Ignore These Rules at Your Own Financial Peril!
It’s that time of year again, my friends! It’s time to talk about money management and wealth building. We’re headed into springtime, which is the season of renewal and rebirth, and always feels like the best time to refresh our goals and plans for how we want to live, how we see the future, and how we plan to live in this world when we no longer want to work, or simply can’t work any longer. I know for many, at least in the appraisal business world, their delayed lifestyle enjoyment plan is based on the fact that appraisers can continue working, in some capacity, well into their 70’s. My father is in his early 70’s, is in good health, is an appraiser, and still inspects houses every day.
However, my recommendation in this regard is not to depend on having the ability to continue earning income that long into your life, at least not income that is based on you having to physically earn it. What we’re looking for as early into our lives as possible is what is referred to as unearned income. It’s a strange name for it because, of course, if it’s income, it’s being earned in some way. But, for accounting purposes, it’s referred to as unearned income and that consists of income earned from investments. It’s income that doesn’t require you to physically work to earn it. That kind of income is called earned income, and rightly so. Earned income comes from your physical labor, as well as from businesses that you operate. Sometimes you’ll hear the term unearned income called passive income. I’m not a huge fan of this title either because I still have to do some work to earn my passive income. If it’s from market investments, I’m researching stocks and funds to invest in, I’m watching the buy and sell signals, reading reports, etcetera. There is still work involved in earning that unearned and so-called passive income. Income from rental properties, if any of you have ever owned them, is anything but passive! It can be some of the hardest earned income out there.
Nevertheless, for the purposes of this episode, we need to differentiate between income and wealth since they’re different. I know people who are what I would consider rich in terms of income, but poor in terms of wealth. Some of these are people earning more than a million dollars in personal income per year yet live lifestyles that eat up most of that income. No problem if you can continue earning that income forever, but what if you can’t. Conversely, we probably all know people who earn relatively modest incomes yet have awesome investment discipline and a plan. My best friend earns an ok income but owns millions in rental real estate. He can’t live off of the passive income yet today, but he’ll be able to at some point in the future when the mortgages are paid down or paid off and those rents will greatly exceed his current lifestyle.
So, for this episode, income is the money you have to get out of bed to go earn, while wealth is the amount of money you need to achieve your purpose in life without having to physically work. I hope you heard that and are documenting those words. I heard Gary Keller, founder of Keller Williams, talk about wealth in that way and it resonated with me so it’s now how I define wealth because wealth is not necessarily a set amount of money, but instead a certain amount of unearned income that allows you to live ‘on purpose’ without having to physically work. With that definition, you don’t have to live by somebody else’s definition or standards of wealth. I’m sure in some circles there are unwritten rules for calling yourself wealthy. If you have a net worth of $1,000,000, I’m sure the deca-millionaires consider you poor. If you’re worth $10,000,000 I’m sure the hundred millionaires consider you unworthy of entrance into the club, and so on it goes. That’s not what we’re talking about here. That’s called comparative wealth and it’s a loser’s game. It’s a ‘keeping up with the Joneses’ mentality and has nothing to do with a true wealth mindset.
Wealth is a state of mind first, a strategy second. If you get nothing else from this episode, I would want it to be that, that wealth is a mindset first, a strategy second and it’s not based on comparing yourself to anyone else, or a set number. Wealth should be based on how much money you need to achieve your purpose in life without having to work. Please also notice I didn’t say that wealth is based on the amount of money you need to live the lifestyle you desire to have. That’s the way it’s often taught and I think it’s the wrong direction to come at this thing because most people will give a cursory thought or two to a particular lifestyle image without connecting it to anything more meaningful like your life’s purpose. How is having a helicopter tied to your life’s purpose? Well, if you’re Tony Robbins and your life’s purpose entails being able to get to locations quickly and easily to teach and spread your message, a helicopter might be necessary. Do you and I need a helicopter? Who’s to say? If it’s tied to your life’s purpose and intention then maybe you need one?
