Building wealth is achieved in stages and requires a repetitive cycle of activities to succeed. These activities include earning money and distributing the money into savings and investments. The investments close this cycle of wealth building by making more money. If you would like to learn how to accelerate your wealth-building journey, read on to better understand the cycle of wealth building!
Let’s cover each stage of wealth building in more detail!
Stage 1 – Earning Active Income
Starting out, we go to work to earn money in a “9 to 5 job.” This income is called active income.
Active income requires spending your time to earn money. When you don’t spend time working, you don’t earn money.
Your employer pays money into your bank account, usually on a weekly, fortnightly or monthly basis.
We spend a lot of money on living expenses, such as food, car expenses (fuel, insurance, maintenance & repairs), housing expenses (rent or mortgage), loans, credit cards, leisure and so on.
If we have enough left over, we can save the money.
Sometimes we may need to dip into our savings to pay for living expenses or unexpected emergencies. The savings account seems to take a long time to grow, if at all!
Stage 2 – Building Up Savings
Over time, if we can live below our means and spend less than we make, we can slowly add to our savings.
Stage 3 – Earning Interest on Savings
The savings will increase in value as more money is added, and a small amount from interest payments.
However, interest payments from banks are not very high. You’ll be lucky to earn a few per cent per year. With savings of $10,000 earning 3% interest per year, you will earn $300 in interest. That’s better than nothing, but it will take a long time to grow wealth relying on bank interest alone!
To grow the savings account, less money needs to be spent and more saved. But this can be difficult when living expenses are high.
Stage 4 – Investing Your Savings
With some savings built up, you can invest your money to make it work harder for you.
A popular investment option when starting out with a small amount of money is the stock market. Index funds and exchange-traded funds are good investments for beginners. They are also popular with more experienced and long-term investors.
Many apps are available to automate and simplify stock market investing. For example, Acorns, eToro, M1 finance, Webull, and many more.
Alternatively, if you are more hands-on and would prefer to dive deeper into stock market investing, seek out an online broker. Most banks have brokerage services that are easy to set up.
Stage 5 – Grow Your Investments to Close the Cycle of Wealth Building
Over time, these investments will increase in value and, depending on the stocks held, pay dividends, which are a type of passive income.
Passive income is income that is earned without actively working in a job.
Unlike active income, where you only get paid for the time you are working, passive income can be earned while you sleep, while you are on vacation, or doing other non-work activities.
Think of this stage as the beginning of a small snowball, about to be rolled down the snow slopes. The increase in value of the stocks and dividend payments reinvested into the fund will continue to grow your wealth over time.
Stage 6 – When You Earn More, Invest More
If you begin earning more, either by working more hours, being promoted at your current employer, or finding a higher-paying job at another company, you will have more money to spend and more to save.
With more savings, you can buy more investments.
As you grow your savings and investments, you can continue to buy more investments.
This stage is where you push the snowball down the slope. Your passive income will grow faster over time, just like the snowball.
Stage 7 – Invest In Higher-Value Assets
At this stage, you can begin investing in more expensive assets, such as real estate.
Rental income from real estate will provide more passive income, but beware of the costs associated with rental properties. Make sure it yields a positive cash flow!
Over time, the savings and passive income will increase further.
Stage 8 – Watch Your Passive Income Grow
When you own enough investments, passive income can begin to cover more and more of your living expenses.
You then have the option of working in your 9 to 5 job for fewer hours. But you may still rely on some active income.
It’s important to continue investing to help grow your investment assets, which in turn will continue to increase your passive income.
Stage 9 – Do You Still Need Active Income?
There will come a time when you own enough investments that passive income can easily meet all your living expenses, including unexpected emergencies (insurance is a must!), and continue to grow.
At this point, you no longer need to rely on active income to help pay for your lifestyle. You could reduce your active working hours, or even quit your 9 to 5 job* and retire to focus more on your passions and dreams.
*NOTE: Before you quit your 9 to 5 job, make sure you have assessed your financial situation carefully. Your passive income sources need to be reliable now and into the future. They should be bringing in sufficient income to cover all living expenses, unexpected emergencies, and other expenses such as vacations and hobbies.
You should also account for inflation. Make sure your investments can continue to provide the income you need when the stock market falls, or when inflation increases more than expected. We strongly recommend visiting a qualified financial planner to help you with this decision!
Stage 10 – Managing Your Investments
Growing wealth is one thing. Maintaining wealth is another.
Managing your investments becomes your new “part-time job”, and over time your investments will continue to grow when managed effectively.
Stage 11 – Financial Freedom
When you no longer rely on working a 9 to 5 job for income, and your passive income can cover all your living expenses, you are officially financially independent.
The amount of income generated by your investments must be sufficient to maintain your living expenses, plus a bit more to ride through market fluctuations, inflation changes and other factors outside of your control.
Congratulations. You are now financially free!
Stage 12 – Living Your Dreams!
When you become financially free, and your investments continue to grow at a rate at least to cover your living expenses, you can work on what you want, when you want.
With the right financial management, you can now afford a better lifestyle and do what you always dreamed of:
- go on extended vacations
- buy a luxury car
- own multiple holiday homes
- donate larger sums of money to charity
- set up a business
The choices are limited only by your imagination and dreams.
As long as your investments and passive income cover your expenses and lifestyle, you can continue to live this way indefinitely. But, it requires a good foundation in financial literacy and discipline!
Do you follow these wealth-building steps? What other steps have you tried that have worked for you? Leave a comment below!
