I am talking about 3 broad stages of building wealth today. Sometimes, it is important to revisit why we want to invest and where we are in our journey through life. Otherwise, it is easy to fall into the daily routine of working and forget about the big picture. People want financial freedom so that they are free to do whatever they wish to. It could be travelling the world, doing charity, taking up their favorite hobby full time, etc.
But in today’s society, you need money for everything, so unless you were born into wealth, it is likely that you would be working eventually. Yet, the very definition of financial freedom is that you won’t necessarily need to work anymore. Of course, some people love their jobs so much they don’t want to stop working.
My father is a good example. He has been teaching his whole life, and he is a great teacher. He is now past 60 year old, formally retired and he doesn’t need so much additional income that he must continue to work. Yet, he continues to give private tuition because it keeps his mind active, and at the root of it, he really loves to teach.
That doesn’t depart from what seeking financial freedom is all about. You still want to achieve that because you want that freedom to do what you desire, not feel that you are forced to work because you need the income. My father could stop all tuition tomorrow, and it would not affect his lifestyle one bit because he doesn’t need the income from giving tuition. For him, it is a choice, not a necessity. Hence, he has achieved financial freedom.
Achieving financial freedom is a journey and there are generally few stages everyone on this road has to go through. I would broadly classify it into three stages. In the first stage, which many of us are all in, we are all working and building up our wealth at the same time. In this stage, your primary source of income is from your salary (or business if you are an entrepreneur. Income from capital gains, investments, dividends, passive sources are all quite minimal at this point.
This is a very key stage, and if you are not careful, you will end up staying in the stage for a long time. Perhaps even up till retirement. This is the stage where although your primary source of income comes from the sweat off your brow, you won’t stay young and fit forever. You can’t work forever either (and most of us don’t want to!). So, in other to achieve financial freedom, we have to move on from this stage. This means we have to build up our passive wealth so that in time to come, it can supplement, then eventually totally take over as our primary income source. Passive is anything that can generate income or gains which can be spent. It comes from having a second house to rent out, stocks and unit trusts which give dividends and grow, or anything else. The key thing is that it must be wealth that is hard at work helping you to generate even more money all the time. If its income from a second job, or a second business that requires yet even more energy and time from yourself, then you haven’t created more wealth, rather you have created a second income stream but one that requires you to continue exchanging your time and energy for money. The goal in this first stage build your passive investment returns per year to a level where it equals your or approaches your yearly expenses by which time you would go on to stage two.
Let’s take an example. If you spend $30,000 per year. If you can build your passive investments to the point they are generating (including all passive income and capital gains) a yearly return of $30,000, then you would have passed stage one and arrived to stage two. When you have achieved this, even if you stopped working, you would at least get by. Yearly expenses here would refer to essentials rather than luxuries. When it comes to wants, the sky is the limit, and if you set a target on how much you want to spend a year vs how much you actually need, it would be a far larger amount. That will come later.
I will talk about later stages in another entry because most of us are still in this first stage and how we handle this stage is most crucial. Many people don’t even start this stage of building wealth. Instead, they keep spending everything they earn, without building up their passive wealth, and they stay in this stage forever. The first step towards progressing in this stage, is to spend less than what you earn, and to invest that money wisely. Try not to aim to big initially. You don’t have to set up the next Google business, or immediately buy a house to rent out. Start small, and build your way up. If you have only $100 to save each month initially, start from there. As long as you keep to it, eventually, you will have more to invest, and your investment options will automatically widen.
Stocks and unit trusts allow you scale from small to big quite easily without losing beat. While you can’t exactly buy a house and rent it out with a capital of just a few thousand dollars. You can start to grow your wealth through stocks and unit trust immediately with small amounts. Why do I not mention savings accounts amidst all this? The reason is because given the 0.1% interest rates which savings accounts offer, you will never get anywhere relying on them to build up your wealth.
There are many distractions and temptations for us during this stage as we try and build up our passive returns. Most of us are in the early to mid stages of our career life during this stage, so there will be a lot of material things we desire to buy during this stage. Be it buying a car, getting married, going on trips, buying nice clothes, i-phones, LCD TVs, there’s a long list of things we would love to buy during this stage. And when we have children, there are lots of expenses which come with those too as well (I have two children so I know!).
Take note though, that I am not suggesting we go into a hermit scrooge like existence just to get out of stage 1 as fast as we can. We would hate our life, and we won’t be able to keep up some bread and water existence just so that we can save up more money. The idea is to do everything in moderation. Plan it out and be conscious that you want to save some money each month, track your expenses, and you should be alright (unless you have a spending problem). There are always some alternative which a cheaper, but doesn’t necessarily mean you will live in a miserable existence. Take food for instance. There are lots of yummy food at relatively cheap prices (we are talking about Singapore here!), and there are also lots of yummy food at high class expensive restaurants. You just have to choose not to go to those places all the time and you will be surprised how much of a difference that makes.
In conclusion, this first stage of building up your wealth is the hardest, and often the longest, but if we know where we are going. We can all get through this stage! There are few short cuts to this stage, and few people are able to zip through this stage in a short time (meaning a few years). Accept that this stage will take a while, but if we keep at it, we will eventually past this stage onto the next!
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