We believe that the financial status which we get in society is by the amount of money which we earn and then the quantum of it which we spend on liabilities like beach houses, cars, costly holidays, imported furniture etc.
I get pained when I see today’s youth earn a lot, spend more than they earn, buy liabilities with negative leverage believing it to be assets, get in a debt trap and then for the entire life they become a “slave of money” – wage slave of the employer, tax slave of the government and loan slave of the bank. This is a financial stupidity.
We actually get financial status by the amount of wealth which we build which can be different from the amount of money we earn.
To understand this concept clearer you decide which of the categories mentioned below you belong to.
over spending
This is the category of a reckless person, who earns a lot of money but unfortunately has negative net worth. This is because he understands the concept of earning money very well but not how to build wealth. This is a category of a person who might have a big fat salary but with it goes a big house mortgage, a posh home and costly cars on high interest loans along with imported furniture, jewellery, foreign vacations financed by credit card. This person never builds wealth.
No doubt, he earns a lot of money but most of his money goes in just paying interest on unnecessary revenue expenditure like foreign vacation or bad capital expenditure — those assets like car, beach house which take away money from your pocket or a house which do not put any money in your pocket. He then uses the wealth effect — borrows more against his existing assets to finance further expenses and luxuries. It all goes well till his asset can keep financing his recklessness, the day asset prices start falling, his net worth becomes negative and he tumbles like a pack of cards. People in this category are those who earn a lot of money but have no wealth.
Money savers
The second category is perhaps the category of the most financially illiterate person. No doubt, he has more wealth than the first category and a positive net worth but the amount of sacrifice which he does for that wealth is much more than what he gets in return. This category person does not know that after former US president Nixon removed the US dollar from the gold standard, money is no longer money but just a “currency”. In essence, the US and all other central banks can and actually do literally print “paper money” backed by no tangible asset like gold. Hence, the money is bound to lose value over a period of time as more and more currency chases fewer and fewer real assets.
He earns good income and then “saves” all the money in an instrument like a bank fixed deposit. This category person, although earns a “safe” return on his capital, but is at big risk to the financial monsters — inflation and income-tax. He pays the highest amount of income-tax. At the same time, the inflation monster eats into his real return over a period of time and makes him poorer and in turn reducing his standard of living.
Investing own money
The third category is of that person who invests his own money in productive assets like equities, rental real estate or in inflation hedges like gold and silver. This is a clever category of investor, who converts his income into wealth. He is educated on the principles of finance and investments, knows how to save taxes, enhances his real income by investing in natural inflation hedges like gold and silver and builds wealth over the longer term. Dividends from equities are tax free, rentals from real estate subject to lower rate of taxation after deductions, long term capital gains from equities and real estate after satisfying certain conditions are tax free.
Using leveraged money
This is the ultimate category and the person with the highest financial literacy. He invests not only the money that he earned but also borrows to invest in productive assets.
He understands the basic principles of how to use money to create money. He realises the fact that the cash flow from his productive assets have to be good enough to repay the interest EMI on his loan. He knows how to make net positive cash flow after tax. He knows how to create a productive asset out of thin air. This is the category who literary prints his own money.
To conclude, earning money is the first premise of being wealthy but by just earning money nobody can become wealthy unless s/he understands how the principles of finance work in this modern information and currency age and then makes money work.
Remember, you have limited time and energy at your disposal to “work for money” and hence unless you make “money work for yourself” you cannot become wealthy and once money starts working for you, there is no time limit, no boundary to which it is subjected, it can just keep creating and multiplying wealth and you can legally print money for yourself.
The writer is general manager for investments at Tata Investment Corporation
