5 Key Lessons For Financial Self-Improvement
Understanding these concepts will help you find your way to wealth.
When I first started my adult life around fifteen years ago, I had little understanding of finances, investing, or how to build wealth. I focused on my job, my house, and my 401k, assuming that by doing what everyone else was doing, I would soon be rich.
Before I knew it, even though I had a six-figure engineering job, I was living essentially paycheck to paycheck. My net worth was inching up at a snail’s pace rather than the rocket speed I had assumed. My income was going to pay for my mortgage, car payments, and other expenses, leaving me little cash to invest.
Something had to change.
I decided to learn how to build wealth. I had realized that following the standard path of getting a good job, buying a big house, and saving money in my 401k were not going to get me to financial independence anytime before 65 (and maybe not even by then!). I wanted to do better.
I read dozens of books on personal finance, investing, the stock market, real estate, and building wealth. I learned a lot of good information that I started applying in my life with significant impact.
There are many lessons that I learned over the past decade, but below I discuss the five I believe to be the most important.
#1 — Assets vs. Liabilities
The most fundamental and important lesson I learned is the difference between assets and liabilities. By the official accounting definition, assets are anything you can sell. But to me, this definition doesn’t help you build wealth because you start thinking that cars and jet skis are assets.
I prefer the simplified definition used by Robert Kiyosaki that assets put money in your pock while liabilities take money out of your pocket.
A jet ski for personal use is a liability because you pay for it, and it produces no income (it takes money out of your pocket). If you take that same jet ski and rent it out, it can become an asset if you bring in more money than you need to pay for the jet ski (it puts money in your pocket).
The middle class in America is finically challenged in a big part because they buy liabilities that they believe are assets. Even your personal residence is typically a liability because you pay more to live there (mortgage, taxes, insurance, maintenance, etc.) than you get in appreciation when you sell it.
Read also: 10 commandments for personal finance
One of the main actions I took to build wealth was to move out of my expensive house and turn it into a rental. Rental property is an asset because it has positive cash flow (if done properly) as your tenants pay all your expenses. My returns went from around 0% to 20% when I changed that house from a personal residence to a rental property, which transformed it from a liability to an asset. The difference to my wealth was striking.
If you focus on buying assets and avoiding liabilities, you will start to build wealth.
Everyone needs a place to live, a means of transportation, and so on, but these are expenses that should be minimized as much as practical.
#2 — Stop Acting Rich
Once you learn the difference between assets and liabilities and get on a path to build or buy assets and avoid liabilities, this will help you with the next crucial lesson — acting rich will keep you poor.
Hyper-consumption is prevalent throughout the world these days, and many people are led to believe that buying STUFF will make them happy. We believe having a nice house, driving a fancy car, wearing expensive clothes and jewelry, and eating in prestigious restaurants is what we deserve for having a job with a decent salary. We think that if we look richer than our neighbors, then we must somehow BE better than them.
However, this behavior is the opposite of what it takes to build wealth. Wealth is built by spending less than you earn and investing the rest. How can you invest if you spend all of your money to buy liabilities that decrease in value?
Let’s look at two new doctors, both with good salaries:
Jon buys a new Ferrari for $200,000 to show the world how successful he is.
Jane buys an investment property for $200,000 that produces positive cash flow.
After ten years, who do you think will have built wealth?
Jon’s Ferrari “investment” will be worth around $150,000 if he is lucky. Jane’s investment will be worth around $300,000 (4% appreciation) and will have provided her around $1,000 of monthly cash flow that she could use to save up for another investment property.
Jon, by trying to look rich, is destroying his wealth. Jane, by not worrying about looking rich, is building wealth.
So focus on assets instead of liabilities and stop worrying about LOOKING rich and start working to BECOME rich.
#3 — Good Debt vs. Bad Debt
The next important financial lesson is around debt. This is easy to simplify once you have a good understanding of assets and liabilities, as discussed above.
Bad debt is the debt you use to buy liabilities, which work to make you poor. Good debt, then, is the debt you use to buy assets, which work to make you rich.
Some gurus, like Dave Ramsey, suggest that ALL debt is bad debt. This is good advice for people with no assets as it helps them get out of hurtful consumer debt that keeps them poor, but once you have your finances in order, you will want to look at using debt too fast-track your ability to build wealth.
Debt is dangerous and needs to be treated with respect, but using a reasonable amount of leverage to purchase stable assets (not stocks or crypto, please) can turbocharge your returns. If we continue with the example used above where Jane, the new doctor, purchased a rental property for $200,000, we can see the power of leverage.
Above, I assumed that Jane purchased her property with cash (no debt). She was able to grow her wealth at a respectable 9%, compounded annually. This comes from 4% appreciation plus 5% average cash return over the ten years ($12,000 / $250,000 average value).
However, let’s now assume that Jane is instead using that $200,000 as a down payment on an $800,000 apartment house ($600,000 loan) that produces the same $1,000 per month in cash flow and appreciates at the same 4%. Not only does she get appreciation and cash flow, but now she also gets debt reduction. Not to mention that she gets the appreciation on the full value of the apartment house, not just her equity.
