Why Wealth Building Begins with Financial Habits
The Difference Between Income and Wealth
Earning a lot of money seems like a reliable way of accumulating wealth. But income and wealth are different concepts. Income is the revenue coming from business or investments and earned through work. Wealth is the assets owned less than debts owned. A person earning a little can have a lot more assets than another person earning a lot and spending everything he earns.
In this respect, income serves as the fuel, while wealth is the destination. Without a well-defined route and proper habits, the fuel won’t make any sense. Habits of financial planning, budgeting, investing, and savings serve as the basis for accumulating wealth regardless of how much money a person earns per year – $40K or $400K.
The focus of successful wealth builders lies on financial habits that they can control. While they realize that economic conditions and unexpected events can influence short-term results, their habits eventually lead them to victory.
Personal Finance Tip #1 – Make a Realistic Budget
Using the 50/30/20 Budget Method
Creating a budget is crucial for every financial plan and without it, it would be impossible to track money movement or find ways to save or invest. People do not budget because they consider budgeting to be restricting. But a good budget gives a freedom of using money wisely and allocating every penny for the right purposes.
One of the most widely used budgeting methods is 50/30/20 rule. Under it, 50 percent of income goes to necessities, 30 percent to wants, and 20 percent to savings or debt reduction. These numbers may vary depending on the person, but they give a good guideline.
Category Recommended Allocations
Necessities 50%
Wants 30%
Savings & Investments 20%
In addition, budget reveals spending leaks that slowly drain wealth. Subscriptions, impulsive expenses, and lifestyle changes can take thousands of dollars yearly. Regular budgeting helps to become aware of money spending.
Personal Finance Tip #2 – Pay Yourself First
One of the most effective wealth-building practices involves payment of self first. Paying oneself means making a contribution to savings and investments at once when a person receives a salary and living on the rest. This practice eliminates the temptation of saving whatever money will be left at the end of the month and turns saving into priority.
Experts suggest making such payments automatically by transferring money directly to savings or investment accounts. Automatic payment system removes the burden of doing something manually and makes the process easier and regular.
Personal Finance Tip #3 – Create an Emergency Fund
How Much Money Should Be Saved for Emergency Situations?
Nobody knows when something unexpected happens and it always takes money. The function of an emergency fund is to act as a cushion to protect a person from using credit to solve problems caused by emergencies.
Most financial advisors advise people to keep three to six months of living expenses in an account that is easy to access. Unfortunately, a huge number of Americans lack an emergency fund because according to statistics, 55 percent of people have enough savings to cover three months of expenses, while 23 percent have none.
People can start small by accumulating $500 to $1,000 first. This is enough for covering many small emergencies. Once a person accomplishes the goal, he/she needs to continue saving until an appropriate sum of money appears.
Personal Finance Tip #4 – Eliminate High-Interest Debt
High-interest debt can prevent a person from accumulating wealth. Credit cards, payday loans, and similar expensive sources of financing take away money which can be used for investments and saved in case of emergency.
The analogy of filling a bucket with water while it leaks from the bottom illustrates the essence of making investments with high-interest debt. The cost of interest payments is so high that it eats money which could have been accumulated instead.
A person needs to pay off high-interest debt first and keep paying other debts’ minimums. In case a person manages to pay off debts, he/she should transfer monthly payments to investments or savings accounts.
Personal Finance Tip #5 – Automate Financial Transactions
Automation simplifies good financial habits. If savings, investments, and bill payments happen automatically, there is no need to make such decisions again and again. Such decision-making process reduces the chance of missing opportunities to save or invest money.
All financial experts agree that automation makes people save more and succeed financially in the long run. Automation means that good habits won’t depend on mood or time pressure anymore and keep going without interruptions.
Automatic investments in retirement, emergency, and savings accounts as well as automatic bill payment will help a person to get rid of late payments.
Personal Finance Tip #6 – Increase the Savings Rate
According to experts, savings rate can be the main determinant of how fast a person builds wealth. Although the return on investment is also important, the savings rate may affect a person’s wealth building more because the faster rate means faster accumulation.
According to recent research on retirement, the savings rate of around 12% to 15% of income is recommended to accumulate enough wealth for retirement, but many people save far less.
There are many ways of raising the savings rate each year. A person can direct every raise, bonus, or tax refund towards investments instead of buying something or upgrading his/her lifestyle.
Personal Finance Tip #7 – Start Investing Early and Be Consistent
The Magic of Compound Growth
Investments make money work for the benefit of a person. Due to compound effect, the returns on investment bring additional returns and form a snowball which grows over time.
If the person starts investing in youth, the effect of compounding is more pronounced. Those who started investments at the age of 25 manage to accumulate more money than those who started investing ten years later even if the latter contribute more.
