I started investing in 2013. The significance of this year was that I completed my first year as a teacher and I began a Masters program that would pay me a stipend of $1,000 per month. As a young man, living rent free in my mother’s rental unit, I soon found myself with a nice nest egg. My understanding of inflation taught me that as long as my cash sat in a savings account gaining 0% interest, I would lose about 3 percent of the spending power each year. Basically, if I put $1000 in the account, the next year the spending power would decrease to about $970. This course of events led me on my current journey toward financial freedom and wealth. I hope this inspires you to do the same.
The first book I read on financial literacy was Rich Dad, Poor Dad by Robert Kiyosaki. I highly recommend reading this book. For many, this will be the foundation of your financial education, as it is surely mine, and through it you shall find that creating the type of wealth and prosperity that you seek is actually very attainable. In the book, the author shows the income statements of three types of people: the poor, the middle class, and the rich. Today, I am going to show you the same.
The Poor Person:
The income statement above shows you the cash-flow pattern of a poor person, or my former income statement. As a young man collecting his first “career paycheck” and having no rent, I had money to burn, and that’s what I did. To understand an income statement, be it a personal one or that of a business you want to invest in, you must first understand what an asset, liability, and expense are.
- An asset is something that you own of value. It may be a stock, bond, note, rental unit, or business. Assets will produce income in the form of dividends, stock growth, rent, revenue etc.
- A liability is a debt that has been taken on. Typically these are car loans, student loans, residential mortgages, and credit card debt.
- Finally an expense, is something you spend money on. Examples include rent, food, taxes, credit card payments, student loan payments, car payments, pretty much everything else.
Learn to distinguish the difference between these words, you will hear and use them a lot from this day forward.
Now we can analyze this income statement. From it we see that this person has money come in via a job and goes straight out of the expense column. They have no assets so the only way for them to earn money is to sell their life by the hour. A person with this type of income statement will never create wealth, thus exiting the “rat race” will be nearly impossible. This is also why many lottery winners go broke after 5 years.
The Middle Class:
Four months into my new job, my student loan payments began and I purchased a new car. I effectively became middle class, and the diagram above is how my income statement looked.Notice my move from poor to middle class did not come from an increase in income but in liabilities.I think this shows that you can make a lot of money and still be poor if you don’t understand the financials . In the book Robert Kiyosaki, drives home the importance of paying yourself first. What this means is that you should purchase an asset before paying your liabilites and expenses. The reason for this is because assets generate income and they will change your cash flow pattern from the diagram above too the one below.
Currently this is my income statement, it is similar to that of the “rich”. Again this is just a mentality switch. By investing in an assets, you are able to trade your money and not your time to produce income that will cover your expenses. In truth, being rich is just having your assets generate enough income each month to cover your monthly expenses. Once that is accomplished you can effectively retire and explore your dreams. Once I understood what an asset was I began trying to purchase as many as I could.
The key takeaway I would like to leave my readers with is that you must pay yourself first. We all have heard the phrase it takes money to make money, now you know how to apply it.