Where are you in the wealth building process?

Let’s review what I covered previously in What is Wealth?
• Invest 10% of your earned income for life
• Net wealth equal to all earned income within 50 years, but achieved in 20 years

 

• How much do you need to become financially independent?
• Whatever it is, it needs to last 50 years because most of you will live to 100

 

So where are you in the wealth building process? I will define four categories of wealth, regardless of age. All categories exclude any net asset value of your home, or principal private residence. These are:

 

Level 0 – Indebted individual.
This category describes individuals whose net debt exceeds their net assets. A person with a credit card debt of £10,000 and no net assets is no worse off than an individual with £10,000 in the bank, and a property mortgaged for £100,000 with a market value of £80,000. Both people are in net debt of £10,000.

 

Level 1 – Ordinary individual.
This category describes individuals whose net assets are between £0 and £50,000.

 

Level 2 – Sub-HNWI* individual,
 or affluent. This category describes individuals whose net assets are between £50,000 and £500,000.

 

Level 3 – HNWI* individual.
This category describes individuals whose net assets are between £500,000 and £5M.

 

* HNWI means High Net Worth Individual.

 

Analysis of a high net worth individual.
In 2007, there were approximately 500,000 HNWI individuals in the UK, or just under 1% of the population.

Thomas J Stanley, the author of  The Millionaire Next Door, characterizes HNWI individuals as having seven traits:

• 1. they live well below their means
• 2. they allocate their time, money and energy efficiently in ways conducive to building wealth
• 3. they believe that financial independence is more important than displaying high social status
• 4. their parents did not supply economic outpatient care
• 5. their adult children are economically self-sufficient
• 6. they are proficient in targeting marketing opportunities
• 7. they chose the right occupation

 

I would be surprised if readers of this blog did not aspire to being at least a level 3 person, and it’s a fair bet that readers represent all four levels described above.

Regardless of level, we are all interested in reaching a level which ensures we are financially independent, meaning that our net income from investments exceeds our net outgoings or expenditure.

So how much is enough? The numerical value of wealth is not the determinant. It is the ability of that wealth to generate a permanent income which exceeds expenditure.

Let’s take two examples:
1   A pensioner sells her London flat wholly owned for £650,000 and moves into a retirement community in Llandudno, purchasing an apartment for £150,000. She puts her remaining capital into a government bond scheme which guarantees 2% return with capital increasing with inflation price index. She receives 2% of £500,000, or £10,000 per year, increasing every year with inflation. Her total outgoings are £8,000 per year. She is financially independent.

2   A middle aged property investor has accumulated a portfolio of properties worth £4M with a 50% debt to equity ratio. At the age of 60, he decides he wants to retire. He sells half the portfolio, using the cash from sales to pay off the remaining debts, and maintains a £2M portfolio with gross income of £150,000 and net income of £50,000. His total outgoings are £40,000 per year. He is financially independent.

Both these individuals have taken a different route to protecting the real value of their capital investment whilst producing an income which exceeds their personal expenditure. But because the government figures relating to inflation, whether CPI, RPI or any other indicator favoured during the term of a government tend to grossly underestimate real inflation, the first example is less likely to maintain the living standard than the second example.

 

Goals and plans.

End game.

If you get in your car without knowing where you want to drive to, you won’t get there.
Financially speaking, this is the equivalent of starting on the path to accumulating wealth without having an end goal. That end goal should be a time in the future at which you will be generating an investment income sufficient to exceed your personal expenditure at that future time.

Decisions along the way.

If you get in your car to drive to London without a Satellite Navigator, road map, or without reading any of the road signs, and stop off at every place that looks interesting, you won’t know how long it will take you to get there, or if you will ever get there at all. Financially speaking, this is the equivalent of knowing your end goal, but taking every opportunity along the way to invest in something just because it looks good, or better than the last investment.

In both cases, you need a starting point, or where you are driving FROM. Financially speaking, that is an income and expenditure statement.

Whether you are in debt, have a JOB (stands for Just Over Broke) or have a clear business plan to become wealthy, 2009 is the year to revisit basic planning and make sure your plans deliver increasing net income every year. See the blog post Simple Wealth Planning Template 00 where I have placed two links to templates that will allow you to get your financial house in order.