Becoming wealthy has less to do with actual income and more to do with planning for financial freedom. What is discussed here is not a “get rich quick” model, but rather a “slow and steady” method that will set you on the path to making your first million dollars.
The first steps in financial freedom involve understanding and taking control of your financial situation, which include:
- Understanding your income and expenses
- Build budgets
- Reduce or eliminating bad debt and spending to boost budget planning
- Paying yourself first
Let’s briefly discuss each of these steps. More detail on each area specifically can be found in the article archives.
Understanding Your Income and Expenses
If you are counting on accidentally becoming wealthy, don’t bet on it. If, however, you would like to take control of your money situation, you must first take a good hard look at your personal finances. Millionaires are very aware of their money situation and review their financial statements on a regular basis.
The purpose is not to see how good or bad you are at managing money, but to identify inefficiencies and areas for improvement. Plus, without knowing where you are, you cannot plan for where you want to be. This exercise alone can be quite overwhelming and stressful. It will require you to first analyze numbers and face your reality. Both can be very uncomfortable for people who prefer to not talk about money or know they are managing their money poorly. But get used to it.
Step 1: Take a look at your monthly income streams and tally up the total. Most likely this is only your paycheck, but can also include income from rental property, businesses you run that bring in money, etc.
Step 2: Collect your bank and credit card statements for the past 6 months and analyze your expenses.
- How much do you regularly spend on a monthly basis?
- Are your expenses more or less than your monthly income?
- What are you spending money on?
- How much cash do you withdraw and where does that money go?
- What do you spend on necessities (housing, food, etc.)?
- How much is over-spending on dinning out, entertainment, etc.
- What unnecessary things are causing you to flush money down the toilet?
Step 3: Re-evaluate your expenses by calculating what you spend on necessities. Only calculate the expenses that are unavoidable every month, i.e. rent or mortgage, food, regular bills. This does not include Starbucks, cable television or over-spending on groceries/dining. Be realistic. Do not include your monthly credit card payment as an expense, but do include any necessary purchases you made with your credit card.
Step 4: Reflect on the amount of wasteful money that is spent.
- How much is spent on unnecessary things?
- Is eating out costing too much?
- How much extra money would you have a month? A year?
- What can you learn from your spending behaviors?
Now that you have taken a good look in the mirror and understand your financial situation, the next step is to create a plan.
Build Budgets
Believe it or not, self-made millionaires budget even after they have become millionaires. Why? To keep up with their financial fitness. Just like the laws that apply to weight loss and exercise, the same applies to wealth. A person who works so hard to eat healthy and exercise regularly to lose weight can quickly gain it all back once they stop going to the gym. The same holds true for millionaires. The habits and discipline the wealthy developed to make their first million is just as important once they have reached their goals. It’s a fundamental part of their ability to create wealth.
Now that you know your income and expenses from the above exercise, you can quickly begin to plan a budget to stick to. This will help you maximize your income and use it to generate more cash as quickly as possible. Let’s outline a basic, simple budget plan. Follow these steps to create your initial plan, and adjust or alter accordingly. The exact method or system you use to budget is not as important as the discipline in budgeting.
Step 1: First, document the kind of budget you have to work with and what wasteful expenses you can eliminate. Ask yourself the following:
- Without spending a dime, how much of your money is gone right away from rent/mortgage, loan payments, minimum credit card payments, and other mandatory monthly expenses?
- What is a realistic cost to maintain a healthy diet for the month, while minimizing your dining out costs?
Step 2: Hopefully Step 1 has not used up your entire take-home monthly pay. Otherwise, some steps will need to be made to eat on a budget, eliminate debt and expenses, and possibly downsize. Assuming you do have some cash left over, divvy up what is left into five buckets: fun, savings, investing, charitable contributions, miscellaneous.
- Fun: It is important to set some money aside for fun. It does not have to be much money, but be sure to reward yourself for your hard work.
- Savings: Professionals suggest having 3-6 months of savings on hand. Start putting a small chunk of money aside every month to build up this reserve. This should not be an “emergency fund,” but an “if I lose my job and need to support my family while I am searching for a new job” fund. Otherwise an “emergency” will frequently occur and your savings will never amount to any savings at all.
- Investing: Millionaires invest a minimum of 15 percent of their income. If you can’t do that at this point, don’t worry. For starters, just contribute what you can to develop the habit, but you should really stretch yourself here as much as possible.
- Charitable Contributions: You will get as good as you give. There are many reasons to give back to society. For one, it feels good and it is our human responsibility to help others, but there are also tax incentives. Plus, the unusual law of reciprocity that tends to repay those who give in much greater ways. 10 percent of the money you have to work with in Step 2 is a good place to start.
- Miscellaneous: This is for all other expenses that always come up but do not fall into the other categories. “Emergency” costs would also fall in this category
Step 3: Adjust the dollar allocations in Step 2 to realistic goals, but do not put 90 percent into the fun category. Be judicious and challenge yourself.
Step 4: Create a spreadsheet or document that will allow you to track your expenses in relation to your budgets for each bucket on a daily basis, and challenge yourself to stay within these budgets.
Over the next few months you will learn a lot about your spending habits and discover places where you waste money and don’t find it worth it. Believe it or not, people generally find the challenge enjoyable and somewhat fun to see how little money is actually needed to live comfortably. Interestingly, you will also find how resourceful you can be towards the end of the month when you have used up your budget. It’s amazing how far you can stretch a dollar and get by with very little.
Generally people allow their income to predict their expenses and budget. These people will always be burdened by debt and rely on their monthly income. This explains why people who routinely receive raises never actually become wealthier. They adjust their spending habits with their increased income.
Similarly, if you take money right off the top to cover your investing and savings budgets before spending a single dollar, you will never notice it missing. If you create your budget first to determine your expenses, you are well on your way to achieving your money goals. In Part II, where we will discuss eliminating debt in order to reach your financial goals more quickly.
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