The following is a guest post from Todd Tresidder who writes regularly about advanced personal finance topics and investment strategy at Financial Mentor. As most of you know, this line of thinking is near and dear to my heart. :-)
Building wealth is simple.
It doesn’t require luck, genius, or special connections.
You don’t have to attend overpriced, weekend financial seminars or learn the latest tricks and gimmicks sold by slick marketers.
As John Bogle wisely stated, “The secret is there are no secrets”.
The truth behind wealth building is public domain knowledge, simple to understand, and nobody is going to get rich selling it you.
In fact, it is so simple it can be explained in just two sentences…
1. Make more than you spend and invest the difference wisely.
2. Your wealth is determined by your habits.
I know… you’re probably a little disappointed.
You wanted something new, different, and clever – the missing ingredient that has held you back and will produce breakthrough results. Instead, I give you something dangerously close to what your grandmother would tell you. Bummer.
But listen to the voice of experience. I’ve coached hundreds of people from debtors to the wealthy and the pattern is unmistakable. And it’s not just me singing this song. These same truths were taught by Benjamin Franklin hundreds of years earlier, reiterated by numerous authorities since Franklin including J. Paul Getty, and still work today.
It is timeless wisdom that has been proven over the centuries, and will probably work for you also (if you just put it into practice).
In short, if you want wealth in this lifetime with the highest probability of success, then these two sentences contain the essential wisdom you need to know…
Make More Than You Spend And Invest The Difference Wisely
The first sentence summarizes how to manage your personal finances so that you grow assets. It explains the importance of creating positive cash flow that you invest to produce additional positive cash flow.
Notice how it is composed of three separate yet connected ideas to form a single concept…
1. Spend less
2. Earn more
3. Invest wisely
There are endless variations on how to achieve this objective but they all follow two simple themes…
- You can reduce spending immediately through various forms of frugality.
- You can increase your income through various strategies including changing jobs, getting a raise, or starting a business.
In short, you must create a gap between how much you earn and how much you spend that results in savings to invest for growth and additional income.
The twin themes of spending less and making more are not mutually exclusive, but they do require very different mindsets.
Frugality is about living on less and requires self-discipline. For most people there is a feeling of sacrifice when following this path thus making it difficult for many to succeed. If that is you then frugality is a slow and difficult path to wealth because you will be in constant battle between lifestyle desires and financial freedom goals.
For others frugality is a pleasurable journey in simplification where fulfillment results from redirecting earned income toward financial freedom goals rather than squandering it on spending. It is not uncommon for extreme frugalists to save 70% of income and achieve financial independence in less than 10 years, but it’s not everyone’s cup of tea.
Another alternative is to raise the income side of the equation. The advantage to this approach is there is no theoretical limitation to how fast your wealth can grow because your earning capacity is unlimited.
Many wealth gurus teach the income side of the equation as the “fast path” to wealth; however, if you don’t master the spending side of the equation you still run a high risk of failure due to the all-too-common mistake of allowing spending to rise as fast as income.
The greatest wealth builders focus on both sides of the equation together. They maximize savings by controlling spending while growing income at the same time. It is the quickest, most certain path to increased savings for investment.
The third component to the equation - invest wisely - is also simple because everything you need to learn is available for free in the public domain. You don’t have to take investment seminars or build extraordinary expertise. There are two well proven paths...
- Paper Assets: Conventional buy and hold using low cost index funds and proven asset allocation models. Vanguard Funds offers you everything you need.
- Real Estate: Direct ownership of positive cash flow real estate in your local area.
In summary, achieving financial freedom is really quite simple.
- Spend less than you make and invest the difference wisely.
- Rinse and repeat until the income from your investments exceeds your expenses. At that point you’re infinitely wealthy and financially independent.
With that said, the sad truth is few will achieve financial freedom despite the desirability of the goal and the simple path you must follow to achieve it. The reason is explained in the second sentence….
