The difference between people who will become wealthy is really a matter of cash flow – how your paycheck flows through your hands and gets spent or saved. Most people have a cash flow that is linear:
1. Money is earned through work and deposited into the checking account.
2. The money is sent to various bills, including car payments, credit card payments, and other liabilities.
3. On some months the balance in the checking account grows, but most months it stays constant.
Cash flow here is entirely linear – it flows in the top and flows right out the bottom. This way of managing money results in no money being available for things that eventually come due like home repairs, car repairs, replacement of vehicles, college, and medical bills. When these expenses occur, debt is added to the cash flow plan, causing obligations to increase and requiring even more income just to balance the expenses and avoid going further into debt.
People who become wealthy use their money to invest and make more money. They have a circular cash flow plan where money flows into assets like stocks and bonds. Money then flows right back from these assets into their checking accounts, adding to their income. Their cash flow plan looks like this:
1. Money is earned through work and deposited into the checking account.
2. Some money is used to pay for expenses, but payments for debt are kept to a minimum.
3. Some money is used to buy assets like pay off the home, purchase stocks and bonds, or buy real estate for rentals.
4. Money from the assets flows back into the checking account, increasing the amount of income received.
5. Some money is used to add to lifestyle, but much of it is used to purchase additional assets, compounding income and causing it to increase each month. Because of the additional income, cash is available to pay for things like cars and home repairs, so debt is not incurred. Without debt, more of the money earned through work can be used for expenses and purchase of assets since less is used to pay interest on debt.
In percentage terms, the cash flow plan of a future millionaire would look something like this:
1. 25% of income goes towards a house payment. The home is on a 15 year loan that will be paid off by age 40-45, a few years before college expenses start.
2. 15% of earnings goes into a retirement account such as a Roth IRA or a 401k. This cuts the tax bill and ensures that money will be available for bills in retirement.
3. 10% of income goes into a taxable investment account. This account is mainly invested in things that don’t result in a regular tax payments such as index funds and long-term stock holdings so that investments can grow without the return-zapping effects of tax payments each year.
4. 10% of earnings goes to save for expected expenses like college and replacement cars. Because cars are bought for cash, there are no car payments. Cars grow nicer over the years as income from assets and work increases.
5. The other 40% of the paycheck, plus perhaps 25% of earnings from the taxable account, are spent on lifestyle. The remainder of earnings from the taxable account are reinvested or used to fund the expected expense accounts.
Growing wealthy isn’t a matter of working hard and earning more money. There are broke people who make $30,000 per year and broke people who make $300,000 per year. It is a matter of how money is handled once it is earned. Set up your cash flow like a wealthy person and soon you’ll be one.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
