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3 steps to wealth

16 Jun 2019, 7:52 p.m.   Team Rebo  

Here's some good news: becoming wealthy is simple.

Steady on though - don't order your Lamborghini just yet! Note that I said 'simple' and not 'easy'.

To build personal wealth, you just need to apply one very simple formula:

  1. Produce more than you consume (a.k.a. 'spend less than you earn'). This will leave you with a surplus which will become your investment capital.

  2. Invest your surplus into things which will pay a return in some way. I'll give some examples in a moment.

  3. When your investments pay you (giving you even more surplus) reinvest these proceeds into further investments.

If you follow this recipe for a long enough period of time, you are all but guaranteed to become wealthy. The key is sticking to the plan.

OK. Let's have a couple of examples.

Simple example

Here's a really simple way to implement the principle I outlined above.

Let's say you can set aside £500 each month from your salary. This is the 'producing more than you consume' part.

You open an investment ISA (to keep your investment returns tax-free) and set up a standing order to pay the £500 into your investment ISA each pay day.

You instruct your ISA provider to automatically invest the incoming money into a fund which provides a real rate of return of 5% per annum. All investment returns accumulate in the fund

You keep this arrangement going for 20 years. You'll need to adjust the amount you pay in each year by the rate of inflation. This is the 'investing your surplus' part.

Plugging our numbers into a compound interest calculation shows that after 20 years, you'll have wealth of just over £200,000 producing roughly £10,000 of investment returns each year (in 2019 pounds).

If you let the experiment run for 30 years, you'd have just over £400,000 of wealth producing roughly £20,000 of investment returns each year.

This illustrates what happens when you reinvest the proceeds of earlier investments.

Continuously saving some of your income and investing it in a fund is a simple and reliable, albeit slow way to get wealthy. Of course, you can accumulate wealth more quickly by saving more of your income.

But, assuming you don't earn hundreds of thousands of pounds per year, this method is limited to making you moderately wealthy and it will take a while for you to get there.

How about a slightly more interesting example?

More complex example

Arguably the most potent way of becoming wealthy is to own a profitable business.

Now, this might sound intimidating, but thanks to the widespread adoption of the Internet, opportunities to execute this strategy are much easier to come by than they were for previous generations.

There are many examples of online enterprises including blogs/websites, online retail stores and Software-as-a-Service (SaaS) businesses. These businesses can be highly profitable and have low capital requirements (i.e. you don't need a lot of money on hand for things like stock and machinery).

Let's say that you earn £50,000 per year for your job but you know that you could live comfortably on £40,000 per year. You are therefore producing more than you consume.

You negotiate a reduction in your working hours so that you now work 4 days per week for a salary of £40,000. You spend the 'spare' day you now have available each week building up a small e-commerce business. This time you are investing surplus time rather than cash.

After 18 months the business is producing a profit of £25,000 per year and takes 8 hours per week to run. You now work full-time again but you earn £65,000 per year (£40,000 from your job + £25,000 from your business) compared to the £50,000 per year you earned when you worked full time at your job.

You could choose to channel the extra money you now have into traditional investments (like in the first example) or you could invest it into developing your new business such that it provides you with an even larger income. These are both examples of reinvesting the returns produced by your investments.

Of course, this method comes with much higher risks than than in the first example (you could end up sinking a lot of time into a business that fails) but also the potential for higher rewards (and a faster route to becoming wealthy).

Go and get rich!

There you have it. You now know everything you need to become wealthy :-)

Whether you decide to take the 'slow and steady' approach of simply buying traditional investments out of surplus income or the entrepreneurial approach of investing your surplus time and/or money into a new enterprise, the principles are identical. You need to generate a surplus, invest it productively and keep reinvesting any gains that you make.

The crucial lesson here is that you must stick to the plan and continue to apply these principles consistently over a long period of time. Like I said at the beginning, becoming wealthy is simple, not easy!

Of course, I've glossed over some of the details for the sake of brevity. Please make sure that you do your own research before trying to execute either of the strategies I've described here.

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