One of the most important things you can do in aligning your finances to be more productive is define what wealth means to you. Obviously being wealthy is something of a relative term. Someone at the poverty line in the US would be seen as extremely rich in other parts of the world.
The Rich Dad Poor Dad books give an interesting definition of wealth. They say that wealth is determined by how long you can survive at your current standard of living if you quit your job today. So once you stop getting your regular paycheck, how long can you live off your savings and passive income sources before you go broke.
I think this is a very healthy description of wealth because instead of focusing on being rich, it focuses on having the freedom to do what you want while maintaining your quality of life.
Once you’ve come up with your definition of wealth you’ll start to see that there are multiple ways of achieving it. With the definition above, you can become wealthy by making more money, but you can also increase your wealth by lowering your cost of living.
Lets say you normally spend $50,000 per year on living expenses and you have enough money in savings to go 6 months if you quit your job today. If you change your lifestyle and drop your expenses to $25,000 per year, you’ve effectively doubled your wealth. You can now go 12 months without going broke (actually a little longer because your money should be earning interest). If you work for a year and set aside the extra $25,000 you can now go for 18 months.
By working to increase the amount you make (and save) while decreasing the amount you spend, you can increase your wealth from both sides of the equation. The trick is to lower your costs in a sustainable way. You can’t just stop spending money, but you can cut out things that can be replaced with better alternatives. For example, if your current entertainment is to sit and watch cable television, you could replace that with going on walks in the evenings. It is better for you and will save you around $50 per month.
As your wealth increases so does your freedom. If your wealth is 2 weeks (the amount of time before you’d go broke without a job) you are very much a slave to your employer. If your wealth is 1 year, you have the opportunity to take career risks that other people just can’t. Once you get to the point where you can go 5 years without a job, it frees you up to make financial decisions like starting a business, taking a sabbatical, or taking a risky job with the potential for very high payouts in the future.
What is your definition of wealth?
Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity. Watch for more Wednesday financial posts in the future.
When you mention that one can increase your wealth from both sides of the equation, either by making more money or by lowering your cost of living, I inherently feel that the first method of increasing income would be a much better option than to lower your cost. My definition is wealth simply means having the monetary means to afford what I want, when I want it. For example, being able to buy and afford a cup of starbucks coffee without second thought, instead of having to substitute it with instant coffee. True wealth is created by expanding our means, not lowering our standards.
@Ryan – The problem I see with your definition is that it tends to constantly push “being wealth” out further than whatever you have right now. As your income increases so will your spending. In the end you have the same amount of freedom as before–maybe you have a bigger cashflow, but you are still the same number of days away from being broke if you were to quit your job.
That freedom is what will allow you to expand the top part of the equation–the amount you make.
Lets say I make $100,000 per year. I live in a rural part of the country where my housing expenses are less than $10,000. My commute time is 3.5 minutes. My used car costs $8,000. My life is simple, but I have everything I need. In the end after you take all expenses into account, it only costs me $30,000 per year to live.
You make $250,000 per year and live in Silicon Valley. Your housing costs are about $15,000 per month. Your new car cost $75,000. In the end you spend $249,000 per year.
In this situation I would argue that I am much more wealthy than you. Obviously to the outside observer, you would look much more wealthy, but with the definition used here, it isn’t how rich you look that matters. It is the freedom associated with the wealth that should be the focus.
Even though you make 2.5 times what I make, I have a great deal more freedom. If used correctly, this freedom will allow me to take advantage of financial opportunities that simply will not be available to you. I have an extra $69,000 per year that I can invest. This may mean investing money, or it may mean covering living expenses in the future so I can invest my time.
Wealth is having more than you want.
I read “Rich Dad Poor Dad” and this is definitely a part of that book that stuck with me because it was such a fresh angle on money and lifestyle. Great post!
Wealth = Assets
Wealth != Standard of Living
It’s good to have some austerity but don’t become cheap!
@Juan – Someone once said:
Being rich is having money, being wealthy is having time.
Wealth can’t just directly equal assets because there isn’t any absolute scale. What is wealthy in one place is poor in another. My point is that even in the same town, some people have everything they need to enjoy life and others can’t seem to get by. Both positions have very little to do with how much money you actually have.