You must gain control over your money else the lack of it will forever control you – Dave Ramsey
This statement cannot be truer now than ever.
Did you know? – 60% of the population in the most developed countries of the world have less than $1000 in savings and cannot last for a week if they were to be devoid of their next paycheck.
Have you ever wondered how did someone manage to get rich and where did they start? If Yes, don’t worry you are not alone. The intention of this blog is to share some key points to help answer this question and help you manage your money better.
Look at the Wealth Distribution Chart below:
As you can see clearly,
The top 5% of the demographic has been handed over generational wealth from the earlier generations which make them RICH.
The next 15% of the demographic is the upper middle class. These are the people who own a house, go on vacations, can afford their children’s University education, have sorted out their Retirement or they are already well on their path to do so. They are generally those who have taken sound financial decisions in general by saving and investing money. They know the importance making their money work for them and their next generation is highly likely to be in the top 5% demographic that inherit generational wealth.
The remainder 80% of the population is who my article quotes ‘the Average Account Holders’. who will most likely end up in a situation where they need to go to work to earn a living when they get older delaying their retirement. Chances are that post retirement most of them will depend either on further government subsidy or their family in order to sustain their lifestyle or heavily cut down their lifestyle. This is the category of people who have lived paycheck to paycheck when they should have saved and invested.
The objective of this blog post is to give the readers a perspective and a base case scenario highlighting a key difference between how the RICH manage their money as opposed to the AVERAGE. The scope of this blog will be to suggest basic strategies and action points to give the readers a starting point since the author has learnt things the hard way making mistakes in the process too and believe everyone deserves to have debt free life and a great retirement, the only things you need are a strategy, discipline and patience. If you can follow some key principles, chances are that some of our readers will move from the 80% demographic to the 15% demographic.
How Do Average People Manage Money?
The 80% demographic, the Average Account holders get their paycheck credited to their account and expenses go out from a single account for all expense type, there is no organized way in which the amount goes out which makes it extremely difficult and time taking process to track expenses down the line.
The Average Account looks something like this:
This induces a high chance that people will end up spending the amount almost until it is exhausted. In the process ‘We Do Buy a Lot of SHIT’ and some of you might agree with me.
Worlds greatest investor of all time, Mr. Warren Buffet has made it really simple to understand which means you have to save before you spend.
Do not save what is left after spending, but spend what is left after saving – Warren Buffet
Knowing what your fixed expenses are, having a budget in place and planning for them will really help a long way.
In such a setup we only end up saving the money we could not spend which is a disaster recipe in any scenario. Meaning that we never get out of living ‘paycheck to paycheck’ situation ever until we take control of it.
How Do The Rich People Manage Money?
It is a well known fact that wealthy people manage their money differently that the rest. But what is the exact difference? you may ask.
This will enable you to imbibe some of the things straight away and start doing them as early as possible whereas some things will take a bit more practice, experience, knowledge and a lot of patience since the goal is to start working towards being rich slowly but in a sustainable balanced manner.
This is how the Account Setup looks like for the Rich folk:
Multiple paychecks come into their checking or salary account, if you notice the subtle difference in the above image, the Rich folk usually have more than one source of income (e.g. their primary source of income, dividends from the stocks they own, a paycheck from adverts from their blogging site, etc.)
They usually have a budget (that is the starting point) and know what money they need for their basic needs and then they calculate what amount can they safely put aside that can be further allocated for other things such as their holidays, investments, etc.
The accounts you can create and allocate money to are as follows:
Bills Account:
The Bills Account is always used for catering to the basic needs such as Groceries, Utilities, etc. This would be a Transactional Account which would not yield a lot of interest on the amount in there since you will be transacting on this account on a regular basis.
You will be very surprised to know how frugally can the Rich people live. The best example of this is worlds most successful investor Warren Buffet who has a net worth of $90 billion but still continues to live in the same house he bought the year 1958 for $31,500 about 62 years ago in Omaha, Nebraska whose current value is around $652,000.
