Two Simple Equations that Lead to Financial Success

Last night I spoke to several hundred people on the basics of personal finance success. The following post is a summary of my opening comments. If you enjoy it and would like to receive free, daily suggestions on how to grow your net worth, you can subscribe to Free Money Finance using your feedreader and this link.

Americans today are in need of financial help. And for the life of me, I can't figure out why. Ok, actually I can, but it is still puzzling to me that so many people are having so many financial problems when the keys to success are so simple. And this was BEFORE the economic downturn too, so don't think people are in trouble only because of a poor economy. Granted, the slump hasn't helped, but things were bad before things were really bad.

How bad are they? According to a survey of 5,000 people highlighted in the book The Difference: How Anyone Can Prosper in Even The Toughest Times by Jean Chatzky, 54% of Americans live paycheck-to-paycheck, barely getting by, and are one financial problem away from money trouble. Another 15% are what the survey calls Further-in-Debtors – people who are going backwards financially every month. So between these two groups – almost 70% of people are either struggling or going backwards financially.

And what makes these results so perplexing is the fact that the principles to succeed in managing your money are pretty simple. They are both easy to understand and few in number. You don't have to be Einstein to succeed financially -- anyone with normal intelligence and a bit of self-control can prosper.

You have probably heard of the 80/20 rule, right? Also known as the pareto principle, it states that, for many events, roughly 80% of the effects come from 20% of the causes. In finances that would equate to getting 80% of the results out of 20% of the advice or tips. But in money management, the rule is more like 90/10 or even 95/5. Following a few steps will get you almost all the results you need (and certainly enough results to make you wealthy.)

Personal financial success ultimately comes down to two very basic financial equations. There’s no doubt about it – if you master these two equations alone, you will become wealthy and be far ahead of most Americans:

• Income – expenses = surplus

• Surplus x many years = wealth

Yep, that’s it. It seems pretty simple, doesn’t it? In fact, these seem to be “common sense.” But remember that these are two equations that 70% of Americans can’t get right.

If you look at these equations, you’ll see that all efforts to improve your finances come down to two things: increasing your income or decreasing your expenses. The more you do of each of these, the better.

So why can't most people get these two equations to work in their favor? Many would say it's simply because they don't earn enough money. And for a small portion of the population, this is the reason. But the survey above also identified why so many people are in tough financial shape: they spend too much. They can't control themselves and they simply over-spend. So they live paycheck-to-paycheck or worse, are falling more behind every month.

I've covered all this information previously when I wrote How to Be at the Bottom of the Financial Barrel. I also posted thoughts from the book above on What Makes Wealthy People Wealthy, The Difference Between the Wealthy and Everyone Else, and How to Be Financially Comfortable. But for those of you who don't want to read all those articles, here's the short version of how to be financially successful:

• Spend less than you earn (the bigger the [positive] gap between the two, the better)

• Do it for a long time

And for those of you who want a ton of suggestions on how to make and save more money, check out Thousands of Ways to Make and Save Money.

Comments

[Money Reasons]

Wow 70%, I had no idea most people were in that boat!

I blame a lot of our problems on the media, and too many options to spend money. Older generations weren't bombarded with infomercials, and the newest TV type (what is the big thing now LED TVs?), iphones and other tech gadgetry...

The best someone like you can do is to continue what you are doing. Educate couple thru church and the web. Then hope that it spreads from there!

Then again, it might be a good book too... Instead of promising get rich schemes, you could write out how a frugally religious lifestyle can lead to financial happiness in addition to spirital happiness?

[Eugene Krabs]

Oh hey! Congrats on your speaking engagement!

[Mark Gavagan]

Great post! THIS is easy for even my 6 and 4 year old daughters to understand.

"Everything should be made as simple as possible, but not simpler." ~Albert Einstein

[RJ]

It's good to see some statistics about how many people live paycheck to paycheck. I'm not surprised that it's around 50%, but a little saddened.

[Liz]

This advice ALWAYS bears repeating and never gets old, no matter which way it is explained! Thanks!

[Old Limey]

In the first equation "expenses" is a vital component that must be carefully controlled.
Often, for young married people, interest can be a major contributor to "expenses".
Thus it's extremely important to minimize the amount of interest you pay, since you are not getting any goods or services for the money, it's strictly money that you are paying a wealthy person or company for loaning you some of their money.
The first step is to know what interest rate you are paying someone for the privilege of using their money. You then need to try to eliminate the debts you have with the highest interest rates, even though the may be small debts.
When taking on debt you need to research all of the options available to you to ensure that you are getting the best possible interest rate. It's also crucial that you read the contract carefully so that you understand what may happen during the life of the loan. Is it fixed or adjustible, is there an interest rate reset, is there a balloon payment, is there an early payment penalty? You want to avoid surprises later on. It's worth sacrificing in other areas in order to get the best possible rate on a large, long term loan because the interest adds up to a huge amount by the time you make the last payment.
Also if you can make the payment it's always far better in the long run to take the shortest term loan you can, particulary on a large home loan.
Credit Unions should also be investigated they will often have a better loan than a bank.

[twitter.com/BruceWBenson]

The discipline to live below your income is the key. It is not much different than the discipline to burn more calories than you consume. Both are surprisingly hard, but doable by just about everyone. Find the motivation, support group or financial tool of your choice and then just go for it.

Bruce Benson

[JimmyDaGeek]

Charles Dickens said it best:
Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pound ought and six, result misery.
David Copperfield, 1849

[PF]

While I agree that many people who save don’t know how much as a percentage they save and by knowing they have a much better chance to improve that situation (knowing is half the battle G.I JOE…)

The old saying of saving 10% of your income is more meant for retirement. Which means for most people a 401K. So you should have this deducted from your pay before you ever receive it. Making it much easier to not spend it.

You should pay yourself first, make it line item number one after your taxes. Until you make it a priority to save you wont control your money. You can always find something else at the end of the month to buy. We take 15% for retirement and an additional 15% for longer term but taxable investing right off before we do any budgeting. The retirement is 401K and IRA’s and the other 15% is brokerage accounts and MMA/CD’s. Then we plan for our month. V-Day, Tires and even a pet aren’t unplanned you know Feb14th is VDay every year. Tires wear and you can estimate when they need replacement while owning a pet comes with some expense. Factor these in, knowing when they will happen make them easier to put aside money to use for them later.

I don’t want to put down the formula, just want to supplement for people to see. If you pulled 10% for retirement from gross and then saved another 13% in an emergency fund quickly life becomes a lot easier as those balances add up quickly.