The 5 Basic Terms Every Rich Person Knows

by Kel Davis

Control your future by simply understanding some basic terms.

So many people leave school (including myself) without the knowledge of the five basic wealth creation terms. These are income, expenses, asset and liabilities. The fifth term is cash flow.

There are three cash flow patterns that represent how a person lives their life.

 

This first diagram is the cash flow pattern of a poor person.

The money comes in from a job, or business and all flows out as expenses. They usually spend 100% of what comes in, constantly looking for a few extra dollars every week.

 

The second diagram shows the cash flow pattern of the middle class.

The money comes in, and then the person feels good when buying a car, home, boat, holiday home or gym memberships. The result is money flowing out to maintain these items as quickly as it comes in.

This is often called ‘Keeping up with the Joneses’, or ‘looking good’. Underneath they are rushing from home to work, slaving away to keep the high income. They usually spend 110% of the money that comes in, giving rise to the general advice of cutting up the credit card and getting out of debt.

Australian ‘negatively geared property’ also falls into this category as it takes money out every single month, limiting the number of properties that can be bought. Only when a ‘negatively geared property’ is sold can it be determined if it was a good or bad investment. This is why I categorize negatively-geared property a middle class investment.

 

And the third diagram shows the cash flow of the rich.

The money comes into the income section from the assets the person owns. These assets can be shares, business or property. The money continues to come in regardless if the person is working or not.

Knowing the difference means buying assets that put money into the income section every single week and month. The property I own provides ‘tax advantaged passive income’ allowing me to buy more and more properties. I can add other assets to the income column simply by buying more income producing assets. Rarely do I wish to sell the properties. Flipping houses (buying to sell for a capital gain) is not in my strategy as I want the positive cash flow every single month. Flipping for selling at a gain, works only in a rising market. Flipping and ‘negative gearing’ strategies both fail in a falling market.

For years I kept focusing on building my property portfolio giving bigger and greater cash flow from this passive income. I know the home I personally lived in is a liability, so I chose to live in a small two-bedroom unit, a simple place in an average suburb. I did not want to live the lavish lifestyle unless (and until) my passive income could afford to pay for it. Instead of just looking rich, I wanted to experience it from inside (my soul) using a property portfolio.

When the passive income from property rents (that covered all property expenses and still paid a return) exceeded my monthly personal expenses, then I never had to work in a job again. Worth repeating this, never HAD to work in a job again – Ever!

When passive income, without me working, is greater than my personal monthly expenses, I reached my definition of ‘financial freedom’.

Travelling, sleeping, holidaying or playing with the rental money coming in every month, is a feeling of freedom that is difficult to describe. One sentence in my first book is that ‘I am no longer a slave, working for money’. While sounding harsh it gives the point of not having to work in a job or business that is converting my personal time for money. The desire for wages, a job or ‘time for money’ no longer controls my decisions, giving me so many other lifestyle choices. Holidays, vacations, relationships, friendships and lifestyle changes when ‘time for money’ is no longer a deciding factor.

So many people work hard for an income, either in their business or in a job, then it is all spent within the next few weeks. They end up chasing a better paid job, or struggling with the business cash flow. The reason is simply because they do not watch their personal and business ‘cash flows’.

I know it is hard to invest if there is no money left at the end of the week. If there is no money left, before investing, consider first looking at your personal monthly expenses, deciding what is essential (for living) and discretionary (optional) spending.

If you are restricted by money, stressed about cash flow, or worried when looking at the bank balance, consider your personal cash flow and what you want it to look like.

Remember, “it is not what you earn that makes you wealthy, it is what you spend and how you spend it.”