UNDERSTANDING WEALTH

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WHAT IS WEALTH

Wealth can be defined in a few different ways. 

Definition #1: The difference between one's assets and liabilities, and is measured by net worth

Assets – Liabilities = Net Worth

Definition #2: Number of days you can maintain your current lifestyle if you stopped working today

Definition #3: Income from assets exceeding living expenses.

Wealth is increased by three processes

1) Increasing assets

2) Decreasing liabilities

3) Increasing Cash Flow

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Assets, Liabilities, & Cash Flow

Assets – Things that appreciate in value over time or produce residual income. In other words, an asset is something that will be worth more in the future than it is worth today, and has the ability to make money on its own. The best assets both increase in value and make money at the same time. If it does not increase in value or produce residual income, it is NOT an asset.

Examples of Assets (Guns)

-        Property: land, real estate

-        Securities: stocks, bonds, mutual funds

-        Businesses

Example of shiny non-assets (Butter)

-        Cars (unless they are certified antique classics or used in a transportation business such as a taxi or Uber)

-        Jewelry: Gold and silver can be considered as assets because they are precious metals that can be melted and sold. But we do not consider gold and silver to be assets when it's in jewelry because the jewelry will not appreciate in value. Diamonds hold even less value.

-        Clothes: If your clothes don't put money in your bank account while they are sitting in your closet, they are not assets. It's nothing with looking fly, however being fly doesn't translate into residual income.

Liabilities – anything that you are ‘liable’ for and don't own outright, meaning that you still owe money on. Liabilities are debt obligations. For example, if you have a car loan of your vehicle then your car note is a liability. Failure to pay the car note will result in it being repossessed and your credit score being dinged. Another example is your home. Even though your home is an asset, your mortgage payments are a liability until the mortgage is completely paid off. The bank actually owns your home until your mortgage is paid off.

Examples of liabilities

  • Cars (auto loan)
  • Credit card debt
  • Student loans
  • Personal loans

Cash Flow - money coming in vs money going out. If your income is more than your expenses, you are cash flow positive. If your income is less than your expenses, you are cash flow negative. The goal is to increase income and reduce expenses to improve cash flow. 

There are two types of income: earned income and residual income. 

Earned income - money that you have to work for. This is income that you get from working a job. If you don't go to work, then you won't get paid.

Residual income - money that your assets produce. This is income that you do not have to work for. Assets generate residual income without you having to work for it. Examples would be receiving rental payments from tenants who live in your rental property, or dividends payments from your stock portfolio. 

INCREASING RESIDUAL INCOME SHOULD BE THE FOCUS WHEN BUILDING WEALTH because you can own many assets that produce residual income, but you there are only so many hours in a day that you can work a job. It's impossible for a person to work 24/7, but assets DO work 24/7 to make money. This means that you can make money while you're sleeping! Having assets that make money for you frees up your time.