A Guide To Financial Planning
Why the rich get richer.
Have you ever wondered how the rich keep getting richer, while broke people stay broke, and the middle class seems to be shrinking. Well, this isn't nearly as mysterious as it may appear when you examine the specific differences in how broke people, the middle class, and the rich, spend their money.
How the rich spend their money.
In this article we’ll look at exactly how the rich spend their money so you can evaluate for yourself, why they keep getting richer and the broke keep getting broker, and why the middle class remain so stressed out. Let’s get started with a review of some financial terms we will be using in this article.
Terms to familiarize with in this article; Cash flow, expenses, assets, liabilities.
The terms that you need to be familiar with are; cash flow (which means money you bring in), expenses (which means money you spend), assets, which is the most confusing one. You're probably familiar with the traditional definition of an asset, which is something you own or have equity in. However, back in the 1990s Robert Kiyosaki introduced us to a new definition of an asset in his ground-breaking Rich Dad Poor Dad series of books. Robert taught us that an asset is something that pays you, and that's the definition we'll be using here. Liabilities is the last term, and it's defined as things that cost you money.
As an example, a house is typically viewed as an asset, but can it actually be a liability. Yes, with our revised definition, anything that costs you money is a liability, not an asset. If you have a mortgage, your house is an asset to your banker, because it pays him or her every month, but could a house, also be considered an asset to you. Yes, in the right circumstances it could when it pays you money. Let's say you buy a house, rent it out, and it paid you a positive cash flow every month. That would then be considered an asset.
Now let’s go through the main terms of this article one more time, just to be clear before we continue. Cash flow is money you make, expenses is the money you spend, an asset pays you, and a liability costs you. Now that we’re familiar with the main terms in this article, let's take a look at how broke people spend their money.
Living from paycheck to paycheck.
When I say broke people, I'm not referring to the destitute. I'm speaking about that large portion of our society that lives from paycheck to paycheck and who never seem to have any money. I'm sure many of you can relate to that group. On payday, broke people buy what I'm going to call stuff. Well what stuff? That's inexpensive things that people buy but don't really need to survive. You go into someone's house and you can't find any counter or tabletop space in the whole house because of all this stuff on it. Their house and their cars are full and cluttered with stuff. Where do they get all this stuff? They buy it at the flea market, at the garage sale, at the dollar store, at the craft show, etc.
Cash flow comes in, but goes straight out the expense column to buy stuff.
So cash flow comes in, and then it goes straight out the expense column to buy stuff. You see, broke people never really educate themselves on assets and liabilities, they justify buying all of this stuff by claiming that it costs so little. But over the years, it's all they ever have.
The problem is, their outgoing cash flow, never produced or created incoming cash flow. Now please understand, I'm not undermining or taking any shots at this or any group. I just see a lot of financial difficulty out there, and it really doesn't need to be that way. Creating wealth isn't a mystery, it's a formula. The only reason someone doesn't create wealth is because they either don't know the formula, or they don't apply the formula. Now let's take a look at the middle class.
The middle class - The group that society mistakenly thinks are rich.
The middle class is the group that society mistakenly thinks are rich; they're not. Yes, they typically earn a six figure income and many of them appear rich, but it's what they buy with their money that keeps them prisoners of the middle class. What they typically buy are liabilities, remember the definition of a liability (things that cost you). By buying liabilities, the money gets pushed up and out their expense column. Liabilities are items like; cars, boats, houses, aero-planes, credit card debt, etc.
Now, let's see just how this happens, the middle class gets a nice paycheck let's say $10,000 for the month. They then split that down the middle and pay their monthly expenses with one half, and with the other half, they make a down payment on a new car. The car costs, $5,000 down, they add on the insurance, and the maintenance. That liability now costs, $1100 new dollars every single month. A few months go by, and they want the boat, then a vacation home, a Rolex watch on their credit card, a vacation on their credit card, and before you know it, their liabilities have raised their expense levels to near or above their income levels. They actually spend equal to or more than they make, meaning that, they have to go to work and make a certain amount of money every single month just to cover their liabilities.
Middle class educate themselves to exchange their knowledge and expertise for someone's money.
The other important issue with both broke people, and the middle class is that normally, all of their cash flow is dependent on their own effort, meaning that they've educated themselves to exchange their knowledge and expertise for someone's money. Also, the money they earn is usually the highest taxed form of income (personal income).
Here's an example. And attorney is knowledgeable about law. So people pay him or her in exchange for that knowledge on an hourly basis. The problem here is that, if the attorney isn't sharing that knowledge with a client, then the attorney isn't making any money. This causes, lots of stress and anxiety in their lives. If you ever asked them to take an afternoon off to play golf with you, they very rarely can because of how much money it'll cost them to take that time off. On the surface, life's pretty good, the reality is that, it's a rollercoaster ride. That's the middle class.
The rich spend their money on acquiring things that produce more money.
Now let's take a look at how the rich spend their money. Rich people acquire assets. Again, an asset is something that pays you. If you want to become rich, buy assets that earn you more money. The money cycle looks like this; acquire assets that produce cash flow, invest the profits to acquire more assets that produce more cash flow. Invest those profits to acquire more assets that produce even more cash flow.
The rich spend their money on acquiring things that produce more money. Here are a few examples of assets that produce more money. Investments are the obvious ones, stocks, bonds, real estate, education is another asset. If you learn how to do something that produces more money for you, and you actually do it, that's buying an asset. There's a great quote that goes, “if you think education is expensive. You should see how expensive stupidity is”.
Passive income opportunities are a great way to create income flow.
Another example of assets you can acquire that pay you are cash generating opportunities, especially those opportunities that can create a passive cash flow. Passive, meaning that once you build it up, the money continues to flow, whether you're still building it or not. Here's a small example.
Let's suppose you buy a pinball machine and you put it in a barber shop, and you don't spend any of the profits, you save them until you can buy another pinball machine and put it in another barber shop. This by the way, was Warren Buffett's first business. If you don't know who Warren Buffett is, he's one of the top richest people in America.
The rich are always eager to find those passive income generating opportunities.
The rich are extremely eager to find those passive cash generating opportunities, because those opportunities continue to pay them, month after month, year after year, long after they've stopped working the opportunity. I see this happen again and again with successful entrepreneurs. They find a passive cash flow stream that they build up, and it continues to pay them, month after month, year after year. They then take those profits and multiply them in another passive cash generating opportunity, and then again in another.
In conclusion, here's what I've learned over the years. You can't find these passive cash generating opportunities, unless you're open to looking for them or hearing about them. Once you find them, you must be willing to see what fits you, and then act. These opportunities are out there, you just need to find them. You also must be opportunistic enough that when the right situation does present itself, you don't miss it.
Remember; financial planning is about acquire assets, not liabilities.
All in all, remember broke people buy stuff, the middle class buy liabilities, and the rich acquire assets, preferably cash generating opportunities that can create passive cash flow. They then take that cash flow and invest it in another asset that produces more cash flow. That's the wealth creation formula.
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