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"The Secret Psychology of Wealth"
A Weekend That Will Change Your Financial Life Forever! |
Assets and Liabilities
In the personal financial statement, there are 2 other components that determines your actual net worth, namely assets and liabilities. Now what are assets and liabilities? Before we move on to this, lets explore the definition of passive income.
Passive income is defined as nett income generated from an investment after deducting all expenses required to maintain the investment. It is generally only valid for investments that does not require significant amount of time and effort to continue generating income. Examples of investments that generates passive income are businesses, rental properties, high dividend stocks, bonds etc. For example, a house that is rented for $2,200 and total expenses of $1,850 cash flow or passive income of $350 is generated. In contrast, if the same house is rented at $1,800, there is no passive income as the cash flow from the house is -$50.
This brings us to the definition of Assets and Liabilities.
Assets - defined as investments that generates passive income or positive cash flow Liabilities - defined as expenses/ investments that generates negative cash flow
What role does this play in the personal financial statement?
Assets increases income, which means more money can be placed in savings, which can be used to generate even higher returns. On the contrary, liabilities increases expenses, which reduces savings, an hence your wealth is also reduced.
The basis of generating wealth is to buy in more assets that generates passive income, which will improve your financial status. Furthermore, once sufficient passive income is generated, that is above your current level of expenses, you are financially free, and can maintain your current level of lifestyle even if you stop working totally.
What does this mean? For example, my total expenses is $1,250. Currently, my passive income is derived purely from my rental property, which translates to $350. Lets say I donated all my money to charity but my business idea come to fruitation, and generates another $900 in passive income, and I continue working at my current job, with my current take home pay of $3588, I will be able to put $3588 to work for me every month. In another year, at a rate of return of 20% per annum, I will have $47k in investment. I then leave my job to start a business that generates no income for one year. In that year, at zero income, I can still live my current level of life and STILL grow my investment to $56k. This is just one of the possible scenario that may happen (in fact that's the plan I'm currently working along), and it shows the importance of owning passive income, which allows you to do things you want to do with no worries behind you.
Lets say for a different example. I feel rich as I have $3588 in active income and $350 in passive income, expenses remains at $1,250 and I purchased a flat for myself at $400k. I pay $1,350 a month as installment and maintenance for the flat. This means I have a investable income of $1,338. I continue working for a year and invest all my investable income at 20% per annum. I will have $18k, Lets say I start my business and generate no income for a year. In 7.5 months, I would have spent my whole savings, and would either need to borrow money from the bank, or take out precious cashflow from the business, which may suffer as a result.
I hope this tells you sufficiently the difference between an asset and liability.
Let me give you another example of what can happen if you have the correct financial education. Lets say I need a place to stay, and rent a room for $350. I would have $2338 in investable income. In one year, at 20% per annum, I would have $30k Again, I start my business and generate no income for a year. My savings would be depleted in 31 months. Hence, I have 31 months to make my business work and generate sufficient income (more than $1,250) to allow me to grow my money again (income more than expenses).
I've mentioned that one can be financially independent even if he is a person drawing salary. Is it really possible? Lets take the same example as illustration. Lets assume I sold off my property and put the entire amount into my CPF special account, and could not touch it (ok its not possible as it has exceeded the special account limit, but this is an illustration) I start at zero again. At an income of $3,588 and expense of $1,250, I have an investable income of $2,338. Lets say from now on, everytime I get a pay increment, I increased my expenses by the same amount. My investable income stays at $2,338. However, due to my financial education, I continue to get 20% returns per annum on my money. This would be my financial situation over time:-
Time(years) Net worth 1 $30k 2 $68k 3 $114k 4 $169k 5 $237k 6 $320k 7 $422k 8 $545k 9 $695k 10 $879k 11 $1102k
In eleven years, I would have a networth of $1.1M, assuming I can carry on making 20% per annum. Lets say I cannot as I did not build up my financial education sufficiently, but place it in S&P 500, an ETF instead at 15% per annum. In 13 years, I would be worth $1.1M. Lets say I stop working and take out 5% every year. My networth will still grow at 10% per annum, and I would have at least $55k per annum to spend on. I would still be financially independent, if that's my goal. Why do I say it works? Well, I do have $350k in net worth now in just 3 years. This works out to be 55% returns per annum. I think that's good result for a small time player investing part time.
In summary, your passive income determines your wealth. Once your passive income exceeds your expenses, you would have achieved financial independence, which I am in the process of attaining it with you. Will you travel with me in this journey towards financial independence?? |
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