Don't Let Your Mouth Write a Check That Your Assets Can't Cash

By Ismail Abdur-Rahman, CEO iVIBES

Do me a favor: see if you can count the number of wealthy people you know personally on both hands. To be clear, by wealthy, I mean people who have enough wealth to never work another day in their lives and still maintain their current standard of living. Can you count them on both hands? No? On one hand? That's OK. I can't either.

Simple truth: Most people are broke.

Think about it for a minute. For the vast majority of people in the world, living paycheck to paycheck is a sad reality. How many homeless people in America ended up that way because they got sick or had an accident and were out of work long enough to miss one too many mortgage payments and were subsequently evicted? Even if you can hold on to a job until retirement, your retirement savings are likely to be depleted quickly unless you start amassing wealth now.

Calculating Broke

If you want a true picture of how broke you are, just take a minute to calculate your net worth. The basic formula is the difference between your assets and your liabilities. A 2016 US Census Bureau report stated that the average net worth (excluding home equity) for Americans between the ages of 35 and 44 is was $14,226, and $45,447 for those in the 55-64 age group. That's not a lot of money.

Those figures pretty much guarantee that you'll be forced to work until you die, especially when you consider that the average monthly Social Security benefit paid to retirees was $1354.04 as of October 2016.

Your Household Balance Sheet

Let's start with the basics first. An asset is something you own that either puts money directly in your pocket regularly or can be sold free and clear for cash. Assets have value irrespective of whether you are working.  A liability is basically the opposite of an asset - it is something in your possession that is owned by someone else, and you have to make regular payments to continue to use it.

The reason most people are broke is because they are trying to use their income from working in order to cover their basic expenses, and they end up in debt because they make bad decisions about how to spend their money. While limited income is a factor, lifestyle choices also play a major role in why some people seem to stay broke. The following figure illustrates the typical cash flow in a poor household.

poor households cash flow.jpg

The most dangerous liabilities for many working adults are credit cards, personal bank loans, home loans, and auto loans. In poor households, most of the income goes to paying expenses, and when you've only got one stream of income, that is inevitably a recipe for financial disaster. 

Middle class people often get themselves in trouble because, though they earn higher salaries than their poor counterparts, they spend money acquiring additional liabilities like credit cards, vacation homes, a second car, a higher mortgage payment, and other items that drain the money out of their pockets. Despite their greater earned income, many middle class professionals essentially live paycheck-to-paycheck because while they think the time shares, cars, and boats are assets, they are actually liabilities because of the money they spend making payments to buy them, in addition to the money they spend maintaining them. Unfortunately, for most middle class professionals, these liabilities are never converted to assets. Lifestyle choices can make middle class people look poor very easily. Their cash flow pattern usually looks like this:

middle class hoseholds cash flow.jpg

Wealthy people, on the other hand, spend part of their earned income to acquire assets like real estate and small businesses, and they use these assets to create passive income. The wealthy also tend to have more liabilities than poor and middle class people, but the difference is that they support these liabilities with their passive income, and eventually they are able to convert most of their liabilities to assets.

wealthy households cash flow.jpg

What to Do

The harsh truth is that in order to get ahead, you're likely going to have to take a step back. Social media helps plenty of broke people create the image of a wealthy lifestyle that countless people feel pressured to emulate, leading to bad short-term decisions with long-term financial consequences.

If you're currently in the vicious paycheck-to-paycheck cycle, you're going to need to downsize your lifestyle for a bit so you can stop working like a slave to pay for liabilities and start buying assets. Find a cheaper place to live. Dump the car note for a decent used car that you can pay for in cash. Cut up your credit cards. Make good decisions, and work on decreasing your spending on monthly expenses for the next 2 years.

In the meantime, work on increasing your income so that you can begin acquiring assets. Do you have a particular skill or passion that people are willing to pay you for? Starting a side hustle as a freelancer is a low-risk way to significantly increase your income without having to give up your day job. 

If you're in a slightly better position and don't need an immediate return on your investment, start a small business - preferably one that can eventually automate processes well enough that it generates revenue without your direct involvement (in other words, a passive income).

Once you have your cash flow worked out so that you've got enough surplus income to begin investing in assets, get started. Consider real estate as a good starting point.

There are various ways you can get into real estate investments, but the most important thing to keep in mind is that the investment should cover its own expenses and generate surplus income that can be directed towards another investment. You might consider buying distressed or foreclosed properties and renovating them for use as rental properties. Industrial warehouses and office spaces are also good investment objects, as they aren't typically very expensive.

Once your cash flow is significantly positive, you might consider investing in more high-growth opportunities like equity shares in high-growth businesses or the latest game-changing technology.

A Word of Caution

While creating wealth is a relatively simple process, it's not necessarily easy. Let's face it. If it were easy, everyone would do it, and poverty would be summarily eliminated. It will require significant discipline and and diligence, but if you trust the process, it's very doable for most people within a few years. The most important change you'll need to make is your mindset. The sooner you understand that chasing a lifestyle that your income can't support will keep you broke for the rest of your life, the better. Stop worrying about keeping up with the Joneses and the Kartrashians and focus on creating wealth for yourself. In other words, don't let your mouth write a check that your assets can't cash.