Time is the best ally for investors. Consistency is more valuable than perfection. A person shouldn’t try to make predictions because they usually turn out to be wrong. Making regular contributions regardless of whether the market goes up or down.
Personal Finance Tip #8 – Maximize Retirement Accounts
Retirement accounts can be one of the most powerful wealth-building tools. They offer tax advantages, match contributions or both and ignoring such accounts means losing money.
Some companies match employee contributions to the retirement accounts. This means that a person gets the profit just for depositing the money. Experts recommend depositing enough money into a retirement account to receive the maximum match.
Another reason why a person should deposit money into such an account is that it encourages long-term investment behaviors. Because withdrawals are limited or punished, a person cannot react to short-term market changes.
Personal Finance Tip #9 – Diversify Investments
Diversification reduces risk and maintains growth opportunities. The idea is that instead of investing all money into the same company or stock, a person should diversify his/her investments.
The diversified portfolio can consist of different types of assets depending on individual needs and preferences. The key of diversification is to build a portfolio which performs well under different market conditions.
Diversification acts like a financial shock absorber that evens out the performance of a portfolio.
Personal Finance Tip #10 – Develop Several Income Streams
Having one income source creates financial vulnerabilities for a person. Income streams give financial security and speed up wealth-building process.
The income streams can consist of freelancing, small businesses, rental properties, dividend-paying stocks, royalties, or consulting services. All income streams contribute to cash flow and decrease dependency on one job or industry.
The wealthiest people do not pay attention only to savings but to developing multiple income streams as well. Extra income gives flexibility to people and helps to repay debts and increase investments.
Personal Finance Tip #11 – Do Not Chase the Higher Standard of Living
When a person’s income grows, the expenses grow too. Promotion makes a person buy a fancy car. Raise makes him/her buy a bigger apartment. Pretty soon, a person ends up spending more than he/she earns.
It can result in the situation when the income of a person increases but wealth stays unchanged. Instead of chasing higher expenses, a person should increase savings and investments.
Living comfortably is important but a person should be able to keep a balance. A person can make minor lifestyle changes, but excessive spending harms the financial future.
Personal Finance Tip #12 – Invest in Oneself
The best investment in the stock market is oneself. Acquiring new skills helps a person to increase his/her income, find career options and develop income streams.
Such skills can be acquired in various ways – getting certifications, taking courses, developing professionally or receiving education. Skillset acquisition is a type of investment which gives higher returns than many other investments.
The goal of such investments is to become a better employee and entrepreneur. Skillsets multiply like money and help a person earn more money and achieve financial freedom.
Personal Finance Tip #13 – Protect Wealth with Insurance
Wealth building is very important, but protection of wealth is equally important. The event of emergency can ruin financial achievements of a person if the appropriate protection is not put in place.
People need health, disability, life, homeowner, and liability insurance. Insurances transfer risks to the entity that is better at managing financial risks.
The protection measures should be adjusted according to the changes in financial life of a person.
Personal Finance Tip #14 – Monitor Net Worth Regularly
What gets measured gets managed. The regular monitoring of net worth gives a person insight into the state of finances and reveals problems that need solving.
The formula of net worth calculation is simple – subtract total liabilities from total assets. Monitoring net worth annually or quarterly shows whether wealth grows, stagnates or decreases. Contrarily to income, net worth shows the overall financial situation.
Monitoring net worth also motivates a person and shows the growth of savings and investments.
Personal Finance Tip #15 – Have Long-Term Perspective and Be Consistent
Wealth builders see financial success as a marathon and not a race. Markets fluctuate, economic conditions change and unexpected situations come and go. Having a long-term perspective helps people to have proper perspectives in such situations.
The problem of many investors is their inconsistency. Instead of keeping to their plans, they chase trends, react emotionally to the market decline or keep changing strategies. Consistency often beats complexity. Good habits kept consistently throughout decades give better results than complex strategies which are executed inconsistently.
Common Mistakes in Wealth Building to Be Avoided
Despite having great financial plans, people can make avoidable mistakes. Here are some examples:
Mistake Impact
Not budgeting Overspending and reduced savings
Having credit card debts High interest rates
Not saving for emergency situations The increased vulnerability
Delaying investments Loss of compound opportunities
Chasing investments trends Higher risk and emotional decisions
Chasing the lifestyle inflation Reduced wealth accumulation
Not diversifying investments Increased portfolio risk
Avoiding these mistakes will help to increase financial results significantly.
Conclusion
Wealth building does not require exceptional intelligence, lucky timing, and enormous income. Wealth building requires consistency and good habits which will allow accumulating wealth. Thanks to budgeting, savings, investments, and protection of assets, a person builds a solid base of accumulating money.
The 15 tips suggested here work because they target basic drivers of wealth – earning, saving, investing, and protection of money. Even though the strategies suggested here will not give instant results, they will significantly improve the financial situation of a person.