This article is Part 5 in a short series of blog posts where I will lay out my business and investing strategies at a bird’s-eye level. The Rich Dad books talk about focusing on what you’re good at, but diversifying in terms of the type of asset you own (as opposed to diversifying across industries within one asset class). I’ve taken that concept and applied it to my own passions, as well as the knowledge I’ve gained from all of the reading and research I’ve done over the past couple of years, to determine just what business and investing vehicles I plan to use and how I plan to leverage them.
This article doesn’t talk about an asset class, but rather, how I’ll be able to afford all of the investments I talked about in the other parts of the series.
So, you’ve read my little series, done a whole bunch of your own research, and come up with a sound investing strategy. You know what you need to do to get rich, but how can you afford to buy all of those wealth-generating assets? After all, that’s the whole point of the strategy – if you were already rich and had a whole bunch of money laying around, you wouldn’t need to invest to get there!
The answer is to create a difference between the amount of money you earn and the amount you spend. This can be done by either reducing your expenses or by increasing your income. Either way, you end up with some extra cash – a savings.
The Place in My Portfolio
Wait a second. Didn’t I say in the previous articles that your savings account was definitely not going to get you rich? After all, the value of any cash you have laying around is just going to get inflated away, right? If you just keep tucking your money away in a savings account, it won’t be worth as much in a few years; trying to get rich that way is like trying to outrun a race car.
That’s why it’s probably best to think of your savings account as cash reserves rather than savings. The idea is to spend much less than you earn and hold onto that excess cash, tucking it away for future use. Your savings account is not a place where your money goes that you cannot ever touch. Its purpose is not to cover living expenses later or to fund your lifestyle, except in case of emergency. Remember how I defined getting rich? It’s going to be very difficult to have your savings account cover all of your living expenses for very long as expenses keep climbing higher.
Instead, you should be using your savings account to store excess cash for future opportunities.
You’re not saving, you’re preparing to invest.
Of course, you’ll always want to make sure that your investment account is flush with cash, just in case an emergency arises and you need to dip into those funds to do something like pay for a car or home repair, or if a healthcare emergency comes up. A good rule of thumb is to have six months of expenses set aside, plus extra for investing – although you can go more or less based on your risk tolerance and level of comfort.
Whenever you get paid, through your job, businesses, or other investments, you always want to make sure to tuck a fraction of that income away in what we’ll call an “investment account” (I think that sounds better than “savings account,” since we’re not saving, we’re investing). Paula Pant at AffordAnything.com recommends putting the savings away immediately upon receiving the payment, so that you then force yourself to live on what’s left over rather than trying to track and reduce your expenses so you can save what’s left over. It’s a different mindset, and it seems to work for me. Even though I know I have a lot of money available in my savings account, I still feel like I have to make that last few hundred in checking last until the next time I get paid.
As you continue to get paid, your cash reserves will continue to grow. That way, when you happen to find an appealing investment opportunity in any of the asset classes within your strategy, you’ll find that you have more than enough extra cash laying around to make a purchase, usually with some left over for emergency situations as well as other future opportunities.
Your savings aren’t going to make you rich directly, but they will allow you to be ready when the opportunity to get rich presents itself.
I think the average person has a sense of the problem with trying to save, even if they don’t consciously understand it. Maybe that’s why most people spend every penny they earn, since they know that they can buy more stuff today with that sum of cash than they can tomorrow. The problem is that the average person spends all of their money on luxuries – fancy cars, houses, boats, televisions and other toys – and often goes deeply into debt to buy these things. Rather than providing them with freedom and security, this chains them to their job, reduces security, and adds a ton of stress at the idea of something like getting laid off or getting a pay cut – because these things are major life disasters to the average person, rather than the slight annoyances they might be to the person who is prepared.
But we’re not average, right? If you’re reading this blog, you’re probably looking to get free from reliance on a job or any other single source of income, so you can manage your own schedule and pursue hobbies and family time outside of work.
If you want to do that, you need to buy assets first, luxuries later.
Some, however, are just above average. They want to invest, and they have an idea of an investing strategy that they’d like to follow. However, they can’t afford to buy assets — even if they’re bringing in the big bucks. That’s because they are not willing to cut out the luxuries in life – they’re making the big bucks at work, and they want to make sure others know. So, they buy those big fancy cars and boats, and just hope that some money is left over.
If you want to get rich, you need to have cash reserves. It’s going to take some effort, maybe some pain, but it’ll be worth it later. After all, what doesn’t kill us makes us stronger, right? I’m not going to get in shape by going to the gym only when I happen to have a little bit of time – I have to make myself go consistently. It’s the same with your finances. You have to create that gap between your income and expenses, even if it means you have to sell your boat or can’t impress your friends with the latest fashions for a while.
