Budgeting often looks only at income and spending. Once the two are balanced, the analysis stops there. While budgeting is important since it ensures you allocate your income to the important things first and keeps you from blowing your money on random “stuff” without realizing it, budgeting is only part of the picture.
The fact is, most people have only a few dollars left over at the end of the month after they factor in all of their obligations. It doesn’t matter if they make $30,000 per year or $300,000. Left alone, obligations will build up to swallow all free cash in one’s budget. The insurance bills. The gym memberships. The clothes and the haircuts. The cable TV bill. The mortgage payment and the payment on the condo. Growing wealthy involves investing, and that can’t be done with $30 per month. So instead of just concentrating on making things balance on a budget, begin to look at your wealth “pool.”
Picture a large, crystal-clean pool of water that you can go to as needed, dip in your bucket, and get a cool drink. At first you fill your wealth pool by hauling buckets of water and dumping them into it. Most people spend their whole lives hauling buckets until they are too tired and weak to haul anymore. In the end hopefully they have enough in their wealth pool to last them the rest of their lives.
Obligations are like leaks from your pool. The interest you pay puts a drain on your wealth pool, causing water you’ve worked hard to haul to run out onto the ground and away. If you are able to haul water quickly – you have a large income and work a lot – you may be able to keep your pool fairly deep. Still, if you have enough leaks in the walls of your pool you will eventually be doing all you can just to keep the level up. Many high earners have so many leaks in their pool that water is constantly gushing out.
Assets are like pipelines you add to your pool. They are sources of water that you don’t need to haul. At first these pipelines tend to be small and you barely notice the difference, but with time as you add more pipelines it becomes less and less important to haul water in with buckets.
So in addition to looking at your income and spending, take a look at your pipelines and leaks. At the top of your budget make a list of your pipelines, your estimated return for the year from each pipeline, and the amount of income from those pipelines you will use and the amount you will reinvest. Sum the total income from all of your pipelines.
At the bottom, list your leaks – the obligated expenses you have. Your mortgage, your car payment, you student loan payment, any memberships you have, timeshare fees, etc… Anything you have that you pay each month, such that the money is obligated before you even earn it.
Subtract the total of your leaks from the total of your pipelines. This is your net outflow – the water that flows out of your pool without you doing anything to cause it.
See which leaks you can plug. Can you focus and pay off a loan so that you no longer have the payment anymore? Are there things you buy on subscription or automated draft that you could buy periodically when you felt like it instead? Remove as many subscriptions as practical, keeping only those that you know you would buy every month anyway.
Concentrate on plugging leaks. As you plug each leak, dedicate the money you would have spent on the leak some months to investments so you can build more pipelines. Avoid taking on new obligations, instead paying cash for things as you go. With time see if you can get the inflow from your pipelines to exceed your obligations. At that point your pool will be filling without you doing anything.
Once your asset inflows exceed the outflows from your obligations, your wealth will really start to grow. You can start siphoning off some of the excess to improve your life. Maybe if you have $10,000 net income each year from assets you can take $3000 of it each year and take a week-long vacation. Maybe you can add something to your home or your yard each year. Because you are spending from your pipelines instead of your income the pool will replenish itself.
By looking at what drains from your wealth pool and adding pipelines, you can get a better picture of your financial situation and make the changes that will make growing wealth easier.
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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.