Your Wealth Is Determined By Your Habits
The reason so few people achieve wealth is because they don’t adopt habits that lead to wealth.
As you already know, the formula is simple and fully proven. The only thing remaining is to take action with enough consistency to achieve the goal… and that is where the problems occur.
Procrastination is the single biggest wealth killer. You plan on getting around to it someday. You know what you should do but there is always some other priority. The kids need braces, the car needs repair, the kitchen needs remodeling.
Action is where the rubber meets the road. It is one thing to know what to do, and it is something else entirely to get it done. That is why habits are so critical.
Habits are the reason postal workers become millionaires while lottery winners go broke.
It doesn’t matter if you look at the writings of Benjamin Franklin 250 years ago or Stanley and Danko’s recent bestseller The Millionaire Next Door: Surprising Secrets of America's Wealthy
They don’t earn the most. They aren’t the smartest. They don’t have any special training. They just have good money habits – brain dead simple.
The reason good money habits are essential is actually scientific and results from the mathematics behind how money compounds to grow into wealth. Small changes done over long periods of time can create massive results. It is an easy path to wealth.
That’s why daily habits are so important.
- A daily habit of frugality saves small amounts every day that compound and grow over long periods of time to become substantial wealth.
- A daily habit of increasing your earning capacity through training and education will add small amounts every day to your income potential.
Both of these daily habits will create an increasing spread between what you spend and what you earn which will increase your wealth at an accelerating rate.
This is not rocket science. It is just daily habits dedicated toward a specific goal – building wealth.
The habit causes the action which produces the result. It is simple cause and effect.
Habits are the easiest and simplest way for you to cross the bridge between how to build wealth using the simple formula above and actually doing what it takes to achieve the goal.
You don’t have to intellectualize the process or overcome massive obstacles. You don’t have to get ready to get ready. Instead, you just start today by adopting one habit that serves your wealth goals. Here are some potential starting points…
1. Sign up for an automatic savings program.
2. Optin to your company 401(k) (if they offer it).
3. Prepay a small amount on your mortgage.
4. Find an unnecessary expense and eliminate it.
5. Clean up clutter by selling unused assets (RV, boat, jewelry, etc.).
6. Repair something instead of replacing it.
7. Develop a niche expertise in your profession that commands a higher wage.
8. Start learning about asset allocation or investment real estate.
Just pick one habit and start today. Practice the habit until it becomes permanent then pick another habit and do it again. Then another and another until you can see your wealth grow.
The greatest obstacle to building wealth is procrastination. Habits are the simplest way to overcome procrastination and get into immediate action.
Habits reduce the entire wealth building process to bite sized pieces that are easy for anyone to digest. The compounded effect of all these tiny actions over a lifetime becomes wealth. It is simple cause and effect.
In Summary…
The formula for wealth is simple - spend less than you make and invest the difference wisely.
The mechanism to take action on the formula and produce results is equally simple – adopt wealth building habits.
The only question remaining is whether or not you will do what it takes.
Will you follow these proven, simple formulas to achieve amazing financial results, or will you return to your same old patterns that produce the same old results.
The only thing standing between you and wealth is the willingness to act on this timeless wisdom.
I love this summary. It really is that simple, and yet it eludes so many people. I sent the article to three of my friends before I'd even read half of it.
Posted by: Jonathan | November 28, 2011 at 04:51 PM
@Jonathan - Thanks for your your support. I'm glad you liked it and appreciate you spreading the word.
Posted by: Todd Tresidder | November 28, 2011 at 05:01 PM
Great post. The theory is easy, the application is hard. "Invest wisely" is relative, but I get the point. Thanks for the read.
Posted by: Romeo | November 28, 2011 at 05:48 PM
@Romeo - Yes, I agree. Simple to understand but hard to live. Success is generally not about the "how tos" but about the consistent implementation. That is why I added the second section about habits. This is critical - probably more than the first sentence.
