Wealth Building: The Principles, Part 1

Wealth building is probably the second most important issue in a person’s life. The most important? Certainly happiness and fulfillment.

Interestingly enough, for some people these two things go hand in hand.

Nevertheless, it cannot be denied that at some point in life parts of both issues somehow seem to interact and overlap. That’s how we grew up – money is the ultimate backbone on which everything is built. We are told on a daily basis that we could even be more happy by purchasing more and more stuff.
I like the saying, that some people seem to buy things with money they don’t have to impress people they don’t like. And how much effort one will put in accumulating money to buy something a little more fancy is surely everyone’s own decision.

But what about the really necessary things that also require money, such as food, medical care, clothes?
I’m not saying anything new here: Everyone should strive for the goal of making sure that these things are never going to be linked to financial problems at some point in someone’s life.
You can be hungry, but being hungry and having no money sucks. You can be sick, but being sick and having no money sucks. And for the clothes – you get my point.

There is no serious book or seminar on financial strategy that is not based on the principles of the three primary wealth creation resources. These resources are Time, Personal Capital (or Human Capital, which includes all of your skills, abilities, etc.), and Financial Capital (assets such as Cash, Real Estate, Stocks, etc.).

Three Resources: Easy To Grasp Yet Still Somewhat Tricky To Master / Why You Want To Invest

When designing your life plan in combination with wealth building, the key is basically to use all three resources in such a way, that it has the best possible leverage to move yourself towards your financial goal – ideally the goal of financial independence, where your monthly income always covers your monthly expenses.

When you no longer work and get paid regularly (and your pension is insufficient), you want to generate alternative income from your investments – and that should be your main reason for investing in the first place: to generate cash flow. This is basically the money you have left after you cover your expenses and keep you flexible. However, investments in land should only make sense if they generate money by letting them. Otherwise you just parked your money, with no proper benefits until you sell everything again one day. Similar when dealing with such things as commodities: This is only price speculation, too. There is no economic productivity or value added and therefore it should not fall into the category of investing. But this is what we are looking for when entering retirement or want to stop working. We need cash flow.

When designing your life plan in terms of happiness and fulfillment on the other hand, you surely need to use the same three resources as well, but the leverage will be different (with Financial Capital bein the least important). We will investigate this a bit, too. I will mark these passages as “Small inserts” and you are allowed to skip these without losing information about the financial aspect.

Now, it is possible, that one of these three resources of Time, Personal Capital and Financial Capital can do the job for your wealth building plan on its own, of course, but it will not unlock its full potential. It needs much more effort (including potential luck) and is highly limited by its own number (capacity). That can get quite tricky altogether.

And that’s the sad thing: Actually, a lot more people could achieve financial independence, but they fail because of a bad strategy. They unintentionally let their resources work in such a poor way that from their point of view it seems impossible to even remotely achieve financial independence, and they eventually give up on that goal.

Let’s make this more clear: Yes, you can have a well paying job, high income relative to your expenses, but without proper time management and working on your Personal Capital, the money is prone to be wasted and not permanent. You can have an investment horizon of 50 years, but without Financial Capital and/or constancy to use this time frame consistently, you have not even come close to what would have been possible.

Finally, education and health (probably the most important factor), won’t help you build financial wealth either, if you have a small time horizon left or no capital at all.

Don’t get me wrong, we are only talking about wealth building here. It doesn’t mean that a broke 91-year-old Warren Buffett suddenly needs welfare because financially „it’s all over“. He has enough Personal Capital to throw in to get back on his feet. But it would not be possible to reach his former peak, as his Personal Capital no longer completely corresponds to the other two resources of Time and Financial Capital. Now, is this a serious problem? It depends.

So it may be important to note (and logical) that after you reached your goal of financial independence, there surely is going to be an imbalance within these resources, which is OK to some extend.

That is, when you are no longer working and your income-producing „money machine“ (Financial Capital) is doing its job, Time or Personal Capital now become somewhat irrelevant in this plan. Yes, in theory, now you could start drinking on the beach all day or playing golf for the rest of your life.
But be aware that when an event occurs that somehow wipes out all of your savings, you will have less Time, poor Personal Capital (because of drinking all day I now assume…), and no Financial Capital. Not that much of a problem for (a sober) Warren Buffett and his huge pile of Personal Capital, but what about you honestly?
Would you be prepared?

