Saturday, July 22, 2006

Six key concepts of building wealth

Six key concepts of building wealth

1. Asset Vs Liability

The first concept is to recognise the difference between an asset and a liability. This is actually pretty simple: an asset is something that ends up putting more money into your bank account, whilst a liability is something that takes money out of it. For instance, in almost all regions of the world, a house or other property will increase in value over time. It can be rented out, or re-morgaged to earn money. Therefore a property is an asset. In contrast, a swimming pool would be a liability as it costs money to maintain but doesn’t make you any money. The exception to this would be if you had a swimming pool and ran it as a business, charging people to use it. In general, you want to maximise your assets and minimise your ownership of liabilities. This means try to avoid spending money on luxury items, especially those that loose their value over time. If you are already on a tight budget, you should not be spending your money on expensive cars, stereos or plasma flat-screen TVs. In general these things won’t make you as happy in the long term as you thought they would anyway, and they will often become dated within a few years (i.e. the luxury consumer goods of even 10 years ago are often now looked down upon as out-of-date-junk).

2. Creating values

This concept is an important one, but hardly anyone appreciates it. Every person on the planet who is working for a living is either trading values or creating values. Most people are trading values, and are just about surviving. Almost all of those who are wealthy are creating values.

Let me explain the difference.

The following example comes from an excellent book called ‘Seven Secrets of Millionaires’ by Stuart Goldsmith. This example is a simplification, but it’s a good way to describe how the world works:

Imagine there is an island, and that it is self-sufficient (i.e. it’s not trading with the outside world) and is made up of ten families. In order to get by, the families start to ‘trade values’. Members of family 1 offer to spend 5 hours a day fishing for family 2, if members of family 2 spend 5 hours walking up and down the mountain to bring back clean drinking water from the lake. In other words, an exchange of doing one job for another.

Now, this kind of arrangement is perfectly fine, and is basically how humanity got by for thousands of years, its also how the poorer societies on the planet get by today. It’s also basically how most jobs work even in richer societies (except you are making an exchange for money – usually the lowest possible amount the employer can get away with paying you!). The trouble is that this system never results in progress. The people become trapped into working long days, performing tasks that are hard work and mind-numbingly boring. In a sense it’s a form of slavery. The people would certainly much rather be spending their time on other things.

Now, imagine someone on the island starts to form a plan. They notice that a lot of time is taken in walking up and down the mountain to fetch clean water from the stream. And a lot of energy is used up in carrying the pots of water. “What if,” – thinks this person – “I could create a pipe that could bring the water directly down from the stream into the village? This would save people a lot of time and energy and they’d be willing to reward me for it.”

Now, this person puts in the work necessary to first research how to build the pipe (and if it was even possible) and to whether people would be interested in using it if he made it (they would!). He then puts in the work necessary to build the pipe. Finally, once the pipe is in place, the other families gladly do work for him in order to use his pipe. He only charges them 4 hours of work, rather than the 5 hours it used to take them to walk up and down the mountain to collect enough water. Suddenly, this man’s family is much wealthier as they have all the other families in the village working four hours a day for them. The other families are also a bit wealthier than they were before, because they now only have to work four hours rather than five in order to get the clean water they need.

Everyone in the village is now wealthier because the man created something valuable that didn’t exist before.

That is the meaning of creating values.

Can you also see, yet again, the importance of originality, of creating something new?

Incidentally, virtually all the great leaps in wealth throughout history have occurred through the invention of new technologies. And, if you define a new technology in a very broad sense as a new system for helping other people meet their needs with greater ease, then you can see that you should also be in the business of creating a new technology, not necessarily an electrical system, but another form of system for helping people.

3. Debt avoidance

In the West most people are now in debt. Access to credit is now easier than ever. Banks are practically begging you to sign-up for their latest credit cards. Virtually all the things that people go into debt to buy are liabilities and not assets. This is the absolute worse thing you can do: buying liabilities on a credit card or with some form of loan or repayment plan. Not only is the liability constantly dropping in value once you’ve bought it, but you also are paying interest on the money you borrowed to buy it.

Paying back money that you owe virtually ALWAYS takes longer than you expect it to. Sometimes it can take years and years.

The exception here is when you borrow money in order to buy an asset. Such as getting a mortgage in order to buy some property.

4. Leverage and passive income

Put simply, leverage is any technique which allows you to get a large result for comparatively little effort.

Doesn’t that sound great!?

One of the secrets of building up wealth is doing something once and getting paid for it over and over. Now, this sounds greedy, but its not. What it means is that you have created a system for allowing a certain, finite amount of your own effort to help lots of people all at once. If you have created something which is genuinely useful and beneficial to them (i.e. it’s not something that harms them, or cons them) then this is a fantastic outcome all round, for them and you.

5. Business vs Job

It’s very hard to build up significant wealth if you are working for someone else. The only real exceptions are if you have some stock in the company you are working for, and it suddenly leaps in value, or if you are working at the top of a very highly paid (but highly competitive) industry such as law or investing. Otherwise you are always going to be limited in how much money you can make. Therefore I highly recommend that you at least consider the possibility of some kind of business or personal money-making venture outside of your ordinary job.

6. Entrepreneur vs Engineer

Many people miss out on wealth because they fail to understand the importance of marketing.

There are basically two ways of thinking when it comes to making money: the entrepreneur way and the engineer way. The entrepreneur focuses on what people WANT, the engineer focuses on the product itself.

So, for example. Lets say an engineer was thinking of creating a new kind of digital camera. He might slave over the design for months, maybe even years, trying to make sure it had every possible feature, and was totally perfect and state-of-the-art. He would end up working long days, because in order to control the quality of the product he’d feel like he had to do everything himself. In contrast, an entrepreneur type might look for a camera that already exists, and see if he could market it in a new way. Or he might do a little bit of research into what consumers actually want in a camera, and have one designed that meets their needs. For instance, while the engineer might cram every possible function into the camera, including an alarm clock and a phone, the entrepreneur would realise that most people just want a camera that they can point and click, and don’t ever even use 90% of all the extra features on it.

The other difference between an entrepreneur and an engineer is that the engineer starts out to create a business, but ends up just creating another job for himself – one in which he will probably end up working harder than ever! The entrepreneur, by contrast, will realise that in order to make best use of his time he should work on his business as much, if not more than in his business. So, instead of working non-stop himself, he will use strategies to automate or have others help out with the work.

You should try to think more like the entrepreneur than the engineer.

*Tip*: a winning business strategy is for one person who can make something of value to team up with a person who is good at selling. Which type are you: a maker or a seller?

What if you are employed or unemployed?

At this point you may be thinking that the six principles are great for those who are self-employed, or who run a business, but what if you are out of work, or if you are employed in a traditional style job.

Well, firstly, these principles can also help you.

Firstly, even if you are already in a job, there is nothing to stop you from starting a part time business, which, if it grew, could even free you from your job. Many thousands of people have started businesses while already working a job. Yes, it will be harder because you are more pressed for time and energy. You just have to make the most of your spare time. For example, by cutting back on the amount of TV you watch, or on the amount of your free time you spend just surfing the web (I personally waste far too much time doing that!).

Secondly, a great principle if you are already in a job is to become ‘too big’ for your position. What this means is you do every aspect of your job with excellence – better than any of your colleagues. You also look for extra tasks, projects or responsibilities you could take on. You look for ways you could do something extraordinary in your position. If you approach your work with this kind of attitude, not only will you have an increased sense of motivation, and self esteem, but it is highly likely that this will become noticed and you will be offered some new opportunities.

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