth creation strategies. Consider where you are on your journey, develop a side hustle income and do whatever it takes to generate additional revenue streams.
Live below your means, keep your expenses intact and invest every cent you can.