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Wealth Building Made REAL Simple

July 15, 2007 by Pinyo.

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, wealth building in a nutshell…

REAL Wealth Diagram

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:

Builders = Income and Assets
Bleeders = Expenses and Liabilities

To build wealth you have to focus on increasing your Builders and decreasing your 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 (necessity), or wants (discretionary).

Necessity expenses — e.g., food, shelter, clothing, taxes, transportation, etc.
Discretionary expenses — e.g., hobbies, entertainments, luxury items, etc.

Note that necessity expenses 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.
IOUs — 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

REAL Wealth 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

REAL Wealth Builders 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!

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17 Comments

Compounding, 30. July 2007, 7:57

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…
Pinyo, 30. July 2007, 8:37

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.
Rad, 30. July 2007, 9:31

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
Pinyo, 30. July 2007, 9:39

Rad - thank you. Wouldn’t your grandma be offended?
Rad, 30. July 2007, 9:49

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.
Jason, 30. July 2007, 23:24

This is a good post, I agree it resembles RDPD, but nothing in RDPD is all that original. So good work.
Pinyo, 31. July 2007, 4:24

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.
Moneymonk, 3. August 2007, 15:40

Wow sounds like Rich Dad, Poor Dad. But it’s good advice for anyone that is not familier with RDPD
Pinyo, 3. August 2007, 15:52

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.
Minimum Wage, 7. August 2007, 14:28

My student loan didn’t give me any leverage; I earn minimum wage today. Can I get my money back?
Pinyo, 7. August 2007, 14:34

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.
Jason, 7. August 2007, 16:01

Your major/career may make it more or less difficult, but I don’t think it’s impossible for anyone.
Minimum Wage, 7. August 2007, 17:51

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.
Pinyo, 7. August 2007, 19:10

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.
Minimum Wage, 4. September 2007, 16:00

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.
Make Friends, Earn Money, 10. January 2008, 12:14

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.
Pinyo, 10. January 2008, 21:12

@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.