An investment in knowledge pays the best interest. — Ben Franklin
Editor’s note: This post was written by Jim Hudson of AccelerateMe.net
If you’ve been following Street Smart Finance for any length of time, you’ll know that wealth building is not about get-rich-quick schemes, or scammy business opportunities. It’s about personal financial education, developing long-term thinking, consistency, the principle of compounding, along with a little hard work. I say ‘a little’ because you really don’t have to work harder than anyone else to build wealth, but you do have to be playing the right game. And reading this blog is a great place to learn the rules of the money game.
This article is about how you can attain financial freedom by building what I call, ‘an Automated Wealth Machine.’
Wealth vs. Financial Freedom
Wealth is simply the ownership of instruments of value. Financial freedom, on the other hand, is the ability to live as you wish, without any financial constraint. So, a low-income family on a small patch of land that are self-sufficient can live financially free as they fit that definition.
Everyone should strive for financial freedom. It must come long before wealth. It begins with financial education and it begins in the mind.
Let me tell you the story of the wealthy lawyer. Here’s a man who makes just over a million dollars a year, has the luxury car, mansion, and all the toys of the rich. He’s certainly ‘income rich.’ But he’s mortgaged up to the hilt, has ever-increasing debt, and is suffering trying to maintain the illusion of being a ‘wealthy lawyer.’ All his income is spent before he earns it. He has zero financial freedom.
His secretary, on the other hand, makes just $30,000 a year. A tiny income to be sure, but she is much closer to financial freedom. Let’s look at how she’s doing it.
She’s done a little research on the financial freedom mindset, and planned her expenses a lot better than her boss. The day she gets paid, she divides up her income into different accounts:
- basic needs
- debt-destruction
- investments
- emergency
- education
- generosity
- and play
If she were in business, she would have an 8th account: tax.
Structure of the Automated Wealth Machine
Her basic needs are bare-bones necessities such as food, clothing, rent and utilities. Nothing more. She learned the hard way that having a credit card will cripple her efforts to become financially free, so she made eliminating her debt her top priority. So, she allocates a large portion of her income to the debt-destruction account. Once it’s paid off, she will ditch that account, and reallocate that money to the others. If you have bad debt, I suggest you do the same.
Next is her investments account. She knows the power of compounding interest and builds her small investment portfolio every month with dollar cost averaging. She is diversified across different asset classes (not just different investments within the same class), and is learning about macro-economic wealth cycles. She invests for both the long-term, and is learning about trading.
She has an emergency account which she is building up to have enough to cover 6 months living expenses if she should ever need it.
Her education account is for her continued financial and personal development education. The single best investment one can make is in themselves. How do you think she set up her own Wealth Machine?
The generosity account is for any cause she wants to contribute to, and become involved with. Notice she doesn’t label this ‘charity,’ as charity doesn’t involve any exchange and growth of value. And through her education, she knows that value exchange is paramount to wealth building. Charity is included in this, but it isn’t the be-all and end-all.
And finally she has the play account, which is for anything and everything she wants to blow her money on. It’s completely guilt-free spending from this account, because she knows that for every dollar she’s put in here, she’s put 3 in her investment account.
Our heroine worked out the proportion of her income that she contributes to each account, and sticks with it religiously. The proportion you choose will be based on your own goals.
Results
The ‘Wealth Machine’ is a very simple concept that has many benefits. First, it allows you to be aware of, at a glance, of your financial health at any given moment. Second, it conditions your financial discipline and makes it very easy to stick to your long-term plans for realizing your goals. And the more you add to your financial education, the more the Wealth Machine will help you go from broke, to financially free, to truly wealthy.
Lastly, don’t let the simplicity of the ‘machine’ put you off from implementing it. I’ve been using it for a number of years now, and I can tell you that I wouldn’t be where I am today without it.
(Photo courtesy: Tonyolm)
To learn more about this and other achievement strategies, you can access free articles at AccelerateMe.net. Jim Hudson is a business owner, and developer of success tools such as the Accelerated Meditation.
Thanks Jim. That’s a pretty good way to categorize your budget. Wealth really does always come back to Income > Expenses with the caveat that you treat your investments just like an expense. It’s the one “bill” that will take care of you in the long run!
I like your theory to treat investments just like expenses. Simply put, it’s all about spending wisely.
Yeah, that’s a great way to think about it.
I will say that it would be rather difficult to accomplish all of those things on a $30,000 income. It’s possible but it ultimately depends on how much debt you have and what your living situation was (and if you had kids or not).
Saying all of that, I get the point and it’s definitely a great system and way to start that wealth-building foundation.
Agreed. 30K is not much these days, but if you are prudent with your money then 30K can get you closer to your financial goals compare to someone making 100K and living without any plans for the future.
I agree with Jason. Maybe for a time you would have to put education above some of the other ones? That way you would allow yourself to make more and then get further ahead. Just an idea. Could be completely ill-informed. But 30k is so minimal. I love that you broke it down like this, though, because it’s such a simple outline, but as you said, sometimes the simplicity of it keeps people from doing it which is a real shame.
Simplicity is the key not only to your happiness but also to your financial well-being. Again, 30K is not much these days, but this shows that our attitude towards money is far more important than amount we earn.