Automatic Expenses Account:
The Auto Expenses Account is used to pay for all the auto deduction expenses such as paying your Rent/Mortgage, Health Insurance, Medical Insurance, etc.
This also has to be a Transactional Account that does not yield a high interest since deductions will be happening every week/fortnight/month based on the frequency set for the aforementioned payments.
Emergency Account:
A very important aspect of Personal Finance is the Emergency Account. This account is a life saver when it comes to covering the rainy days.
This is an account that should be tapped into only when you have big unexpected expenses that would cater for events such as job redundancy, an unexpected car or house repairs, etc. This can be a savings account with High Interest since the money would only go in and would be taken out only during emergencies.
Emergency Account has so many benefits that I can write a separate blog post just to highlight its impetus. The reason it is so key is because it can save your day and avoid taking on high interest debt (or bad debt) just to cover for that rainy day.
As we discussed earlier about having a budget as a starting point as this gives you the amount that you need per week/fortnight/month to sustain your lifestyle. Based on this number, calculate the amount you need to sustain over a period of 6 months. This is the amount you should aim for to have as cash in your Emergency Fund.
Example: If Joe has a budget in place and knows how much he needs to sustain his lifestyle for a month if he was to have no income in that month. For the sake of conversation say his number is $4000. In such a case Joe aims to have at least $24000 sitting in cash in his Emergency account.
Once you have that much amount in your account you can allocate that amount you have set aside for Emergency Fund to either Investments, Retirement, Holiday or Shopping accounts.
Retirement Account:
Ideally, if applicable everyone should be part of the Government’s retirement fund, be it the IRA, Super Annuation, KiwiSaver or similar.
In case you are not, then you will have to take care of your own retirement funds. When you get paid you should without fail, transfer a set amount based on your salary to your (or better if automatic transfers) your retirement account. This way you can sleep well at night knowing you will be taken care of after your retirement.
Investment Account:
One of the most important aspects of getting rich is understanding that ‘your money makes money for you’ even if you are not working.
Rich people know that compound interest is the eight wonder of the world and use it to grow their wealth getting rich in a sustainable manner. They understand that the money invested today grows tomorrow without even looking at it.
Example:
The index funds that track S&P 500 index (representing the top 500 companies in US) has returned around 8% each year on average for over 90 years now. If I were to calculate returns based on this number, say I invest invest $10,000 today and leave it there for the next 30 years without even looking at it, I will have $100,000 after 30 years.
(Please Note: Historical returns do not guarantee future returns, you can have higher or lower returns based on the state of the economy and other factors for the time period you are invested in. That is the reason I have just taken a huge sample size of over 90 years)
This is just a base case scenario of what Investing can achieve without doing any work apart from saving up the money and investing, bringing the power of Compound Interest in play.
Holiday Account:
It is very important to reward yourself after you get paid so you keep yourself motivated to follow this organized routine. Your Holiday, Travel or Fun Account can serve you funds for your next vacation to your dream destination that you might be looking forward to or it can fund your new hobby such as painting, reading, blogging, etc.
This could be a savings account with High Interest since the money would only go in and would be taken out only when you go for a holiday, travel, etc.
The names and reasons for the accounts for each individual can vary. As an example, if you wish to save money to fund a deposit for your first home, you can create a separate account for this. It really depends on what your personal financial goals are, how you want to achieve them and the time frame you want to achieve them in.
Conclusion:
Enough of me telling you about How the Rich Manage Their Money. Now it is time you take some actions on your part by creating a budget as a starting point. This will give you the magic number you spend towards your needs and wants per month. This will help you get to the important task of creating the accounts depending on your personal situation. Once you are setup, the only things to get rich are having a discipline to follow the budget, invest and be patient. If you have any questions or feedback for me please use the comment box below to reach out and I promise to revert back as soon as possible.
I challenge you all to create an account structure within a month and leave me a comment down here once you have. Looking forward to hearing from you all.
Should you want some guidance around budgeting your saving, spending and investing, here is a very good video you can watch to get you started.
Very Helpful.. Thank you!