Wealth Building Made REAL Simple
I want to build my wealth, but I found many personal finance books to be boring and intimidating. They usually go into great detail about setting your financial goals, budgeting, etc. — but they don’t tell you the big picture in a simple and concise way. As the most financially astute person in my family, I use the following explanation to help my family gain a better understanding. Here it is, building wealth in a nutshell…
Wealth building has 4 basic ingredients:
- R = Realized income (or income for short)
- E = Expenses
- A = Assets
- L = Liabilities
You can put them into 2 groups:
- Wealth Builders = Income and Assets
- Wealth Bleeders = Expenses and Liabilities
This boils down to two wealth building strategies: (1) increase your Wealth Builders, and (2) decrease your Wealth Bleeders.
That’s the whole idea. Now let me explain…
Definitions of the 4 basic ingredients
Realized Income
This is the money that come into your household and there are many sources:
- Your job (as an employee or a self-employed person)
- Your business
- Realized income generated by your Assets (money working for you!)
For a more comprehensive list, see my post about alternate income streams.
Expenses
This is the money your household spend because of needs (necessities), or wants (discretionaries).
- Necessities – e.g., food, shelter, clothing, taxes, transportation, etc.
- Discretionary expenses — e.g., hobbies, entertainments, luxury items, etc.
Note that necessities can become discretionary expenses — for example, eating out at an expensive restaurant to satisfy your need for food, instead of buying groceries to cook at home.
However, some discretionary expenses are essential to maintain happy and healthy life; especially for married couples. So don’t over do it.
Assets
This is everything you own that has cash value. There are many types of assets, and their values can appreciate or depreciate. Good assets not only appreciate in value, but also add to your income — usually as interests and dividends. Some examples of assets are:
- Savings – saving accounts, money market accounts, CDs, etc.
- Investments – stocks, mutual funds, ETFs, options, etc.
- Fixed Income Investments – bills, notes, bonds, etc.
- Businesses
- Intangibles – patents, license agreements, intellectual properties, brand names, trademarks, etc.
- Materials of value — your house, cars, jewelries, collectibles, etc.
For a more comprehensive list, see my post about investment vehicles.
Liabilities
This is everything that you are indebted to other people. Just like assets, there are also good liabilities and bad liabilities:
- Good liabilities give you leverage — e.g., home mortgage, student loans, business loans, etc.
- Bad liabilities put you at a disadvantage — e.g., consumer loans, credit cards debt, etc.
Likewise, good liabilities can turn bad. For example, a mortgage that is too large. Here is a post from The Digerati Life that offers good explanation: Good Debt, Bad Debt: The Differences, Illustrated
Wealth Building
Once you understand the basic ingredients, building wealth is a simple matter of increasing your Builders (Income and Assets) and decreasing your Bleeders (Expenses and Liabilities) . This sounds simple; however, it takes a lot of discipline and effort to build wealth.
Increasing your Builders
The basic Wealth Builders Cash Flow is as follow:
- You earn money (your income)
- Save a portion of it (add to your Assets)
- Your assets appreciate in value
- Your assets provide passive income that adds to your income (as interest, dividend, etc.).
For example, Jane used to spend all of her $500 weekly paycheck. After reading this article, she decided to save $50 a week and invest it in a mutual fund. After 1 year, she saved $2,600 of her own money, and the mutual fund appreciated to $2,800. Additionally, it provided her with a distribution of $50 (passive income). As a smart investor, she reinvested that $50 to buy more shares. In this example, Jane increased her Wealth Builders by saving, investing, and reinvesting her money.
Decreasing your Bleeders
The basic Wealth Bleeders Cash Flow is as follow:
- You pay taxes on your income
- Spend your money on things that you need to survive (e.g., food, shelter, clothing) and things that you want (e.g., iPhone, HDTV, car, etc.)
- You don’t have enough money so you take out a car loan to purchase the 7-series BMW, and use your credit card to buy an iPhone and a HDTV (adding to your Liabilities).
- You now have additional expenses like car payments, credit card payments, etc.
The problem with people who struggle financially is that their money is tied up in the Bleeders cycle.