Posted by: Todd Tresidder | November 28, 2011 at 05:59 PM
My wife and I took the Financial Peace University course just over two years ago. One of my favorite parts was when Dave Ramsey explained the difference between broke and poor people.
Broke - temporary/"just passing through", possibly due to just being out of school or between jobs, just getting financial house in order.
Poor - doing poor people stuff (payday loans, running up debt, living beyond means), possibly a victim mentality or entitlement issue.
He said if you're broke or poor and do "rich people stuff" (this article!), your situation is bound to improve. We are truly blessed to live in a country where we are able to make these decisions freely.
Posted by: Evan H. | November 28, 2011 at 06:02 PM
Yes, there is a lot of free information on investing out there. That doesn't make it easy to understand. And a lot of it is contradictory.
Posted by: Melissa | November 28, 2011 at 09:52 PM
@Melissa - Yes, there is a lot of noise. However, FMF has been very consistent on this blog. There is a proven asset allocation strategy using low cost providers of index products(i.e. Vanguard) that is the best starting point and easy enough for anyone to implement.
Posted by: Todd Tresidder | November 29, 2011 at 09:19 AM
"Wisely" is the key word. This word can equally well be applied to almost every thing a person does, such as Study, Spend, Marry, Eat, Drink, Drive etc. etc.
Unfortunately there is no one size that fits all, and the devil is in the details.
I spent the first two years of my retirement developing a comprehensive computer program that allowed users to select the very best mutual funds for their needs, based upon many different performance parameters. There were also modules that allowed users to determine the overall health of the market, or market sectors, with a view to reallocating their investments as market conditions changed. The manual for my software contained over 300 pages of instructions. I also read many "thick" books on the subject of investing along the way. My software requires the MS-DOS operating system and has not been available since 7/2008.
Becoming a wise investor is far from being easy. Whatever software you use to help with your investment choices requires spending a lot of time and effort to acquire "Wisdom" along the way, that is if you hope to obtain outstanding results. If you are not willing to make the investment of time that is required your results will doubtless be mediocre and you will have to suffer through large gut wrenching drawdowns in the value of your portfolio.
The bottom line is that "Investing wisely" is highly important in obtaining excellent results but acquiring the necessary wisdom does not come easily and you have to learn from your mistakes, and everyone makes mistakes.
In 1992 when I retired at age 58 my portfolio was in the low six figures and I invested very aggressively, rode the internet bubble up to the top in 3/2000, and then sold everything during the four trading days following the peak. Now, twenty years later my portfolio is in the upper 7 figures and since 11/2007 I have invested ultra conservatively in bonds, purchased below par, that I will be holding to maturity to eliminate possible losses, and earn 5% in tax exempt, and tax deferred interest. This year I am on track to make more than 4 times my gross salary when I retired.
Posted by: Old Limey | November 29, 2011 at 11:55 AM
the plan is indeed solid, proven and time tested. however, many fail to realize that this plan is predicated on hope and time - the fact that one will be alive decades from today and hope that the investments return a handsome profit/gain over time. that is why it is important to widen the gap between what you make and spend, and for most this is a limiting factor given the income ceilings they face at their job. this is where side gigging enters the scene.
Posted by: Sunil l Entrepreneurship & Personal Finance | November 29, 2011 at 02:24 PM
Hey, I think this has some good points, but I am the only one that thinks it is def too long for two simple sentences. I kind of lost interest halfway through the post, and I consider myself very frugal and interested in personal finance. Just with all the great content out there that Ive read, with this one I lost interest. Same old emotional mumbo jumbo that we all know.
Posted by: Chris S. | January 19, 2012 at 08:09 AM
"Investing wisely" isn't all that important, either.
"INVEST" is the important thing. Obviously, you can't
get rich wildly chasing the latest penny stock or putting
all your money in your checking account.....but even
investing in an undistinguished load fund with an
insurance company or bank is far better than never
getting started.....
Posted by: Harm | March 21, 2012 at 03:38 AM