1.27.2013

Putting your pay raise to work

Now that you finally got that nice little raise, what you will do with it? Treat yourself to a nice dinner? How would you spend it? I am sure the question "how do rich folks spend their money" may have crossed your mind at some point or whenever you had a little bit of money to spare. It is no wonder that the rich are getting richer; the poor are getting poorer while the middle class is getting nowhere. The crux of this wealth accumulation balance lies not in our class but in our perception of how to best allocate our money.


Why money is important

Money matters because it gives you the freedom to act freely in the direction you want to go. What I am trying to say is that it does not make you a better person, rather it makes you more of who you already are. If you are a nice person to begin with, the accumulation of wealth will bring a more pleasant personality out of you and vice versa.

This is one of the reasons you may have noticed that money leaves some people with more miserable lives then they were before becoming rich. Think of money as a magnifier of your instinctive traits. Its magnification works by providing you comfort and increasing your power to affect others with your actions.

How the rich spend their money

The rich and the successful view their purchases in terms of an asset or a liability. Generally the more assets you have the better off you will be. Before we continue further, let's look at the definitions for some of these financial terms.

Cash flow and Expenses
Cash flow is the money you bring in while the expense is the money that you spend on things.

Liabilities
Liability is any item that costs you money but gives no returns financially.

Asset
An asset is any item that costs you money but pays you back financially.

Staying poor with good income
No matter how high of an income or cash flow you have, if the majority of your purchases or things you own fall under liabilities, you will either stay in the same situation you're in or will gradually become poorer.

For example: if you buy a yacht, house (real estate depends), cars, expensive clothes, cable TV or rent an apartment, the money you had spent will not grow any kind of equity or give any returns. Furthermore, some of these liabilities will continue to cost you in the form of maintenance, taxes, insurance and cost of ownership.

If you keep acquiring these liabilities, eventually you will get to a point where you will have to spend your entire paycheck to keep afloat.

Putting that pay increase to work
If you want to get rich, you will still need to earn money and spend it, except this time the majority of your purchases will fall under the assets category. You buy things that will give you returns and put money in your pocket.

Some of the most effective assets are stocks, bonds, savings accounts, real estate, investing in start-ups and lending personal loans. The type of investment I personally like is investing in start-up projects through personal loans. Being an angel investor gives you the leverage of gaining a certain percentage in the business and if the business is successful, you earn the money without doing anything. It is easier than it seems. All you have to do is look for people with passion and fresh ideas; once you see such an opportunity, offer them your small investment with the conditions of your choosing.

If you reinvest the money your assets bring in, you will produce more assets which in turn will bring more money, creating an endless cycle of financial prosperity.

Why liabilities are bad?

It is important to audit your financial behavior because over time your liabilities will add up and can get to a point where your cash flow is less than your expenses. You wouldn't call a situation pleasant in which your pay is $100,000 while your expenses are $120,000.

A good way to start is to write down your cash flow, expenses, assets and liabilities. Once you have everything on paper, you will be able to decide what cuts you can make towards your non-necessity, non-crucial items.

LiabilityAsset
VacationsStocks
Cars and  BoatsBonds
HousesSavings accounts
Rental expensesRoth IRA
AirplanesHSA
Credit Card debtLending personal loans
Luxury motor homesInvesting in start-ups
ShoppingReal Estate rentals

Why invest in assets?

Ever wonder what would you do if you lose your job? You are creating a risky situation for yourself if you have a relatively high number of liabilities and your job is the only means of your cash flow. Overall this affects your financial position because:
  • You must bring in a required amount of cash flow every month just to cover your expenses 
  • Your raises will immediately be eaten by your expenses and will feel like as if nothing progressive happened 
  • Liability based expenses will grow over time and will eventually surpass your cash flow 
  • All of your cash flow is coming from your work. So if you lose your work, you lose your cash flow 
  • You are only getting paid for the hours you are working
  • Your pay is the highest taxed cash flow
In contrast to the regular pay, your assets will be taxed differently and will provide you a secondary source of income regardless of whether you are working or not.

Bottom line

Monthly expenses are directly proportional to the level of liabilities present. Without proper planning and pay allocation you will not be able to help yourself or others.

If we look at the lives of Sir Richard Branson, Bill Gates or Warren Buffet, they were able to engage into philanthropic activities only after they became rich. Regardless of if you are a jerk or a nice person to begin with, your goodness or wickedness will not really matter if you are not progressing anywhere wealth-wise. You will not be able to help others if your own situation does not allow you to do so.

So next time you have that spare dollar in your pocket and you are ready to spend it, think twice about how you can get maximum return for its value!

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