Shift Your Perspective For Better Focus

So, to better relate the above concept to our society, we can take a look at our traditional belief system:

The traditional drill has always been to get a good education and start a good job while you are young, accumulate and save money (aka “spend-less-than-you-earn-and-put-the-difference-in-something-like-a-retirement-plan”) to retire at maybe 65. And then to live from there with your (hopefully plenty) savings and finally enjoy life.

Well, that sounds kind of reasonable and, to be fair, quite similar to our goal, but there are certainly some flaws (or rather, inaccuracies) in this life „plan“ if we look at it from a broader perspective.*

*Small insert: By far the biggest misunderstanding in this belief system is apparently that when you retire, you can allegedly feel free and enjoy your time now. But psychologically, this assumption is the most dangerous threat to happiness in general because it ties external things (your financial freedom with all its benefits) to your inner feelings (happiness), which are not the same – or shouldn’t be at least. If so, all the “rich” would be happy and all “poor” unhappy – which is of course complete nonsense.

Yes, the whole idea behind this statement of getting education -> work (save money) -> retire seems to be that when you are around 65, you ideally have now the Financial Capital, while you are lacking the other two resources of Time and Personal Capital. Which is okay, as we discussed, right?

Let’s see.

“…to get a good education and start a good job while you are young,..”.

Correct. This advice already includes two resources for solid financial wealth building (Personal Capital and Time), however it does not necessary accomplish the very same thing (wealth) automatically and by default, which is quite frustrating to be honest. But so many people just assume it does, presumably because the resources of wealth building match and it kind of logical, doesn’t it? Additionally, many (older) people still rely on this model (or worse: blindly advise it to younger people because this path is “how it has always been and it is what worked”).

But these people overlook the big picture and forget about all of the resources and assets a person has. Plus: Taxes, inflation, (health) insurance and a longer life expectancy require more money to be accumulated than in the past in order to maintain the average lifestyle for as long as possible without running out of money before death. Hence, adjusting and optimizing someone’s strategy to suit their personal life should be paramount.

Sure, getting a job early in life means making money that ideally you can save a little each month. But do you „only“ have to cover your expenses or are you also willing (and capable) to start to use the leverage of Time?

Why Starting Young Is Ideal To Benefit From The Powerful Effects Of Compounding:

I’d like to illustrate this with a small example: If you (or better your parents for you) start investing when you are 2 years old, it ONLY requires $22.03 a month to save in order to reach around $100.000 when you are 65. And over such along period of time, the above assumptions are more than fair. For some people it may be even too conservative.
More fascinating, the whole savings add up to a total invested amount of only $16.654 during these 63 years. And there is almost no disadvantage (besides that you have $22 less to spend every month). You are not wasting any Time, you don’t even need to throw in more Personal Capital or even Financial Capital. To achieve such a reward for such few effort is almost as cheap as it gets. Big investors always seek to risk as little as possible to make as much as possible. The term is assymmetric risk/reward.

But since more risk is usually connected with more profit and less risk is connected with less profit, the compounding effect gives everyone on the planet the opportunity to build financial wealth.

Just imagine the way around: You were given $16.654 and you want to turn these into $100.000. Now you need to bring already some Personal Capital to the table in order to know what you are doing. And more Financial Capital is required, too: Instead of $22.03 per month you need to have $16.654 at once.
If you say „I can just give the $16.654 to a professional. He will take care and make $100.000 for me“, please read this post until then end in order to see how the fees will kill your savings.

A second amazing thing is, you not only need to have a higher saving rate if you start at a later age, but, all in all, you also need to put more money aside.
If you start at 35, you have accumulated an amount of $46.044 out of your own pocket, to reach $100.000 at 65.
Same here: You can try to make $100k out of $46k at once – it is definately possible. But it will be trickier.

Here is another impressive example:

If you were given an account with a monthly savings rate of $100 as a two-year old baby on the other hand, you’d have almost half a million dollars by the age of 65! Also, your invested sum has more than sixfolded. Now take a look at the age of 45 in the first column. If you start saving the same amount of $100, your invested amount will not even have doubled. Worse, you can show up for „only“ $40,000.

To compete with the baby-account to also reach half a million dollars by the age of 65, check out the second column what you need to do:
If you start at 45, you need to save $1247 each month instead of $100. Additionally, your total invested sum will be $275.000 compared to $75.000 to reach the same result. That is a difference of a stunning $200.000. That’s why it is so important to never underestimate your cash-flow, because these $200k extra in your pocket are nothing less: Money you can spend as you wish on YOUR terms and with no disadvantages to the later outcome of your saving plan!

I hope the above statement makes more sense now, why more people could achieve financial stability.

But let’s see what else we need to do!

Continue in Part 2.