Friday 25 February 2011

6 Steps to Maximise Your Wealth Potential

The DIY Income Investor is about generating wealth by maximising income from your savings and investments. 

The Wealth Potential is the surplus cash you have to save or invest. So the greater this is, the faster your wealth can grow. The faster your Income Snowball will roll.

We have highlighted previously the Wealth Potential formula:

                            Wealth Potential = Income - Expenditure

Step 1: Adjust Your Mind

Reducing expenditure is not easy, if you haven't tried before. The funny thing is - once you start it gets easier and easier. Why? Because it is a state of mind.

It is about 'decluttering' your mind (and inevitably your home) by focusing on what is - and is not - important.

If you haven't done so already, have a look at Zen Habits' guide to decluttering - that should start unlocking your mind-set.

Warren Buffett - one of the greatest investors the world has ever seen - grew up with a money obsession - he hated to spend money (unless it was making more money). Why? Because behind each dollar bill he could imagine the trail of interest or dividend payments that the dollar could produce in the future. At an annual growth rate of 5% his dollar would become two dollars in 15 years, and would continue multiplying.

Step 2: Identify Your Total Expenditure

Most people do not know where their money is going.

If you have Excel or any other spreadsheet program, just start to make a list of what money you spend - either by day, week, month or year (then multiply the individual number by 365, 52, 12 or 1 to reach the annual total for each item). It doesn't have to be terribly accurate at first; the main objective is to capture everything you can think of. Remember, you need to think about the annual cost (which can be shocking, if you haven't done this before) - for example, ths following will total around £500 a year:
  • a £2 coffee each workday (say, 250 workdays per year)
  • a weekly £10 take-away meal
  • a monthly £40 gym membership payment
The main cost categories might be:
  • food & drink (from the supermarket)
  • holidays and days out
  • financial expenses: mortgage, financing costs (e.g. car), debt repayments
  • expenses related to running your home: rent, insurance, utilities (gas, water, electricity, TV/cable/satellite), land/property/council tax, etc
  • personal expenditure (and that of your family): restaurants, snacks, coffees, activities, hobbies, books, CDs/DVDs, etc
  • vehicle expenses: insurance, road taxes, fuel, repairs
  • other stuff: schools, birthdays, Christmas/other religious holidays, etc
Once you have a rough list, work out the annual total and the percentage of each item. Identify the biggest items (e.g. food & drink will probably be one of the largest) - you need to think in more detail about the largest items.

I'm guessing that you won't capture all of your expenditure the first time. As the bills come in (or you notice you're spending on something you haven't included) - add the item or adjust the estimate you made.

Step 3 - Reduce Debt and Cut Your Largest Cost Items

First, if you have debts (e.g. credit card) you are paying much more in interest that you could possibly make by investing. You need to pay off the debt as an absolute priority. This applies to mortgages as well - see here - although you should also have some cash savings in reserve, too.

The best place to start reducing other expenditure is with your largest cost items. There is always a way to reduce the cost, if you apply your mind to it.

The biggest item for many people will be the cost of the weekly (or more frequent) food & drink shopping from the grocery/supermarket. There are lots of resources on the Internet to do this  - for example, here. Our own basic tips are:
  • take a shopping list, and don't deviate much with impulse buys
  • never buy branded goods (i.e. use supermarket brands or their budget lines) - if this is hard for you: why? (Hint: advertising brainwashing...). Blind tests have shown that most people can't tell the difference.
  • compare prices at different supermarkets
  • if you see a good deal, buy in bulk and store at home
  • make use of any supermarket special deals
A second major cost item is likely to be holidays. Either skip the holiday this year, or think about a cheaper one nearer home.

Bundling your TV, telephone and broadbank could save a lot too - see here.

Step 4: Identify Your Target Income

You are saving for a reason - I'm guessing that you are aiming at some form of financial independence: to cover periods of unemployment, a career or lifestyle change or retirement - or even for a legacy to leave children.

One way to focus on a target is to identify what income your would need - either temporarily or permanently. To do that you need to know your expenditure - and this is where Step 2 really pays off: the lower your required expenditure, the easier it is to reach your target income.

Obvious, really - but think about it for a bit. If somehow you could reduce your expenditure, you could reach your financial goals more quickly. You could save years of your life for things that you want to do, as opposed to things you have to do.

Step 5: Develop an Investment Plan

On The DIY Income Investor we give you a number of tools to help you make the best use of the cash you are saving - or perhaps better ways to invest any savings and investments that you might have - making your money multiply more quickly.

Your plan will be based on a spreadsheet - starting with your current income, expenditure and savings and projecting this forward as many years as you want to. This is pretty easy to do, once you get started, even if you are not familiar with spreadsheets. The target will be to try to cover your expenditure (hopefully now significantly reduced) from your savings and investment income. You could build a graph of your estimates for the future.

Step 6: Keep On Doing It

You will find that - perhaps surprisingly - reducing expenditure becomes easier and easier. After many years of pushing down our family costs, I am still finding ways to reduce them further. You will need to look at every item of expenditure and:
  • either eliminate it completely (e.g. magazine subscription, cable film channels)
  • or find a cheaper supplier (utilities, insurance)
  • or reduce your consumption (e.g. by driving the car in a more fuel-efficient way)
Tracking your costs, income and savings is also essential. We found initially that after only a couple of years, our initial estimates of savings and income generated from our investments have been exceeded by a large margin.  This isn't actually hard to do - possibly once a month or even less frequently.

After a couple of years you will begin to see the benefit of your actions and understand better why less is more.

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

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