There are two ways of doing that: you can reduce your expenses, or you can increase your income.
There are many things that everyone does or buys that can easily be cut out of your life, even if only temporarily while you make your way towards being rich. If you’re not already rich, you don’t need a fancy new car that you can’t afford, and you don’t need to go out to lunch and spend $15 to $20 every day. By driving an older car that you paid for in cash and bringing your lunch to work with you, you’re already saving a ton of money.
You don’t have to be a coupon-clipper or scrounge for the best deals, either. By spending extra time trying to decide if the paper towels that are $2 more are really worth it, you’re actually losing in the long run by adding time and stress to your life. You can still go out with friends and enjoy your free time, too. After all, money is a resource and should be used to make your life better. But by changing your habits a bit, buying generic brands, eating out less, and not putting yourself into debt when you can help it, you’ll find yourself getting to financial freedom much more quickly.
Of course, there’s a difference between “frugal” and “cheap,” and I don’t advocate being cheap. I’ve known people who cling to their cash so dearly that, when we would go out for drinks as a group, they would only drink when others bought pitchers and would never chip in or buy a round themselves. That’s rude; it’s a good way to offend people and a bad way to save money.
I also don’t think it’s necessary to go to the extreme. Some people refuse to buy any luxuries, even after they’re already rich. The thing is, you can’t take it with you – so once you have a little bit of freedom, feel free to splurge on yourself once in a while. That’s the whole point of finding financial freedom – to be able to do what you want with your time and money.
But you should try to splurge less until you have that little bit of freedom. My strategy is to try and spend job income only on the important things – paying bills, buying groceries, etc. This would include small business income if I had started doing freelancing and consulting work, since I’d still be essentially trading time for dollars. Once I have some business income coming in, I will let myself buy nicer things like a new laptop with the new source of income – because business income will make you free, job income will chain you down. Sometimes I don’t follow this strategy exactly, but by trying to do it most of the time, I can produce some cash reserves and bring myself closer to freedom.
Increasing income will do far more for you than reducing your expenses. By buying the cheaper brand, you might save $3 each time you go to the store. But by creating a new source of income, there is no ceiling – you can quickly make hundreds more per week with just a few extra hours of work!
Obviously, creating and acquiring assets is the best way to increase your income. By building a software product or other form of online business, you can probably do it without any up-front capital, but you may not see any income from the asset right away. Most other forms of investment will actually require you to put money down – and aren’t we talking about finding the money to do that?
If you’re strapped for cash, you can increase your income by starting a small business on the side. Figure out what you’re good at and do some freelancing or consulting work in your off-hours. Alternatively, you can pick up a sales job on the side and try to make a few sales a week for some extra cash.
This takes more time and effort than reducing expenses, and if you’re trying to start a big business while still doing your day job, you probably don’t have much of those sorts of resources left over. But if you can make some extra money outside of your day job, you can potentially expand your income by quite a bit and create a huge reserve of cash in no time!
As you accumulate cash reserves, you want to continue to keep an eye on where you can allocate that money in your asset portfolio. As I mentioned before, while you want to try to always have money on-hand so you can take advantage of opportunities, you really don’t want to have much of your net worth in the form of cash, since it’s not going to do much to help you grow your wealth. So, as you continue to accumulate money, you want to make sure to buy assets with it.
The steps to using your savings effectively are:
- Accumulate Money. Either by reducing expenses below your income level, or increasing income above your expense level, you want to create some excess cash each pay period that you can tuck into an “investment account.” This money is not to be used for personal items and expenses – only for investments and emergencies
- Buy Assets. Keep on the lookout for investment opportunities, and when you find one that you’ve determined is worth it, jump on it! As your cash accumulates, you want to be sure to spend it on something that has value (an asset) rather than just leaving it in your bank account, where it’s going to keep losing value.
Get to It!
Investing is the key to getting rich, but making sure you have some cash reserves on-hand is the key to investing. It’s very important that you make sure not to spend more than you earn – because even if you’re making a million dollars each month, if you spend all of that money faster than you earn it, you’re never going to get rich.
This is the first and most basic step to any kind of financial health, happiness, and security. Even if you’re not trying to get rich, you should at least try to keep your cashflow in check.
And if you are going to get rich (and who wouldn’t want to do that?), get those cash reserves so you can start investing!
This is just Part 5 of the Getting Rich Through… series.