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:
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).
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.
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.
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.
The idea is to start. Don’t wait for everything to be in place. You will pick up the skills along the way.
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.
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?
Keeping track of where your money goes is an important part of wealth creation.
There is a great book called the Richest Man in Babylon (link to Amazon on the right) which details the process of accumulating wealth.
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.
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.
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.
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 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.
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.
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.
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:
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 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.
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.
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?
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.
The janitor, teacher and truck driver, find it much easier to exit the rat race as they have far fewer expenses to cover.
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.
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.
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.