The secret to growing wealthy is maximizing and controlling free cash flow. Free cash flow is how much money you have coming in that doesn’t have a name assigned to it already. It’s what you have after deducting taxes, your mortgage or rent. your cable bill, your cell phone bill, your credit card payments, and so on. The more obligation you have, the less flexibility you have the less chance you have of growing wealthy. How can you save $500 per month to invest if you only have $30 left after you pay for all of the things you absolutely need to pay for each month?
Some things you obviously need to buy. You need food and shelter. You are required by law to pay taxes, social security, and buy insurance for your car. Some of these things you can reduce in cost. For example, you can buy a smaller house, buy a less expensive car and buy it used, and eat meals in as much as possible. You can bring your lunch to work most days, which has the advantage of getting fewer calories and, if you cook extra at dinner and bring in a portion to reheat for lunch, will cause envy from your coworkers and their pitiful microwave dinners.
Most people, however, will add obligations – things like credit card payments, car payment, time share payments, wireless plans, Netflix subscriptions, etc… until their obligations are so large that their outgo equals their income. All of their money will be spent before they receive it each month. They don’t have the ability then to save and invest. Worse than that, they will end up putting things on credit, meaning that they will pay far more for things than if they had just paid cash.
The cash flow diagram for a “normal person,” which means a broke person, is shown in the figure below.
The only good thing about this cash flow diagram is that some of the money is going towards a house, which means they will be able to sell their home when they get older and use the money to fund a condo and medical bills, maybe. There are way too many people today, however, who are taking out home equity loans and buying bigger homes well into their fifties and sixties. These people will still have no equity when they are ready to retire. Guess who will be paying their medical bills and for their food and shelter when something happens to them?!
The cash flow diagram for a wealthy person, or someone who will become wealthy, is shown in the figure below. By living on less than they make, they are able to put some money into investments each month. These investments in turn provide additional income, which can be used at first to buy more investments, and later can be used to supplement income or even replace income from working.
By minimizing obligations, wealthy-thinking people have more free cash flow each month to invest or take care of the unexpected expenses that occur. They buy smaller houses, drive used cars, take less expensive vacations, buy things of quality that last and are always in fashion rather than chasing trends. While it will grow slowly at first, just putting $300-$1000 per month away will grow into huge sums over a couple of decades if the proceeds are reinvested.
While they may need to forgo luxuries at first early in their careers, later on they will be able to take nice vacations and afford nice things when everyone else is sending all of their money to credit cards. They will be able to help others out in substantial ways rather than giving only a few dollars to neighbors in need. Think of what you could do with the extra $12,000-$20,000 per year if you didn’t have a mortgage payment. Think of what you could do if you had investment income equal to your paycheck. It is well worth delaying purchases.
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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.