Before even thinking about how to build up wealth, you need to determine your own type of financial lifestyle. Simplified, there are three types:

1.  The borrowers Basically, their lifestyle is built on debt. Their creed is to live for today and forget about tomorrow. They buy the latest new cars, wear expensive clothes and jewelry, and their home is financed with a mortgage. Not only are they incapable of building wealth – they’re actually building negative wealth: debt. This kind of lifestyle is not sustainable: as soon as some extraordinary events happen (such as a job loss, illness), the high standard of living can no longer be sustained. Even worse: Depending on the extent of their debts, they put themselves at high risk of suffering from a modern kind of slavery.
2. The consumers A little more responsible towards their own lifes than the borrowers, their maximum spendings are based on their net incomes. No wealth is built, neither positive nor negative. If they are lucky, they can sustain this lifestyle for some time. However, once risks manifest, they need to be financed by debts. From then on, they standard of living decreases, plus they will depend on the mercy of others.
3. The keepers Instead of spending their income to the maximum each month, they are putting aside a certain amount of their income each month. They focus on net worth mentality instead of paycheck mentality. As they have established emergency funds and covered life’s most financially threatening risks with insurances, they have a very low chance of being trapped with the vicious circle of indebtedness. Even though they do not necessarily earn more than the borrowers or consumers, they still lack nothing and can live the good life. Furthermore, due to the magic of compound interest, they are able to increase their standard of living in th long-term

Which category best describes your financial lifestyle?

Do not confuse income with wealth. Even someone earning seven times your wage may have a lower net worth than you – if all the income is spent. However, the maximum amount you can save each month depends on both your income and your expenses, so keep in mind that there is a correlation between income and wealth.

The only certain way of building wealth is to save, the more and the earlier, the better. Do not put your hopes in gambling or the lottery – the chances that you get struck by a lightning twice in your lifetime are actually two times higher than winning a lottery jackpot.

How can you save more?

Basically, there are two ways of saving more:

1. Increasing your income Ask your employer for a salary increase, get a better-paid job or generate some extra-income (like starting some kind of your own business)
2. Decreasing your spendings In order to accomplish that task, you first need to control your spendings. Know your fixed costs of living. Pay yourself first. The rest of your net income is transferred to a separate account, out of sight, so you won’t be tempted to spend it.

Note that the second option is more efficient than the first, because increasing your income will also increase your tax burden. Nevertheless, try to adopt both methods. If you want to adopt the keepers’ financial lifestyle, start saving early, for time is your friend:

‘Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.’ – A. Einstein

Due to the effects of compound interest, your wealth will increase significanttly as you move forwards in time. Try to memorize the rule of 72:

If you’d like to determine how many years it takes your investment to double, simply divide 72 by the annual rate of return. For example, if you are invested in assets which return 6% each year, after twelve years they will have doubled in value. After another twelve years, the worth will have quadrupled.

The trick therefore is to start investing as soon as possible. The difficulty is in choosing an investment strategy  and in determinating the asset classes which best fit your risk-bearing capacity. Knowing the risks of each asset class and their historic correlations is vital for determining your asset allocation.

You will learn more about

• asset classes and their expected risks/returns (both are correlated positively!)
• asset allocation and how it helps you minimize risks
• investment horizon basically, the time you plan to stay invested can have a significant impact on the risks involved

in one of our next blogposts. So stay tuned!