Wealth Creation Fundamentals for any Income Level
What is wealth creation and how do we make the best of the income we have, whilst ensuring we reduce our expenses?
Investing is an important element that we will unpack more in this article as well as simple lifestyle changes to help grow your wealth.
Essentially wealth creation is a simple mathematical formula which can be applied in our lives.
Wealth Creation = (Income – Expenses) x Investment
Let us solve the equation in the brackets first. ‘Income – Expenses’ is your savings. So, the wealth equation becomes:
Wealth Creation = Savings x Investment.
So, to make an improvement in any of these elements of the equation, you will improve your wealth. Let’s look at them individually…
Income
Income is the cash we receive on a day to day basis. There are two broad types of income: active and passive.
• Active income is a reward for our labour, either as wages, salary or, if we are self-employed, business profits.
• Passive income is what we receive from investment assets that we hold. This is things like rent or dividends or interest.
It is easier to generate savings when our income is higher. So, if we improve our income this will generally help us to become wealthier.
How do we help ourselves earn a higher income? One way is by improving our job prospects by education and training. Generally, the time spent studying is a choice and does not automatically generate a better income. After graduating the aim is thought to generate a higher income than would otherwise be.
What about passive income? The mix of income and capital return that an investment creates. An investment creates returns in two ways: the income we receive when we hold an asset, and the capital gain we receive when we sell the asset. Different assets can have a mix of returns.
Cash investments like a term deposit only provide income return. Investments like property tend to provide a greater portion of the total return as a capital gain. The choice of asset an investor chooses depends on whether their other income is currently higher than their expenses. In this case an investor may prefer to invest for a longer-term capital gain. If a passive income is required for lifestyle expenses, then investors may invest for income return.
Expenses
It’s not “rocket science”, reducing expenses will boost savings. This leaves more to invest and should reasonably lead to greater wealth over time.
In reducing expenses, look for things that can be reduced rather than impacting your chosen lifestyle. Look for things that will make a big impact. Switching to a Coles brand instant coffee might save a few dollars, but will it make a big impact? I know my wife loves her Barista branded coffee! In some cases, spending a bit more money makes sense!
The things we often look at are insurance costs, car costs, education costs, interest expenses (for mortgages and/or credit cards), etc.
The aim to reduce costs that do not impact the wealth equation. For example, if you cancelled income protection insurance this will reduce your expenses. But, if you are unable to work due to illness or injury, this will leave you without income. A rethink here can help, and sometimes this may well be money well spent to protect your income and wealth creation long-term.
Investments
Now that you’re saving, you sometimes need debt. If so, how much debt is okay?
When buying your first home you need to save a large amount of money for a deposit. Sometimes with your parents help, or you may have received a windfall. You need to decide how much you’re comfortable borrowing, your savings are then used in conjunction with a mortgage to purchase your home. This is an investment, and the average cost of your first home is increasing year on year.
So, choosing an investment is based on many individual factors, as well as your risk comfort level.
At Financial Streams, our role is guiding you on the most appropriate investment for you. We help our clients find ways to increase their savings by managing their income and expenses. This is the first step in wealth creation. We’d love to chat with you about where you can start!