You’re right, Femmefrugality. The beauty is in its simplicity! And you’ve struck on one of the most important points of the wealth machine: fluidity. The proportions need to shift as time goes by, and as your goals change.
If you have a debt, for example, you might want to put a large percentage into the debt-destruction account, then when the debt is paid, everything else gets more. Or, perhaps you want to increase your generosity account and reduce your living expenses. It’s all up to you! 🙂
That’s right Jason, but it’s all about proportion. I chose an income on the small end of the scale to show that this is possible no matter where you start.
If you actually do this exercise, you’ll quickly see how you need to structure your own proportions. And if your income is small, a large proportion will have to go on living expenses. But you have to have something in each account.
Before I did this, I had one account for “savings” and one for daily spending with a debit card. I felt like I had a lot of money, but really I had to pay my taxes, expenses, everything out of that savings account. So, I wasn’t saving anything. And because I felt like I had a lot, I was deceiving myself.
But when I switched to this system about 5 years ago, I struggled to fit everything in. I felt like I couldn’t afford the things I was spending my money on — and guess what? I couldn’t! So I very quickly changed my habits. The wealth machine makes it fun to discipline yourself.
So, the income amount is irrelevant, the proportions are everything.
Really enjoyed this post, Jim. It discussed financial freedom in a way that is rarely presented. Most of us tend to think of financial freedom with respect to accumulating a large net worth, and living the lifestyle of the rich and famous.
Personally, I’ve always used to terms wealth and financial freedom interchangeably. Thanks for making the clear distinction.
Indeed, wealth and financial freedom are two sides of a coin.
You’re very welcome Anthony 🙂
Yes, financial freedom can be acquired by anyone depending on their financial mindset, and their goals. Obviously if your idea of FF consists of a large house and fancy cars then it’s going to take a larger cash-flow asset base.
But today, people with large incomes are susceptable to financial ruin due to a lack of financial education.
We have something like this set up but we haven’t called it a wealth machine. Great name though. We have named different savings accounts with different names which helps us keep things organized. It works really well.
I like your idea to have multiple savings accounts with different names, Miss T.
Great work, Miss T. I commend you for putting your financial education into action.
This has worked really well for me 🙂
I always aim for financial and life freedom, rather than outright cash. I earn enough cash online to live off. I could earn more, but don’t want to tie myself up too much. I’m happy gradually building up my automated and semi automated online cash streams and living a fairly simple life for the time being. The only debt I have is my mortgage.
Amen! You are a wise man, Jon. Money is a means to what we all strive for, regardless of our ethnic or financial background, and that is to achieve lasting peace and happiness.
I’m sure you’re sick of hearing that $30k isn’t much, it’s not but it all depends on what you do with it. In your example, is the 30k before or after taxes? That could be a huge difference right there.
Just making lots of money doesn’t mean you handle it well, I think you made a great example to illustrate that.
Even if somebody could use the model exactly as intended, it seems like it would be a good guide to keep you on track. 🙂
You are absolutely right Jen. This article shows that it is not how much you make, but how committed you are to shape up your financial future that matters most. Thanks for stopping by.
That’s right Jen, the figure is arbitrary in this example, but deliberately small. Before tax, or after tax, it doesn’t matter; I’m just trying to convey that it’s a really small amount.
You can apply this ‘machine’ even if you have a minuscule income, like the fictional character here.
When you actually do this exercise, sit down and plot out how much of your income would need to go into these separate accounts, you will quickly see that it’s not as easy as it sounds. It takes some thinking, planning, and it will open your eyes to what proportion you are spending on things right now — and perhaps that proportion of spending now will not help you achieve your financial goals.
This helps you change those habits, and focuses your mind on what to do to achieve what you want. It makes it super easy for you once you put in the initial work.
When I did this, I realized I was spending way too much on living expenses (eating out was the culprit). I changed that habit pretty quick.
There is a lot of theory about budgeting, and personal finances, but all that is B.S. unless you actually apply it!
Let’s see a raise of hands to indicate who has actually implemented this in their lives. It’s been a few weeks now, more than enough time. I will hold you accountable. If you can implement something, even if it doesn’t work for you, then you are way ahead of the game, and will succeed where others fail.
This is about taking responsibility. And taking action.
Do this exercise, and report back here.
Well Said Jim. You can become a great financial mentor my friend. I like the way you make this subject of personal finance so simple at its core.
Yes, well I was thinking about how sometimes subjects we are interested in go from being an opportunity to learn and implement, to simply another form of input and entertainment.
We can read blogs, and info-products, and books all day long but if a person doesn’t implement, experiment, test or take action, that person is beyond help.
Don’t let the simplicity of an idea blind you from pulling the trigger.
Jim ‘take action’ Hudson
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you’ve taken some flak along the lines of 30k being a paltry amount of money.
but money is relative, and there are those who would see spending 30k per year as wildly extravagant. for example, you can find a bunch here:
http://forum.earlyretirementextreme.com/forum.php?id=9
my take is here:
http://jlcollinsnh.wordpress.com/2012/05/16/stocks-part-vii-can-everyone-really-retire-a-millionaire/
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