So, you’ve decided that living pay check to pay check isn’t the way you want to spend the rest of your working life, awesome! The good news is, you’ve already taken step one in wealth building by actually doing something about it. Most people either resign themselves to living a mediocre existence or think that they can get there by embarking on some sort of get rich quick scheme.
As always, the following is not financial advice, read our disclaimer
I should probably say at this point, this guide isn’t a ‘get rich quick’ kinda thing, its more of a ‘grow your wealth as fast as reasonably plausible’ kinda thing. Not got the same ring I know, but I think that if we’re going to share what we’ve learned during our journey through wealth creation, it’s important to be realistic. Without sounding corny, becoming rich isn’t so much a thing you can do or a scheme, but its more of a way of life. At first, it wont seem like anything is working, but slowly and surely as you stick to your plan, things will begin to fall into place without you realising it. Don’t get us wrong, people can and do get rich quick (think lottery) but you’ll find that if you rely on luck or a scheme with a small chance of success, you’ll likely lose. Like we’ve said before – the lottery is for people who can’t do maths. Not only that, 70% of people who do get rich by winning the lottery end up broke in 3-5 years and a third declare bankruptcy. This is because 1 – they become accustomed to the money so when it runs out they cant sustain it, and 2 – by not making the money themselves they never learn how to properly manage their money and it’s good money management skills we feel is the key to building long term wealth.
Our basic formula
Now that you’re ready to build wealth the right way (and keep it), its time to start understanding the details. On a broad level, we break it down into a very basic formula, which forms the basis for our whole wealth building strategy:
Earn more + Spend Less + Invest the difference + Time = Wealth
Before we break down each component of what we think makes wealth, we should probably break down what WEALTH actually means. What exactly does it mean to be wealthy? Does it mean a load of cash in the bank? Does it mean you’ve paid off your mortgage? Retired? The thing is, wealthy means different things to different people and its important to make sure you’re clear about what wealth means to you because this will be your GOAL.
To help you with understanding your goal, we’re going to share ours. To us, wealthy means two things:
- Not HAVING to go to work if we chose not to
- Enough money coming in to sustain the lifestyle we want to live
- That money never to run out as long as we live
Note that this doesn’t mean we have loads of cash, it doesn’t even mean that our mortgage is paid off, but it does mean that we are free from the everyday constraints of jobs, bills and other commitments that stop you from having CHOICE. Here’s two examples below to help you think differently about wealth:
If person A earns £100K per year and person B earns just £40K, who’s more wealthy? On first glance, it’s likely the person A right? But what if I told you that the first person works a 60Hr week, whereas person B works just a 10Hr week. Person A could be cash rich, but time POOR.
In the same example, person A could be earning £100K but have bills and commitments of 95K per year, leaving them with just £5K for investing, whereas person B has just £25K of commitments, leaving them with 3 times more surplus cash. The takeaway here is, on it’s own, the amount of money you earn doesn’t always equal wealth.
The first part of the equation is your earnings. Income is probably the biggest part of our equation but we believe the simplest part to master. The reason for this is, we firmly believe that you should be able to become financially free regardless of the amount of money you earn (though, it is easier and faster the more you earn).
In basic terms, you need to earn more than you are spending. If you are getting further and further into debt every month you will never grow your wealth. You need to flip the numbers fast so that you have surplus cash to buy investments, which then gives you bigger earnings, which then gives you more money to invest and…. you get the picture. The easiest thing to do is to immediately cut your spending (see below), but the most effective way to flip the numbers is to earn more, mainly because the amount you can earn is technically unlimited. If you’re earning less than your essential spending, or even if you’re not, here’s some things you can do quickly to boost your income now. Even though were not big fans of trading more time for money, the goal is to earn more quickly so that you can start building your wealth:
- Ask for a raise
- Change companies
- Change career
- Start a side hustle
- Take on a second job
Even though this is one of the quickest ways to boost your surplus cash and is usually all it takes to get people onto the wealth building track, in our experience it’s one of the harder things to do. The problem is, people get accustomed to certain lifestyles and the psychological impact of having materialistic things, especially when everyone is parading their new purchases on social media, is difficult for people to undo. What if I told you that you needed to give up your daily Starbucks? Sounds doable. OK what If I said you need to cut your shopping bill in half? Harder, but still doable. OK, what if I said you needed to sell your car to buy a small car, which you need to keep for the next 10 years. OK that’s harder. What if I said you could be rich in 20 years, but you need to sell your house and move further away from your family into a 1 bed flat? Much harder.
In most circumstances, there’s always a way to cut your expenses so that you’ve got more to put aside, it just depends on how far you are willing to go. The more you’re prepared to sacrifice, the quicker you will be able to build your wealth. Usually, there’s no need to go to the extremes of downsizing, but changing your mindset and questioning your spending can take you a long way. Quick things you can do:
- Move your debt to zero interest cards
- Shop around on your bills
- Cut luxury spending
- Lower your shopping bill
Invest the difference
The final big part of the equation is investing the surplus cash you’re now saving. There’s no use saving loads of cash and having it sit in the bank. Doing this is actually throwing money away because of inflation. Cash in the bank or a low interest savings account loses value over time because it loses SPENDING POWER. Inflation will eat your cash at a rate of 1-3% per year, so you want to be putting it somewhere that’s earning at least this amount to keep up with inflation.
But keeping up with inflation is not what we’re aiming for. We want to be aiming higher than 1-3% if we really want to grow our wealth. There’s no shortage of investment types, but if we take the stock market as an example, the FTSE 100, which is commonly used as a representation of the UK stock market has increased by 8% annually over time, so we use this as a yard stick for returns on investments. If we can make 8% or more, then it’s game on. Some examples of investments that can give you these returns are:
- Investing in the stock market (see our INVESTING FOR BEGINNERS series)
- A side business
- P2P lending
But 8% isn’t going to make me rich
You might be thinking, OK but I can only afford to save a small amount, how the hell is 8% going to make me rich. Its a fair question, and on the face of it, 8% doesn’t sound like much, especially if you’re only investing a modest amount. The reason for this is COMPOUNDING. Einstein understood this:
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it”– Albert Einstein
The reason compounding works is two fold.
The first part is that you earn interest on interest. And then interest on the interest of your interest. And then interest on the interest of the… you get the picture. For example, if you invest £200 per month at 8% per year, after a year you’ll have £2486.78, meaning you’ve earned £86.78. Great but not setting the world alight. However in year two, if you continue to invest £200 per month, by the end of year 2 you’ll have £5172.50. Again, not amazing, but importantly, it’s more than double, even though you’ve only invested double. The thing that supercharges this is TIME
Investing for 2 years only nets you a small amount. But what if we kept that going for 30 years? You will have invested a total of £72,000. But your total end balance will be £281,710, almost 4 TIMES the amount invested. As you can see from the chart below, after about 16 years, the amount of interest earned starts to overtake the amount you’re investing, which is when it really starts to snowball.
Obviously, if you can put more away each month or make more than 8%, you can reach even higher goals quicker and faster.
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