After ten years, the numbers look like this:
Apartment house value = $1,184,000
Remaining Debt = $428,000 (assuming 4% interest and 25 year amortization)
Equity = $756,000
Annual cash flow = $12,000
Compounded annual growth rate =18%
And that doesn’t account for growth in cash flow, which would increase her returns even further.
So now Jane, after 10 years, has $750,000 in equity and $1,000 per month in cash flow while Jon has a nice car worth $50,000 less than what he paid for it.
Avoid consumer debt but learn how to use financing to boost your returns as you acquire more and more assets.
After a decade of investing, I now have almost $2 million in debt on a total of 8 properties, but I have $0 in consumer debt. This has helped me turbocharge my wealth building and allowed me to grow my net worth and passive income substantially.
#4 — Be A Contrarian
What do you think most people would do if they did manage to save up $200,000 in cash? Would they buy the apartment house (asset) or the Ferrari (liability)? Maybe not a Ferrari, but probably a larger personal residence, a new car, build a swimming pool, maybe get a boat or a jet ski, take a vacation just to make your friends jealous on Instagram, etc.
Most people, unfortunately, don’t know how to build wealth. I know because I used to struggle financially despite having a good job with a good salary. We don’t learn about money in school, so we end up learning about it from our parents. If your parents are not good with money, then you likely won’t be either unless you actively work to break the mold.
The way to move up the wealth ladder is not to do what your parents or friends are doing, but to do what others who have found success are doing.
What you will find as you study successful people like Warren Buffett, Grant Cardone, Bill Gates, Jeff Bezons, Elon Musk, etc., is that they don’t follow the crowd. If you follow the crowd, you will get what the crowd has. If you want more than the crowd, then you need to think and act differently.
If you rush in to buy stocks as the market is shooting up (because everyone else is buying, and it’s sooo exciting!), you are much more likely to buy high and sell low. This is not a good investment strategy, but unfortunately, it is what too many uses. If instead, you can hold your breath and buy stocks when the market drops, then you are much more likely to buy low and be able to sell high in the future.
I think you will find buying low and selling high is a better investment strategy, but it takes courage to not follow the crowd and do the things that build wealth. When all of your friends are driving luxury cars, it takes some internal strength to stick with your old Honda and instead buy investment real estate.
Peer pressure is usually detrimental to your wealth.
You need to be confident enough in yourself and your actions to withstand the bad advice you will likely get from your family and friends.
Learn to follow your inner investor rather than the crowd, and you will build wealth.
#5 — Risk and Knowledge
The final critical lesson I wanted to discuss in this article (although there are many more!) is the reality of risk. Many people believe that investing is dangerous, that putting your money into real estate or the stock market is risky. We all know a story about someone who put their money into a “sure thing,” only to lose it all.
Of course you can lose money investing, but there is an antidote to this — knowledge.
What is risky is giving your money to people you don’t know to invest in something you don’t understand. Knowledge is key. If you don’t understand real estate, then you shouldn’t buy real estate. If you don’t understand the stock market, then don’t put money into the stock market.
Warren Buffett has said, and I agree:
“Risk comes from not knowing what you’re doing.”
This doesn’t mean you shouldn’t invest. What it means is that you need to learn what you are doing first before throwing your money at something you don’t understand.
Figure out what interests you and learn all you can about it. It can be stocks, real estate, starting a business, bitcoin, whatever. Pick one area and focus so that you can become an expert, then practice what you learn. You will never know everything, so after you get a good basic understanding, you will need to start practicing to get better as experience is the best teacher.
It is also important to understand that 99% of what you need to know about investing cannot be learned at school. Do not think that because you didn’t get a degree in finance, that you can’t invest.
When you fully understand an asset class, like single-family rental homes, then you will know which houses are good to buy or not, which areas are good, what price you should pay, what rent to charge, how to handle tenant screening, etc. You can’t possibly know these things without studying and learning about them. If you just buy the first house you see, hoping to strike it rich, you are much more likely to fail than someone who has diligently researched the investment class first.
So instead of binge-watching Netflix, order some books and read up on personal finance or investing. You won’t regret it, and it will substantially reduce your risk as you invest for yourself and your family’s future.
I have learned many lessons over the past decade as I studied and practiced to become a better investor. You are not likely to get rich by accident unless you win the lottery or marry well, so you might want to start thinking about what interests you that you can use to build wealth.
I started off investing in low-cost index funds, which allowed me to build up a down payment to start buying single-family houses to rent. I also went through a process to reduce my expenses and increase my income to give me more money to invest. I read and learned a lot along the way, and I now have a portfolio of 7 houses rented out. I also took the step to buy a commercial property with a partner, furthering my knowledge and my ability to build wealth.
Last year, I took advantage of time during lockdown to learn more about the stock market. I finally read “Security Analysis” by Benjamin Graham, Warren Buffett’s teacher, and in the past year, I have been able to make a nice profit from investing in individual stocks as well as selling options. If I had not learned about this beforehand, it would have been very risky, but by studying and practicing (stocks are easy to practice on paper before using real money), I have been able to continue to accelerate my wealth.
The path to wealth isn’t complicated, but it is difficult.
It requires you to learn and grow as a person so that you can do new things that will help you improve your financial life. But in the end, as you approach financial security and even financial independence, it will be worth the effort.
CONTRIBUTED BY Building Arks with Jason Clendenen
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