For most people, however, imagining that kind of lifestyle thinking that will motivate them to want to be wealthy is a pipe dream and likely not helpful. It’s not helpful because the first rule of being wealthy is knowing your financial freedom number. Your financial freedom number is the first base of the whole process and it’s the amount of money, or unearned income you need to live out your purpose and lifestyle. For some, having $5000 per month of investment income coming in pays all their bills and allows them to exist in the kind of lifestyle that will allow them to live out their purpose. When have you ever heard that $60,000 per year makes you wealthy? You haven’t because nobody is teaching that version of the definition of wealth. Get it hammered into your head that wealth is first a mindset, and then a strategy and the strategy is first to have all of your bills covered by unearned income.
Aside from winning the lottery, this is the first step in thinking about money. How much of it do I need coming in to cover my house payment, gas for the car, food for the kids, entertainment, some travel, a few nice cigars every month, maybe the vacation property, and so on. How much is that? Think on it, dream on it, and tie your life’s purpose to that number if you want to infuse your journey with some real meaning. You’ve got to know your financial freedom number first to even get started on this wealth journey. Is it $3000, $5000, $20,000, or $200,000 per month of unearned income to finance your life on purpose and the lifestyle that will help you live that out. If you don’t know your number, you’ll never know when you’re done and you’ll never have enough. If you don’t know your number, you’ll never know when you can stop needing to physically earn it. Knowing what that number is gives you a finish line to know when you’re done. If you don’t know where the finish line is, no amount will ever give you freedom. So, knowing your financial freedom number equates to freedom for you.
The next step or phase of this wealth building journey is to create a plan. Know what your number is, know why this number is important, then create a plan to get to that number as fast as possible without making bad decisions and choices. This step entails deciding what method or investment vehicle(s) you need to get there. Will it be rental real estate, stocks and bonds, mutual funds, a business that doesn’t require you to be there daily to run it, an invention, or something else. The rule here is that you either start with a lot of money to make a lot of money, or you have to begin with a little money invested over a long period of time with a decent return on that investment. If all of this sounds like Greek to you, that’s simply a sign that you have to start studying. If you hear something and say, ‘I have no idea what that is or what to do’, we live in the information age where you can just grab the device you’re listening to my voice on and Google ‘financial freedom number’, or ‘how to invest in real estate for dummies’. This is the step where I lose most people because that step is simply too much for them. “Oh, I have to actually do some work and learn new things? Oh no! That’s not going to work for me, I have a lunch date at noon!”
For any of this to be helpful for you, you’re likely going to have to venture into discomfort territory. You’re going to have to make yourself uncomfortable for a bit to learn new things and grow into areas you may not be familiar with currently. That’s how it works with everything. We can’t grow as human beings in any area without breaking the shell we exist in currently. You’ve got to be willing to make yourself uncomfortable to grow, it’s that simple. Know what your freedom number is first, then start to develop a plan to get there.
The next rule of wealth is that you must track your dollars! I’ve done podcasts on this topic in the past and I came at it from the angle of wealth building traps or mistakes. The way I talked about this one in the past was from the perspective of the mistakes people make by not tracking your dollars. I don’t care if you make $1000 per month, if you don’t track every dollar in and out you are likely letting dollars slip through the hole of dumb spending. In essence, start keeping score. You don’t know if you’re winning or losing if you don’t know two things: what’s the goal and am I ahead or behind? March madness is in full effect right now in college basketball. You don’t have to really know anything about the sport of basketball to know that the goal is simple: put the ball in your basket to gain points and do that as many times as humanly possible so that you have more points than the other team when the clock reads 0.00 at the end. The great thing about wealth building is that it’s a game against yourself, to a large degree, and the buzzer, or the end of the game, is when you want to achieve financial freedom. Is it in one year, 5 years, 10 years? When will the clock hit 0.00 for you?
Gary Keller’s phrase on this point is that untracked dollars lead to dumb money. Dumb money in the world of investing is money that is eaten up by inflation. Dumb money is money in your bank account earning .04% interest while inflation is 4%, 6%, maybe 10% real erosion of your spending capacity. Dumb money is buying a jet ski with a bank loan when you have nothing in your IRA yet. Dumb money is living on credit cards to fund a lifestyle today that will keep you from living on purpose 5 years from now because you’re still paying on the interest. We want to get into what’s called the ‘safe money’ zone, at a minimum, or the ‘healthy and wealthy money’ zones at best. The healthy and wealthy money zones are where your money is earning 9% and higher returns on your investments over a long time horizon. Track your dollars in and out as diligently as possible. That’s the third rule.
