We’ve heard it all before haven’t we?
The simple way to build wealth is to spend less than you earn. Let me demonstrate this as a simple equation:
Spending < Earnings = Savings
That’s it in a nutshell.
Take what you earn. Now look at what you spend. If what you spend is less than what you earn then what is left over is savings. Let that grow and invest it properly and you will build wealth. You only need two numbers to figure out that math!
Let’s use dollar figures. You earn $3000 a month. If you spend $2999 you have a dollar left over for savings. What’s a dollar you ask? In today’s economic climate one dollar of savings will put you in better shape than corporate giants like Lehman Brothers, which is declaring bankruptcy, Enron, Worldcom, or Merrill Lynch, which was bought by Bank of America. And that dollar will have friends joining it every month as long as your spending is less than your earnings.
Now imagine if you could increase that savings amount either by spending less or earning more? The savings will build up faster!
Let’s change the equation slightly now:
Spending > Earnings = Debt
Spend more than you earn and you are in debt. You have to be. Where else could the money come from unless it’s borrowed?
Back to the numbers… You still earn $3000 a month but now you spend $3001. You’re in debt. Where do you get that extra dollar to get out of debt? Maybe you borrow it from a friend? Maybe you put it on a credit card (another name for debt)? Either way it won’t materialize from out of nowhere.
And what happens the next month?
Either you lower your spending by a dollar (assuming no interest) or you increase your earnings so you can pay back the debt. If you don’t then your debt increases! Just like our savings example that debt will keep growing until you find a way to pay it off. If you let it grow too long then you get to be in the same boat as some financial institutions as you either have to declare bankruptcy or find someone to bail you out (and really if someone bails you out you will probably still be in some sort of debt).
As complex as personal finance can be sometimes it still boils down to a simple equation. Plug in your spending and earnings.
Too often we over-complicate the ideas that make up personal finance. In reality the concepts are pretty simple, aren’t they. Sure, you can go nuts poring over the different ways you can invest your money but the simple concept is clear — spend less than you earn and you can save. That savings can help you build wealth.
Are you saving or in debt?