There are many books, blogs, and gurus telling you what’s needed to obtain wealth. Wealth has a lot to do with your mindset. Let me reinforce or shift your understanding.
Wealth isn’t about how much money you make or spend but rather about how much money you keep. Understanding this will revolutionize the way you think of wealth and shift your behaviors to achieve it.
High Income Is Not Wealth
Many people are taught that the key to wealth is a high-earning career. It’s true more money gives you more opportunities to create wealth.
But you can make a million dollars and spend a million and have no actual wealth. I know doctors who make $400,000 a year but saddled with student loan debt, expensive cars, and large mortgages. When all things are said and done, they are living paycheck-to-paycheck.
Let me give a more relatable example:
John Smith makes $100,000 a year but has expenses totaling $98,000 per year. He manages to save $2,000 of his income.
On the other hand, Jane Diaz makes $50,000 a year and saves 10% of her salary. Jane has $5,000 in her savings account.
Who is the wealthy person in this scenario? Jane is wealthier with $3,000 more saved compared to John.
This simplified example illustrates that spending has a lot to do with wealth creation. If you’re spending all the money you’re making, then you won’t have any money left to build your savings or investments. There are variables I left out such as renting vs owning or contributions to retirement plans.
My goal is for you to understand the difference between income and wealth. Sure, income is an integral part of wealth building, but it’s not the only factor to consider.
Make More Spend More: Lifestyle Inflation
Lifestyle inflation happens when your spending increases at the same rate as your income grows. For example, your salary went from $50,000 to $75,000. With the new salary, you decided to buy a new car and move into a more expensive apartment. Instead of investing to create wealth, you’ve decided to upgrade your lifestyle. There’s nothing wrong with a little life upgrade, however, doing so requires that you continue to make at least $75,000 to pay for the new lifestyle.
As a result, you’re making more and spending more which results in very little money to invest or save. Wealthy people desire to save and invest. They want money to work for them as opposed to working for it. Instead of exchanging more of their time for a paycheck, the wealthy use the money to make more of it.
Today, I want to share with you two equations to calculate wealth and calculate the opportunity to create it.
How to Calculate Wealth
Wealth can be described through the accumulation of money, assets, or life experiences. I’m focusing on financial wealth in this article. To calculate your wealth, the following equation can help you:
Net Worth = Assets (Own) – Liabilities (Owe)
Net worth is the value of all the assets you own minus the liabilities you owe.
By growing your assets and lowering your debt obligations, you can positively impact your net worth. In order to grow your net worth, you’ll need income to buy assets and pay off liabilities.
To determine your potential for creating wealth, use the following cash flow equation:
Cash Flow = Income (Money In) – Expenses (Money Out)
Cash flow helps you know how much of your income you keep after all expenses.
You can impact your cash flow by increasing income and lowering expenses. Doing either or both, you’re able to positively impact your cash.
Here is the key benefit of these equations: the money left over can then be used to make money with money. You can use the surplus to save and earn interest or invest in the stock market, properties, a business, or any other asset-building activity.
Yea, it’s that simple. Increasing the amount of money you make and or decreasing the amount of money you spend impacts your wealth creation. The value of your income is determined by how much of it you keep to invest that yields a return.
What Impacts Wealth?
When you understand your assets and your cash flow, then you’re a step ahead in making strategic moves to create wealth. You may decide to increase your contributions to your 401(k) or prioritize debt payoff and even increase income by asking for a raise and starting a side gig along with reducing monthly expenses.
The additional money you have after expenses the more you can invest in assets that generate income, capital gains, dividends, and profits. This is moving forward on the financial wellness roadmap. You’re entering the financial independence stage of your journey.
And since this is phroogal, I need to point out that wealth is also a mindset. It’s understanding what’s most important to you and prioritizing your wellbeing. Wealth should give you freedom and peace of mind that allows you to spend your time as you see fit. If that’s not the case, then do some work to understand your values.