What are the basic building blocks to personal finance? At the very heart of it are the following steps:
A. Bringing in more income.
B. Spending less than you bring in.
C. Investing the excess in wealth building assets.
D. Start early and Rinse and repeat.
But let’s see how it plays out in the 4 financial building blocks of Income, Expenses, Assets and Liabilities.
Within the Income Statement, there is income and expenses. Income is salary, wages, tips, royalties, rental revenue, dividends. Expenses are utilities, mortgage, phone, groceries, gas, home repair, etc. The amount left over is the operating income. That operating income can be used to invest in assets or pay down debt.
The Balance Sheet is Assets and Liabilities (Debt). Assets are the things we own that have value (if we sold them) such as house, car, rentals, stocks/bonds. Liabilities are the things we owe such as mortgage, student loans, cars, etc.
So, let’s see how each of the A, B, Cs play out in the financial statements I’ve outlined above.
A. Bring in more income.
At the beginning this is mostly career/job income. Later, once assets are large enough, those assets will produce income instead. These can be things like rentals (my favorite).
The key to this step is hard work, some luck, geography, etc.
B. Spend less than you bring in.
This means lowering expenses such as debt payments and excess expenses. This requires a careful reflection on wants vs needs. And this is where my wife and I have spent the most time coming together as a team to figure out. As we’ve joined forced on managing our finances, we’ve had to discuss our priorities, dreams, etc. At first it was hard, but we slowly worked through our difference, set goals and work towards them together.
The key to this is budgeting, habit building, discipline.
C. Invest the extra in wealth building assets.
This is where we’ve historically not had much activity because we’ve been paying down debt. We currently have one paid off rental and some dividend paying stocks. But we plan on working on this more in the future.
The assets available after subtracting the debt is the net assets (or wealth) someone has. There are a lot of people who have large incomes, but they spend it all and have little or no operating income. Or they have a big operating income, but they spend it on non-appreciating and non-cash flow producing assets. These are the bad assets.
The key to this step is understanding investing, discipline, wisdom, perspective and emotional control.
D. Start early. Rinse and repeat.
Starting early has a huge impact on wealth building. But once you start, you have to keep it up which I think is the hardest part. Anybody can go to the gym once, but going consistently over a LOOONG period of time is really really hard.
The ways to succeed at this art to build buying habits, budget weekly or monthly, track progress regularly, automate as much as possible and keep an eye on the end goal.