No. This is not a post about the 1%. It’s also not a post that describes why some people are wealthy and others are not, although there may be some great practical lessons in that on building wealth. This is a post about how to create the wealth gap between what you make for income and what you spend on your lifestyle. This ‘gap’ is where wealth is built.
There is NO secret to becoming wealthy
Do you really think it’s a secret as to what it takes to become wealthy? I’m pretty sure, deep down, that you know as well as I do how to create wealth. It’s more a matter as to whether we will actually follow through on doing it.
I’ve said hundreds of times, many times on this blog, that there really isn’t much genius to building wealth. It’s more a matter of consistently doing the basic things that build wealth and doing them over a substantial period of time.
One of the most critical ‘things’ that needs to be consistently done in order to build wealth is to build a gap between what we take in for income and what we spend each month on our lifestyle. There’s no question that if we were to make significantly more income each month than we spend and we used that difference, that gap, constructively to build wealth we would be able to create a substantial amount of wealth in a short period of time.
How big does the gap have to be?
However, how much does this gap need to be in order to create wealth? Well, that depends. Obviously, it depends on what level of wealth you are planning on achieving and within what period of time you’re looking to do it in.
So right off the bat, two very important variables that we need to identify in order to build wealth is the amount of wealth that we want and within what period of time we are looking to do it in.
Unless I’m way off base, don’t we all want to be multi-millionaires as soon as possible? Of course we do! And interestingly enough, therein lies the problem.
Most of us don’t have a realistic expectation of what it takes to build wealth. In addition, most of us also don’t have much patience in letting the wealth building process run its course.
This isn’t meant to hurt anyone’s feelings but building wealth takes time! In fact, and no surprise to any of us the more wealth you’re planning on building, the higher probability that it is going to take a longer period of time to do it.
How are we going to create this gap?
Before we jump in looking at the numbers of how we’re going to create this gap and build wealth, let’s come to a basic conclusion: most of us have BOTH an income problem AND a spending problem. Let’s be honest with ourselves. One of the first reasons that we struggle building wealth is that we don’t make enough income to create that gap.
In counseling a lot of my students, we discover that the basic yearly net expenses for most single individuals here in the United States ranges from around $20,000 to $25,000 depending on where you live. (I realize that those of you living in Boston, New York, LA, San Francisco, etc. just fell out of your chairs knowing that that’s not even enough net income to pay your rent but we have to start somewhere!)
Regardless of where you live and the required income/expense adjustment that needs to be made for that location, a basic yearly lifestyle will include rent, utilities, transportation, food, medical, clothes, entertainment, etc.
Whatever that number is for the most BASIC level of living, and I MEAN basic, is what will establish our starting point for identifying the gap.
Although we can argue all day long as to what that basic expense should or could be, would you agree with me on this?…if two individuals both have a basic yearly expense of $25,000, the individual who makes $100,000 is probably going to have a larger ‘gap’ between what they make and what they spend than the other person who makes $35,000, right? So from this standpoint, most of us will start out with an income problem.
As it turns out, we have a spending problem
However, many of us also have a spending problem. Using the above example, if that person who makes $100,000 a year spends all of it and the person who makes $35,000 is able to keep everything above their $25,000 of expenses, the person who makes $35,000 is going to have a $10,000 gap and our 6-figure earner is going to have a $0 gap.
So that lesson of “it doesn’t matter what you make, it’s what you’re able to keep” is partially true. Why do I say partially true?
Well, if you only make a little over $25,000 and are even able to keep every penny of that over $25,000 you’re still not going to be able to build wealth. That’s just the harsh reality of math.
So let’s review. We all have a basic level of yearly expenses that in comparison to one another, not considering the “level” of these expenses, are very similar.
Of course, if you choose to drive a Lamborghini and wash your meal down with Dom Perignon you’re going to have a much higher expense basis than others. However, if that’s not the case, it’s going to be similar with most people’s basic living expenses.
In addition, if we’re able to have enough of a gap between what we make and what we spend AND are able to keep that amount, we are going to have the opportunity to build wealth. I talk about how to do this in detail in my following post https://thefinancialstoic.com/?p=132 Here’s a spoiler alert; it requires that you pay yourself first!
Do the math
Now let’s do the math! If I make $75,000 net income a year and have a basic net yearly lifestyle expense of $35,000, what am I going to have to do to accumulate $1,000,000 in 20 years? That is a great question and one that I do the math on with students at least weekly, as this reflects the financial situation of a fair amount of Americans.
The answer is that this individual would have to create a gap of $2,200 a month and invest that into assets that could generate 6% annually over those 20 years.
Now that doesn’t seem like a hard thing to do, does it? In addition, in this example it also leaves our individual with an additional $13,600 in straight out disposal income to spend or invest ($75,000 – $35,000 = $40,000 & $40,000 – $26,400 = $13,600).
Even though our sample individual is not at either ends of the extremes from an income or expense standpoint, they represent the possibilities of a very simple and obtainable wealth building scenario.
So now that we have our gap between what we make and what we spend, what do we need to do with it in order to build the type of wealth we are looking to build?
Conclusion
Now here’s where the TRUE magic comes into play. Because our individual in our example has a reasonable time horizon in order to build wealth and has reasonable expectations on the process, all they have to do is what I would consider as passive investing.
More specifically, they don’t need to take big risks, as they only need 6% annual growth. They also don’t need to pick a runaway winner in the stock market either, as the S&P 500 had a 13.6% annual average return between 2010 and 2020 (although this is historically higher than the 10 year periods before this).
The ‘magic’ of having created a reasonable gap AND having plenty of time is that you don’t even have to be a knowledgeable investor per se. All you need to be able to do is be able to match the return of the market and doing that doesn’t require any particular investment skill or prowess. Just a commitment to do it.
So, where does this all leave us? The reality is that the true wealth gap is between those individuals who create a ‘gap’ and those that don’t!
