Building wealth (Pt 2): Spend less and invest the rest

If you don’t find a way to make money while you sleep, you will work until you die.   
(Warren Buffett)

I  assume that for most people looking at their personal finances feels like looking at a Jackson Pollock painting, a big swirly, inscrutable mess that threatens to engulf them if they come too close.  (Exhibit 1) Each dot represents a purchase.  Multiple dots (or strings of purchases) create  unruly lines.  This noisy backdrop of daily consumption is punctuated by large, sporadic purchases (e.g., car, computers, home) that further convolute the picture.  How does one begin to make sense of these many mundane financial decisions, much less build wealth?  As with many things in life, the formula for building wealth is simple.  The discipline required to build wealth is hard.  With that said, let me first highlight the formula for building wealth.

Exhibit 1: Autumn Rhythm by Jackson Pollock

 

Know yourself.

As trite as this Greek maxim seems, it still holds as true today as it did in ancient times.  If you don’t know who you are, you won’t know where you’re going and, more importantly, why you want to get there in the first place.  Wealth is a resource that can be built to help power you to your destination.  But, the journey is often long and, thus, requires clarity and conviction to stay the course.  If your goal is financial independence, but you’re not sure for what end, then you’re more vulnerable to distraction, derailment and/or discouragement en route.  Here’s a list of questions that I ask prospects to answer to help them gain more clarity on why they want to embark on the long and often arduous journey towards financial independence:

     ·       What were your earliest money memories and how have they influenced your actions as an adult?

     ·       What kind of life do you want to live? What role do you see money playing in that?

     ·       What has prompted you to seek out financial advice at this point in your life?

     ·       What are you looking for in a financial planner?

     ·       What does success look like for you?

The purpose of this exercise is to help people reflect on their past, to better understand their present and to gain more clarity around what and why they want to create a certain future.  As often the case, without doing the necessary inner work, it’s difficult, if not impossible, to do the outer work.

Know your money.    

People typically have a good sense of their earnings, but less so their spending.  Oftentimes, many underestimate their spending, which can easily lead to debt: credit cards, student loans, car, mortgage.  Debt impedes wealth building like no other!  Imagine running a marathon with a 20 lb ball chained to your leg for years, if not decades?!?!?  To preempt or address this issue, it’s critical to get more visibility into your cash flow: how much is coming in and how much is going out?  Here are some ways to get that visibility:

      ·      Leverage free financial tracking software, such as Personal Capital or Mint.

      ·      Put as many of your expenses on a credit card as possible and then pay off monthly balances in full.  Export the inventory of expenses into a spreadsheet on a monthly, quarterly, semi-annual or annual to analyze your spending.

      ·      Track expenses via a spreadsheet.

Personally, I use Personal Capital to track my finances.  It’s secure, accurate (mostly), effortless and free.  However, regardless of how you want to track your money, it’s important that you have a “system” for doing so.  Otherwise, you will inevitably find yourself buried in countless, daily transactions that will hinder your efforts for financial clarity and, thus, progress.

Next, it’s important that you live within your means; your spending is below your earnings.  Only by saving money will you create the opportunity to invest (or put it to work for you).  Otherwise, you consign yourself to a life wherein you’re always working for money rather than positioning your money to work for you.  Below is graph that outlines the relationship between savings rate and working years.  If you’re able to save 64% of your gross income, you can retire in 10.9 years.  While money can buy you a lot of stuff, the greatest gift it can buy you is probably time and freedom.  If you value your time and freedom, then it’s critical that you have a better sense of your (target) saving rate.