When it comes to becoming wealthy you don't really need to do anything that special. In all honesty the "pillars" I'm about to share may even sound too simple and obvious, and you might be a bit sceptical about their effectiveness.
But let's think about it, with almost anything in life if you wanted a large group of people to make a lot of progress in a certain thing the best strategy is to teach them the basics really, really well. If you try to teach them all the really advanced stuff they will struggle to apply it and it will also get in the way of them doing the basics.
The very same concept goes for personal finance and wealth building. Not everyone can become an investment banker, accountant or financial analyst, but everyone can become reasonably wealthy by following a simple set of rules with some discipline and consistency.
In my opinion there are 6 different rules or "pillars" that can help almost anyone living in a modern society gain more control of their own financial future. Following all of them is obviously going to give maximum effect, but even if you follow just a few of these you should be able to put yourself in a much better position in life when it comes to your wealth.
Have a Clear Budget
"Every penny has a plan and a job to do."
To be in control of your finances you need to understand and have a plan for every single penny that you own an earn. This means being accountable for your spending, taking in stride all of the mistakes or splurges that are outside of your planned budget and working with them so that they don't affect your future financial stability.
Start with gaining an understanding on what it takes for you to survive; these are the bare essentials such as living costs, food, bills and debt payments. Track them, plus any other spend, over a few months so that you can figure out how much of your income is going towards "survival". Once you know this you can start making decisions on what is really essential and if you're able to optimise by finding cheaper alternatives without sacrificing too much on the quality or standard. You don't need to buy top of the range meat when local supermarket brands would suffice, for example.
Life is about more than just surviving on the essentials but understanding what this level is will give you a great foundation to build up from. Once you know how much of your income each month is going into the essentials you can start to make a better plan for the money that is leftover.
Split that leftover money into two budgets, one for building up your future wealth and the other for doing fun things. Both of these are hugely important for you to successfully improve your financial situation.
The money you set aside to build up your wealth is to be invested for the long term so that it can grow and provide you with a good level of income without needing to work so much in the future. The money you set aside for fun things is so that you are able to enjoy life in the present without losing motivation on your long term goals; after all, there's no point just living in survival mode from now until the end of your life.
Always Be Prepared
"You are going to encounter hits and setbacks when it comes to money."
Financial emergencies can come in different shapes or forms, the most common being an unexpected and unavoidable cost such as house or car repairs, or a sudden job loss leading to reduced or no income in the short term. You always want to be prepared with an amount of money set aside specifically for these events, known as an emergency fund or rainy day fund.
Your financial journey is for life regardless of if you actively work on it or not, so the occurrence of a financial emergency is not a matter of "if" but "when".
What is considered a financial emergency can vary from person to person but it is always wise to maintain a list of candidates; anything on the list should have an action plan. With this level of preparation you will have a better chance of overcoming the challenge quickly and more efficiently, which will take away a lot of the stress and may even reduce the amount it costs you. You may even find that some of the emergencies you have on your list turn out to be inconveniences that didn't actually require money to handle, but only because you had an action plan for it.
The amount of money you should keep in an emergency fund will depend on your own levels of confidence in getting back on track after a financial emergency. You don't want to have too little for obvious reasons, but you also don't want to have too much as that excess money could be put to better use such as being invested for the long term. A typical recommended amount is 3 to 6 months of monthly expenses, and whether or not this includes non-essential spending is entirely down to personal preference.
Starting and building an emergency fund is always a trade off between speed (putting a lot of money in each month) and financial flexibility (leaving some money behind for other things) that takes into account the level of exposure (ability to handle emergencies). Exposure will reduce over time as the emergency fund builds up, so while you will want to prioritise speed towards the start when you are highly exposed you might consider rebalancing towards more financial flexibility later on.
Always make sure that you are storing your emergency fund in a place that isn't at risk from a huge loss of value and is easily accessible when needed. You can use a mixture of different accounts and banks to mitigate the risk of a single account becoming inaccessible for a period of time. You never know when a bank might have an issue with their withdrawal systems at the end of the day.
Keep Control of Debt
"If you’re worth nothing, it means you’re debt free"
In building your wealth you obviously want to be worth more than nothing, but on the plus side if you are worth nothing it also means you owe nothing. This is a much more advantageous position to be in when compared to being someone who struggles with debt. There is no such thing as good debt or bad debt, there is only debt you are in control of and debt you are struggling with; if you have the latter then this is something you need to resolve as soon as possible.
Small debts with high interest can be more dangerous than large debts with lower interest, as the amount owed can quickly build up through compounding if you're not careful with keeping up with the payments. You also want to be wary of getting lulled into a false sense of security by low interest rates on debt; if you can't handle the payments then don't get involved.
Tacking your debt is all about being honest with yourself and taking full accountability. Gather the information you have about each of your debts so that you can get to work on formulating a strategy. Your budget should prioritise debt payments over anything non-essential, including things that build your wealth for the future. After all, debt is akin to negative wealth so you need to get that sorted first.
A debt repayment strategy involves both money and psychology. Quick progress by paying off smaller debts early can give you a motivation boost, even if it means you have to pay slightly more overall when it comes to clearing down all of your debt. However, always work through the numbers in your strategy to make sure the plan actually makes sense.