The fourth rule is to get comfortable with the area between boredom and mastery. In the martial arts world, we talk about this as the blue belt or brown belt purgatory. In complex arts like Aikido or Brazilian Jiu Jitsu, it can take 8, 10, 12 or more years to attain a black belt. Some of the first ranks are relatively easy to achieve in that you really just have to show up consistently and learn some of the basics and you get some stripes on your belt and eventually you test into some colored belt ranks. In both of those arts there is a blue belt level and a brown belt level. These levels feel like real solid accomplishments, and they are! However, the time in between those ranks, and then the time between brown belt and black belt can feel interminable. It’s an endless purgatory of training that can last years and years while you’re working on mastery of that art. Many will give up at these stages if they’re only goal is to achieve a black belt. If you’re goal is simply to train every week and slowly learn, you’ll train as long as your body will allow regardless of the color of the belt you wear.
However, if your only goal is to where a black belt, you may get very bored and uncomfortable with the waiting time. You look out over time and you see the massive chasm between where you are now and where you want to be at some point and you freak out and quit. The same thing happens with investing to reach some level of financial freedom. You do the calculations I’m suggesting you do, you realize you need $1,500,000 at minimum in some kind of investment with a decent return to fund your lifestyle, and you freak out and go buy a jet ski instead. You’ve got to be ok with the boredom that inevitably sets in between the start of your journey and the path to mastery. The path to mastery of anything is a long one. The payoff at the end is massive though so steel yourself for the long slog and you’ll have an uncommon future. Former Navy Seal, David Goggins, has a saying that I love, which is to stay uncommon amongst uncommon people. The way I would say it is to fight with everything you have to be uncommon amongst common people. The world is filled with common folk, and there is nothing wrong with that if you’re happy with mediocrity. If you’re not ok with being average then you have to fight to be uncommon amongst all the common people, ideas, and effort in the world.
The fifth rule is wealth building is simply to invest, don’t speculate. There are a variety of different ways to invest your money and, so, this rule will flex with how you invest. You can be a value investor like Warren Buffet and invest with an extremely long time horizon. You can be a swing trade investor like me and learn the patterns within certain sectors and get in and out of trades on a shorter time frame. You could be a day trader, and so on. Whatever your chosen method of developing passive or unearned income, know the rules and what constitutes real investing and what constitutes speculation. Speculation is based on hope for a positive outcome and sometimes it works, other times you get burned bad.
With all investments, you make your money going into the investment. This may sound confusing to the novice because people tend to think you make money when you sell something. But that’s just when you realize your profits. The money is made when you buy and hold that asset as it grows. You can’t realize a profit if the asset is worth less today than when you bought it, which is why it’s said that you make money going in. I have a few stock investments that are worth less than what I have invested in them because the stock price has dropped. If I sell my shares, I lose money. If I hold them long enough to let the stock come back up and above my average share price, I can sell and realize a profit. So, what do I do? I hold, of course! In fact, I buy more of that stock at the lower share price, which effectively lowers my overall per share cost. It’s called dollar cost averaging. If you believe in the investment, you buy more as it’s tanking and then wait for it to come back up.
Nevertheless, this isn’t a podcast on how to invest but, instead, on the rules for building wealth so let’s recap the rules.
- You must know what your financial freedom number is. Take some time to figure out how much unearned income you need to live on purpose.
- Create a plan to get you there over the time horizon you believe you can do it in
- Track your dollars! You have to know what’s going in and what’s going out. Give each of your dollars a job
- Get comfortable with the boredom. It can take a long time to get there, settle in for the journey.
- Invest, don’t speculate. Buy with the intention of selling, have an escape plan, and remember that your money is made going into the investment, your money is realized when you sell.
You’ve got this my friends. Until next week, I’m out…