If you haven’t done so already, now is the time to make wealth building YOUR BUSINESS. Happy wealth building!
This article was featured in:
- The 111th carnival of personal finance – glastonbury edition hosted by Plonkee Money. For more information please visit the Carnival of Personal Finance.
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Okay, not to seem harsh, but did you just totally relabel Rich Dad, Poor Dad?
I mean, the basic idea is simple, and correct. At least you didn’t go overboard by incorrectly naming depreciating assets as liabilities…
Compounding – Not harsh at all. I did read RDPD and you can read what I think about Rich Dad Poor Dad here. I think calling this Robert Kiyosaki’s idea would be giving him too much credit, since this is Finance 101. I have a couple of books that predate RK’s RDPD and they all talk about Income, Expenses, Assets, and Liabilities. REAL is simply my attempt to explain basic finance so that a neophyte can understand it.
Really nice post, I think I’ll print out your square and put it in up in my Grandma’s house for all to see
Thanks for the simple breakdown
Rad – thank you. Wouldn’t your grandma be offended?
lol
It was more for my uncles and aunts and cousins, my Grandma actually understands these concepts pretty well, even if she dosen’t know all of the terms. Sometimes we can complicate the simplest things in life and make them seem harder than they really are, thats why I love the post.
This is a good post, I agree it resembles RDPD, but nothing in RDPD is all that original. So good work.
Rad – that sounds good, and thanks for the endorsement.
Jason – thank you. I checked out your site, it’s very cool. I’ve added you to my technorati fav. I love the buy me beer thing.
Wow sounds like Rich Dad, Poor Dad. But it’s good advice for anyone that is not familier with RDPD
Moneymonk – welcome to Moolanomy. Yes, I read the book and at one point was inspired by him. But in reality, this is Finance 101 stuff, NOT Robert Kiyosaki’s idea.
Please see my comment #2 to Compounding above.
Your major/career may make it more or less difficult, but I don’t think it’s impossible for anyone.
My student loan didn’t give me any leverage; I earn minimum wage today. Can I get my money back?
Minimum Wage – I am sorry. May I ask what was your major and how well you did in school? Unfortunately, not all majors/careers are created equal.
I got a liberal arts degree with a 3.5 GPA. Why did I get a liberal arts degree and not something more “useful”? I intended to go to law school, and that required a degree…any degree. I also had a minor in comp sci as a backup as well as an exotic (at the time) supplement for a lawyer. Then I couldn’t afford to go to law school and graduated at the bottom of a deep Rust Belt recession, so the jobs weren’t there for liberal arts majors. And the PC reduced demand for my mainframe skills.
Sounds like you are about 20 years my senior and that life dealt you a crappy hand of cards.
What kind of mainframe work did you do? Were you a programmer? I checked Monster.com and there seems to be a decent amount of listing.
No, I never did any on-the-job programming, so when employers and headhunters were screaming for Y2W help, I was frantically waving my hands but nobody was interested in hiring me.
Love this post, I totally agree with your comments about “decreasing your bleeders” as these will sap the financial life out of you. I do think that the internet also breaks the traditional mould of investing given that you can realise assets almost in realtime especially it your investing through online investment broker services.
@Make Friends – Thank you. I am actually working on a more comprehensive post (or may be eBook) that builds on this model…coming soon.
“I do think that the internet also breaks the traditional mould of investing given that you can realise assets almost in realtime especially it your investing through online investment broker services.”
I don’t know if this is a good thing.
This does resemble the basic points in Rich Dad, and yes, this is and should be basic Finance 101. Since this doesn’t appear to be taught in highschools, at least it is good that RichDad/Kiyosaki has popularized it. Many people have been able to learn the basics they were never taught beforehand.
Thanks for reminding us of these basics, Pinyo! It really is as simple a formula as this.
what if life dealt a bad hand of extreme medical bills. i ended putting on credit cards because no Dr. would see me anymore due to owing to much money now I am living on the equity of my house and am unemployed and my equity is decreasing rapidly. any advise. oh yes, every day i look for jobs I have had a number of interviews but have not landed a job yet. how do I pull out of this.?
This is really a practicle advice.