Financial freedom is truly within everyone’s grasp as long as they have the tools, education, and drive to get there. It is a new year, and everyone has goals related to fitness, finances, jobs, and all the like. In order to set goals pertaining to financial freedom, you must first understand the core principles of how to build wealth, and what mindset shifts you will have to make to get to where you want to be. Wealthy people have a very different mindset than the majority of us, but with an open mind, the mindset can simple to understand. To understand financial freedom, you must first grasp the core principle of assets and liabilities.
Assets and liabilities
Liabilities are all around us. They are that Gucci belt you got for Christmas, or that car payment for your $50,000 Chevy Camaro you pay monthly. They are the subscriptions you have you don’t know you are paying for every month, and the seven times you went out to eat last week. Simply put, liabilities are anything that costs you money you didn’t need to spend on things that either have no value after bought or that lose value over time, and drain your ability to gain wealth. For most people, liabilities are all they think about. The majority thinks that to be part of the rich class, you must buy expensive things that make you look rich. This look rich culture we live in is causing more and more people to be poor over the course of time because all of their money is going into liabilities causing them to live paycheck to paycheck for their entire adult lives. This problem can likely be sourced to the lack of financial education in school. Many people graduate college (including myself) and never hear once about money, how to manage money, buying assets, and limiting liabilities. Assets are what creates wealth, and keeps people wealthy. They are anything that appreciates or goes up in value over time. This can range from real estate, stocks, and cryptocurrency, along with many other asset classes. Simply put, wealth is built when you use your money to buy assets, while limiting your spend on liabilities. The goal of assets is to generate passive income. This is the way that wealthy people compound and grow their money exponentially over time.
Passive income and Active income
Active income is the type of income you get from physically working. A job is considered active income where you are actively spending time to acquire money. For the majority of people, this is their only source of income. Once they stop their active work, the majority of Americans have very little money left over for retirement. This is because we have an epidemic of financial misunderstanding in this country today. The key to wealth and making active income optional is passive income. This is the type of income you get from the assets you buy. Appreciation and cashflow are the two types of income people generally invest for and are able to live off of if they so choose when their portfolios are large enough. Appreciation is something that generally takes some time, but it is basically defined as the value of your asset going up over the course of time. Sometimes, appreciation will be higher or lower than the average for whatever asset class you invest in, and this is normal. This is why so many people look to cashflow for passive income because if the proper systems are in place, your income from cashflow will be consistent and go up periodically over time. My favorite form of cashflow comes from real estate investing. When you invest in a rental property, you will have a tenant who pays you rent. For example, let’s say this tenant pays you $1,500 a month to live in your property. After expenses such as taxes, insurance, mortgage, and repairs are paid, what you are left with out of that $1,500 is money you get to keep every month. On a property like this, good cashflow would likely be between $200-$400 a month. This is money you don’t have to work for making it passive income. This is a concept called getting paid while you wait. If you own 10 of these homes making $250 from each a month, you would be making $2,500 a month in passive income. For some people, this may replace or come close to replacing their active income making their active work optional for them. Over time, real estate is an asset class that will appreciate, so essentially you are getting paid in cashflow to own the property, while you wait for the house to appreciate in value over time growing your net worth. Another popular way of investing for cashflow is investing in dividend paying stocks. When you buy stock in a company, generally you predict the value of your company will go up over time based on its fundamentals. What some companies do in addition to this appreciation is pay a dividend to their shareholders. This dividend can be something like a 3-4% yield based on your holdings usually paid out quarterly. So, for example if you owned 100 shares of a stock trading at a $1,000 a share, you would have $100,000 invested in this company. With a dividend yield of 3%, you would be getting paid $30 a share whenever a dividend is paid out. In this example, you would make $3,000 per payment. What you can do with this dividend is either keep it for yourself, or reinvest it into the stock to compound your growth, get better returns on your dividends, and add more money that you didn’t actively work for to your net worth of money working for you. In later posts, I will go into great detail on these topics along with others, but for the purpose of this blog, you now understand the power of passive income in comparison with active income.
Saving and investing
Investing your active income into assets to generate passive income is something you need to do in order to become wealthy. Saving money, although less important is still necessary for emergencies and unexpected expenses. As a general rule of thumb, you will be able to grow your money by using 75% of your income to spend, 15% to invest, and 10% to save. These numbers can be played around with and the more you are able to invest, the quicker you will grow your wealth. This is just meant to be a baseline to go off of. You may be wondering how you can live off of 75% of your income when you are struggling to live off of 100%. This goes back to what we talked about earlier. If you take a deeper look into what we talked about earlier in the liabilities section, you will probably see the majority of your funds are going towards paying for liabilities each month. This can be through car payments, Gucci belts, eating out every day, paying for subscriptions you don’t use, and so much more. If you look closely at your expenses and analyze them from a financially literate standpoint knowing what you know now about assets and liabilities, you should be able to cut out a ton of expenses. If this is something you struggle with, I would love to hear that in the comments so I know I should make a post about limiting expenses.
Conclusion
To gain wealth, you must invest in assets over liabilities. As a rule of thumb, you should roughly follow the 75/15/10 rule, and adjust where you see fit for your own situation. Investing in cash flowing assets will allow you to make earning an active income optional when compounded over time. In addition to this, appreciation will occur increasing your net worth. This is the get paid while you wait concept which will build wealth for yourself and your family. Use this knowledge as a base for your journey towards financial freedom in 2022. If you want to dig deeper into these concepts, I would highly recommend Rich Dad Poor Dad for you to read. The book is the hallmark bible of financial literacy, and its lessons will make you very wealthy if followed over time. Please feel free to share your thoughts in the comments. I would love to hear any questions you may have so I can make future posts based on them!
Link for Rich Dad Poor Dad Here!