I came across the book „The Millionaire Neighbor“ by Thomas Stanley and William Danko, which has studies of Americans circa 1995-1996. They studied the behavior of the rich and synthesized ten main points that describe the qualities of millionaires.
The book begins this way:
„Twenty years ago, we decided to find out how people get rich. Initially, as you can imagine, we focused our observations on the inhabitants of the so-called ‘rich countries. „more prestigious“ neighborhoods across the country. Over time, however, we found an exciting fact. Many who live in expensive homes and drive luxury cars have little equity. Gradually, we discovered something stranger: many people with significant capital do not live in „elite“ neighborhoods at all.. This insight changed our lives to the point that one of us, Tom Stanley, abandoned his academic career, wrote three books on marketing, and became an advisor to corporations offering goods and services to wealthy clients. He also researched the lifestyles of the wealthy for seven of America’s ten most prominent financial services corporations. Together we have conducted hundreds of seminars on defining and satisfying the tastes and desires of the rich. Why are so many people interested in what we have to say to them? Because we’ve been able to find out with pretty good accuracy what kind of people the rich are. Furthermore – and most importantly – we have discovered how ordinary people can get rich. Why are these discoveries so fundamental? Here’s why: most people have a different idea about wealth in America. Wealth and income are entirely different things.
From the book „The Millionaire Neighbor“ by Thomas Stanley and William Danko
You don’t get more prosperous if you make a decent yearly income but waste it all. You’re simply living big. Wealth is what you accumulate, not what you spend.
How, then, does one become rich?
And here, most people’s ideas need clarification. Sporadic are the cases where sudden luck, inheritance, academic titles, or even natural intelligence have allowed individuals to amass significant fortunes. Wealth is most often the product of a lifestyle characterized by diligence, perseverance, financial planning, and, most importantly, self-discipline. Why am I not wealthy? Many people constantly ask themselves this question. These are often hardworking and educated people with high incomes. Why, then, are there so few truly rich among them?
In the course of our research, we found seven common characteristics among people who have managed to accumulate significant wealth:
1. Live well below their financial means.
2. They can allocate their time, energy, and money efficiently, helping to accumulate capital.
3. Believe that financial independence is more important than demonstrating high social status.
4. Their parents did not support them financially.
5. Their grown children are economically independent.
6. Possess the ability to identify different market opportunities.
7. They have chosen a suitable profession.“
These are my observations during my time as a financial advisor. I have consulted over 2000 people during my career. I have shared an excerpt from this book because my experience and opinion overlap with those of the authors. Namely, the accumulation of wealth, in addition to a person’s personal and professional qualities, comes mainly from the habits and, more precisely, those of managing their money.
I’ll briefly share with you below what personal finance management means and how easy it is.
What personal finance actually is
Personal finance is individual money – the money that an individual (or household) has available for personal use.
Personal finance is also the application of principles from finance to the monetary decisions of an individual or an entire family. This refers to how individuals or families acquire, budget, save or spend monetary resources over time, considering various financial risks and future events.
- Revenue sources. These are, for example, salary, remuneration for work done, side income, freelance or business income, etc. A controversial topic is which are the best sources of revenue, as their usefulness is assessed by two different criteria: security and potential profitability. It is widespread among the public that salaried work is a more secure income than entrepreneurship and business. And is that right, especially in these times?
- Saving. Also, a debated point, mainly because of the questions „Is it worth saving“ and „What percentage of monthly income is reasonable to save.“ Some argue that saving is ineffective because it is devalued by inflation and gains value if invested. However, it is possible to offset inflation and keep money from depreciating if invested in financial instruments with appropriate returns and risk.
- Budgeting. Budgeting is a must in personal finance management. The budget helps to plan monthly expenditures and to allocate income correctly;
- The „no borrowing“ rule. Avoiding borrowing is vital to sound personal finances. As a rule, saving and making necessary purchases with money saved rather than money borrowed is better. In rare exceptions, however, borrowing is justified (for example, to buy a home or for investment purposes);
- Investing. Investing can bring higher returns than saving but also higher risk, especially regarding short-term investing or speculation. When investing for the long term (over a more extended period), the return on money tends to be upward, even during temporary downturns.
Many people understand the word „risk“ as something negative. But if there is no risk, there is no opportunity. How do you understand it?
Personal finance management
Personal finance management consists of six main aspects:
- retirement planning;
- investment planning;
- insurance planning;
- tax planning;
- succession planning;
- Budgeting.
1. Retirement Planning – Answers the questions. When do I want to stop working, and how much money will I need to live decently after that?
2. Investment planning – Answers the questions, What date are we today? What financial goals do we have: education, child’s education, home, car, or other? How could I achieve these goals, and when do I want to achieve them? Set goals and make a financial action plan. Evaluate your financial situation
3. Insurance planning – What is worth protecting? Do I have dependents on my income? Which financial goal do I want to meet, regardless
4. Tax planning – there are points in the law that allow us to pay fewer taxes. The money saved from taxes can be used to help solve one of our financial goals.
5. Succession planning: Is it possible to inherit financial assets? When? And liabilities, and who could be their source? How can I avoid inheriting liabilities?
6. Budgeting: This is a unified system for planning, controlling, and analyzing cash flows and financial performance.
Budgeting is a type of financial planning – managing the creation, allocating, and using financial resources.
How do you budget? Do you use apps for this purpose, and do you know of any?
Structure of personal finances
- running costs ( electricity, water, bills, fuel, food, clothing, transport) –
we cover them with our current income (salary or other dividends)
- extra expenses ( unforeseen) – holidays, car repairs, treatment, vacations –
We cover them with our emergency fund ( liquid money we can access at any time) – between 3 and 6 monthly expenses.
- Strategic costs – we cover them with strategic instruments ( they work with compound interest ) they need longer planning. More than 3 years.
- risk management costs – insurance.
The golden formula for personal finance management.
- 50% of revenue – for fixed costs
- 30% of income – for pleasure and short-term purposes
- 20% of revenue – for strategic expenditure
Financial goal equals life goal
Each of our financial goals is met in 3 ways and three ways only:
- Saving;
- Donation/Gift;
- Credit/loan.
Saving is divided into :
- Collecting
- Investing.
Investing in turn:
- Specula;
- Diversification.
When investing, compound interest is used. And is – Anatocism (from Ancient Greek anatomists, „compound interest,“ from ana „upward“ and takes „interest“) or Interest on Interest is the arrangement that Interest is due on Interest that has already expired (capitalizing the Interest). This arrangement consists in the agreement that the debtor owes the creditor, in addition to the principal obligation, interest on the interest thereon (compound interest). Einstein said compound interest is the eighth wonder of the world.
For example, if we earn 2,000,000 euros over our lifetime, depending on how we manage our money (whether compound interest works for us or against us), then we can consume either 2,200,000, for example, or 1,800,000 of it. If we do not use compound interest instruments, we cannot preserve the long-term purchasing power of money, and it will depreciate due to inflation.