Don't try to invest your way out of high interest debt. Always remember that future returns on investments can never be guaranteed whereas interest on debt is ever-present. Think of clearing down a debt as a guaranteed return on your money as you no longer lose a percentage of it to interest.
In the UK, your student loan is a special kind of debt that can eventually be written off by the government, giving it a number of advantages over other types of debt. This makes a difference when it comes to formulating your overall debt strategy as you don't want to make any extra payments if it won't actually give you a financial advantage in the long run.
Grow your Income
"Accelerate your earnings over time by making smart financial choices"
Most people get stuck into a bad habit of spending their money faster than they are earning it, and putting little to nothing towards their future wealth. Even if their income cycle includes saving some money, the lack of understanding behind what's actually effective can result in a lot of wasted effort and simply getting nowhere.
Cash has its place in everyone's finances but by keeping everything as cash in a standard bank account, earning little to no interest, you are guaranteed to become less wealthy over time due to the effects of inflation. It is extremely difficult to keep pace with inflation if you are simply putting money away without growing it effectively.
A better option for the long term is to invest your money into a globally diversified index fund that will return on average around 7% each year. This is more than the target 2% annual inflation set by the UK government meaning your wealth will grow over time in real terms. This is known as compounding growth and the more time that passes the more pronounced that growth will become.
Having multiple sources of incomes will reduce your dependence on any single source and that in turn reduces the risks and impacts if one of those income sources is lost or affected. Time is always limited so you will want to come up with ways to create income sources that can eventually earn you a lot for very little active effort; but typically this will mean you need to put in a lot of effort for very little earnings towards the start.
Whether it is investing into an index fund or working on a new income stream nothing ever comes to fruition overnight. Don't look for shortcuts and adopt a long term view by being consistent, disciplined and patient. Stick to a solid plan to grow you wealth and eventually that growth will accelerate.
Reduce your Exposure
"It’s part of the rules and the system to avoid getting hit by tax"
Sometimes we are all so pre-occupied with earning more and more money it becomes easy to forget that simply keeping more of what we are earning can be equally, if not more, effective when it comes to building up wealth. Tax is a part of the system and it is inevitable that you will need to pay some of your income towards it, but avoiding tax is also a part of the system and it's down to you to utilise the various allowances and shelters that are available.
The way to do this is to understand that different types of income may be treated differently by the tax system, and you could be entitled to some tax free allowances for each type that enables you to keep more of that money before you pay tax on it. Since you can add these allowances together the best way is to spread your earnings between the different types of income if possible.
Besides the tax free allowances you are also able to put your money into certain types of accounts that will grant you some tax relief or tax sheltering on further earnings from that money. The full list of available options for tax advantaged accounts or tax free allowances are as follows:
Individual Savings Account (ISA)
Capital Gains Allowance
Savings Interest Allowance
Rent a Room scheme
By going through the details and examples of the various options, and understanding how and when they can be used, it becomes clear that the action of avoiding tax is in fact a very normal thing that you’re expected to do in order to keep your tax liabilities at a minimum. It doesn’t involve the illegitimate practices that you may envision when you think of the concept of avoiding tax. The only “crime” would actually be missing out on the majority of your allowances and then blaming the government for your high tax liability.
The government has provided the tools and it's down to you to understand how to utilise them to ensure that your money and income isn't over exposed to the taxman.
Forget the Money
"If all you're focused on is money, you will forget how to actually be happy."
Having money can be a great enabler in life but there is only so much you can do with it by itself. If you neglect the other things you have, such as time and energy, then you may lose sight of how wealthy you already are.
The journey towards financial independence is a long one and strange as it might sound you will eventually get tired of making money. There will be many reminders and things in everyday life that make you feel like you’re forgoing the luxuries and enjoyments of the present day, causing your motivation to wane. There’s a psychological side of the journey that you have to tackle in addition to the numerical and mathematical side.
Find a way around this by understanding that your longer term goals shouldn't just focus on money, but should also be about some of the things that you find meaningful in life. It doesn't have to be anything grand or world changing, something like providing a great upbringing for your own children would be more than enough. My own solution for myself is passing on my knowledge when it comes to personal finance by writing this blog, among some other projects that I find interesting.
Grant yourself some freedom to spend some of the money that you have earned so that you don’t feel like your time and energy for today’s fun things are slipping away. You can enjoy that meal out in a restaurant, or you can take that holiday abroad if you've earned it. It might reduce your savings rate and therefore slow down your journey a little, but it can give you a small motivational boost that keeps you on track for the long term, meaning you can make more progress overall. The key is not to lose control of your spending by always remembering to have a clear budget and to work these spending items into it.
Life doesn't last forever and you can never know what will happen in the future, so while it is wise to take steps towards your financial independence by following all of the previous pillars never forget that you are wealthiest in terms of time and energy during your youngest days; don't waste the wealth you already have by chasing the wealth you think you only need.
All of my articles will be focused around one or more of these pillars as I apply them to my own life and journey towards financial independence. As I mentioned towards the start of the article, there's nothing really special about them when you think about it.
But we should all be encouraged by this fact because it means our goals of wealth isn't locked behind a special wall that makes it exclusive for those born with a bit of luck and fortune.
They may have a head start but we have all the tools and opportunities to catch up and overtake them.