Wealth is what you get when your income is higher than your expenses.
So the idea of being “wealthy” can mean, to some extent, what you choose to make it mean. If your wants and needs are modest, then a much smaller net worth may be more than enough to make you wealthy.
And if you haven’t been able to reach this point, perhaps one of the below problems is to blame.
Debt: the black hole of personal finance
Too much debt can be a real wealth-killer. Every time you borrow money, you’re making a promise to pay back the money you borrowed and then some. The higher the interest rate on your debt, the more it will drain your income and make it even harder for you to become wealthy.
The biggest challenge today debt-wise is that it’s so darn easy to borrow money. All you have to do is swipe your credit card or punch the numbers in on a website and boom, you’ve put yourself deeper into debt.
If you’ve got a lot of credit card debt, you may need to make it more difficult for yourself to use a credit card until you’ve broken the addiction.
One old-school way to “freeze your credit” is to stick your credit cards in a container full of water and put them in the freezer. Before you can use the cards you’ll need to thaw them out of the block of ice, which gives you the chance to have second thoughts about spending that money.
Overspending: the American addiction
Americans suffer from a cultural tendency to spend every penny we make — in fact, we often spend more money than we have and end up in debt as a result. Living up to your income means a life of insecurity, because if you spend everything it means you save nothing — and any time an unexpected expense arrives, you have no choice but to borrow money to pay for it.
There’s no way around it: if you want to be wealthy, you’ve got to live below your means and save the extra money. It can be hard to break the cycle of conspicuous consumption, but you can make the process easier if you start small.
If you’ve been saving nothing, don’t try to immediately save 15% of your income. Instead, start by saving 2% of your monthly income (and set that money aside the second you get paid, so it doesn’t get swallowed up by other expenses). After a few months of this, raise your savings rate to 4% of your income, and keep raising it every few months until you hit your savings goals. And make sure you tuck the money away in a separate account suited to your goals (for example, retirement savings belong in an IRA or 401(k), not a bank account).
Inflation: the sneakiest wealth-killer
Inflation is an eternal problem for savers and investors. While inflation can vary wildly from year to year, over the long haul it typically averages around 3% per year. That’s 3% of all your annual returns wiped out by the loss of your money’s value. So if you’ve managed to start saving some money, you must invest that money in ways that will get you a higher than 3% long-term annual return if you want your funds to grow rather than shrink.
Stocks, which boast one of the highest average annual returns of all investments, are a great hedge for low to moderate inflation. During periods of hyperinflation the stock market usually suffers, but interest rates tend to shoot up. For example, take the 1980s, when the government’s attempts to slow down inflation led to a sky-high Fed fund rate of 20% — resulting in enormous returns for investments based on lending money.
Thus, CDs and even bank savings accounts may be a good place to keep your money when inflation soars. And if you manage to buy long-term bonds at or near an interest rate peak, you can lock in those high rates for years to come.
The ultimate wealth-building tool
Given that the average American’s net worth is nowhere near $2.4 million, it’s clear that most people have a long way to go to become wealthy. If you want to beat those averages and become one of the wealthy few, you’ve almost got to have a budget. Budgets are a pain to get started, but once you have one they’re relatively easy to maintain, and there’s no better tool for figuring out exactly what your money is doing.
A good budget not only tracks income and expenses, it helps you to identify areas where you can cut your expenses without too much pain and direct that money into more productive channels. Give budgeting a try for just a few months, and you’ll be amazed to see how much easier it is to become wealthy.
— Wendy Connick
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Source: The Motley Fool