My involvement with financial services business has taught me the wealth formula. So here it is:
Money
+ Time
+/- Rate of investment
– Taxes
– Inflation
——————————————-
= Wealth
True wealth today is having the ability to maximize money (cashflow), time, rate of investment, and minimize or reduce taxes and inflation.
Let’s examine each factor in the true wealth formula. Let’s look at money, or cashflow. Money is most familiar to people and most people work for money and it is very sad. One time a student had asked me what my idea of money is, and where do I think money comes from. Money is simply a representation of value. Values are exchanged all the time, and values do not always take form of money. You see, employees and working professionals go to their jobs/clients and exchange their labor, time, and service for money. The amount of money one gets has to do with amount of time and service rendered – in most cases.
How do you maximize your cashflow? It is very simple. You simply increase your income, or you reduce your expenses. Most people do not think about the latter, as most people are more worried about getting raises and better job opportunities. In David Bach‘s book he talks about the Latte Factor which is the small and often times unnecessary expenses. Take the time to eliminate your Latte Factor.
Here is another important money concept that you should get in the habit of. You should always earn, save, then spend. Unfortunately we are all too comfortable to earn, spend, and save whatever we have left. This is why the poor stays poor, and middle-class stays middle-class or become poor.
Time is of essence when it comes to true wealth today. Get started today! Get in the habit of putting some of your paychecks into a liquid account for unforeseen emergencies. More important is to set aside a portion of your paycheck into a tax-advantaged vehicles for retirement. Not only should you capitalize on your money, you should also capitalize on time. Here is what I mean: Take advantage of compound interest. If you get yourself a CD for $10K and it earns 4% interest rate annually, and you reinvest the interest back to the CD, your $10K will grow into $20K in approximately 18 years (Rule of 72). This is the power of time and compound interest. A 20 year old man who invests $10K in a CD earning 4% interest rate will end up with $40K when he is 56 years old. Another person who started the same CD at the age of 38 will end up with only $20K when he is 56 years old.
Don’t let your money sit in your bank account if you are not going to need it. Your savings account is the worst long-term saving vehicle. How much is your savings account paying you in interest? Less than 2% today, which does not even outpace inflation (national average about 3% inflation rate a year). Why is rate of return important? Rule of 72. Rate of return can be positive or negative, therefore, it is critical to examine different investments and your risk tolerance. CD is relatively safer than stock markets and mutual funds, but its rate of return is also lower. General rule of thumb is that risk and reward go hand in hand.
True wealth today also depends on taxes and inflation. Inflation has averaged 3.08% nationally. So to be truely accurate, you may want to reduce your rate of return by the national average inflation rate when using the Rule of 72. Taxes are inevitable. When you earn, they tax you ordinary income tax. When you spend, they tax you sales tax. When you make money on your long-term investment, they tax you capital gains tax. And when you die, they tax you estate tax.
There are ways to reduce or eliminate each different type of tax. You can get around ordinary income tax by not earning 
. What an idea, but it won’t work out too well. Consider owning your own business as businesses have different tax treatments. You can get around sales tax if you purchase online from out-of-state vendors. You may also travel to a county that has less sales tax rate (ie. Los Angeles County is 8.25% whereas Orange County is 7.75%). On big ticket items the small percentage difference can be large in dollar amount. In capital gains tax, depends on your investment, there are ways to “defer” your tax and later take a distribution from your investment “tax free.” For tax at death, in estate planning, you may use life insurance vehicle to pay for estate tax.
I have given a very broad overview of each of the wealth formula components. True wealth today requires knowledge and understanding of different aspects of money concepts. You should consider investing in good books and classes on money. Or you may just keep reading my blog as I will share in details with you on many specific topics about money.
Read on…