Wednesday, August 27, 2008

My Simple Wealth Building Formula

"Think simple" as my old master used to say - meaning reduce the whole of its parts into the simplest terms, getting back to first principles. ~ Frank Lloyd Wright

When I first started working, my wealth building formula was:

Income - Spending = Savings (i.e. Wealth Accumulation)

My personal goal was to manage spending to be lower than income. Therefore, I would have some money leftover each month, and contribute that amount to my retirement savings.

After a while, I realized a small problem with this formula and approach. It implied that one should actively manage income and spending and the resulting outcome would be savings. So a large part of my wealth building effort was spent managing spending, since income was relatively constant. Also, since savings was the result, it sometimes could be zero or negative in some month.

Over time, I modified my wealth building formula to:

Income - Savings (i.e. Wealth Accumulation) = Spending

In this formula, savings also became relatively constant (at a percentage of income) since I could calculate how much was needed to retire. Savings was no longer the outcome. Spending now became the result, i.e. the money left over after managing income and savings.

Using this formula simplified our lives. First, I didn't need detailed budgets, since the amount for spending was determined by other factors. Second, every month, we knew we were making progress on our savings since we were paying ourselves first. Third, in hindsight, I realize that it caused me to shift my personal finance focus to significantly increasing income, since that was the main factor we could change in this formula.

For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

This is not financial advice. Please consult a professional advisor.

Copyright © 2008 Achievement Catalyst, LLC

1 comment:

Subu said...

Yes, the second formula works. It is like you pay yourself first and then spend the rest.