If we will see it from a positive perspective, the desire to become rich is not only about the abundance of money. It is more about giving oneself the ability to live a life of choice.
So for me, becoming richer each day is an ongoing process. It is not an end goal. I believe that no matter how low or high is one’s income, there is always a possibility to get slightly richer each day.
But to become rich, one must first understand what makes a person rich. If we think that income alone will do it for us, then we are mistaken. The flow of income is an essential first ingredient. But our focus should be on the income plus other things.
What are the “other things”? This is what we will try to visualize in this article. We will take the help of infographics to understand the role of all the ingredients.
It is a point worth noting that, managing the priority of ‘becoming rich’ cannot be done in isolation. It is an after-effect of how well other priorities of life were also handled.
- The process to become rich.
- The Stage Zero Rule.
- Stage A – Foundation Building.
- Stage B – Prepare & Invest.
The Process to Become Rich
We will discuss all steps of the process indicated in the above flow chart. But I would first like to highlight two essential preconditions of becoming rich. I’m talking about the steps indicated in #8 and #9.
- Step #8 talks about the accumulation of assets that will eventually generate passive income. What is passive income? It is that form of income that yields on its own without any effort from the investor. What must be noted here is that accumulation of passive income generating assets is essential to become rich.
- Step #9 talks about financial independence. It is that state of being where all needs of life will get fulfilled with passive income alone. One need not work (job, business) to generate any income (salary, profit). To be financially independent, one needs loads of passive income.
We can say that becoming rich is an advanced stage of financial independence. To become rich, one needs to first cross the milestone of financial independence.
The point is, if one wants to become rich, it cannot be accomplished by skipping steps number eight and nine. In fact, all preceding steps shown in the infographics does an effort to enable one’s ability to execute step #8 and #9.
Stage Zero Rule
Why it’s called stage zero? Because it is where we start. Getting in a job or business and earning our first income is what we all remember. What happens after that? We use our paycheck to buy our first ‘thing’.
If you are somebody who has already seen your first paycheck days long back, you can still apply the stage zero rule. In fact, for you, it’s implementation would be more subtle.
Do these two things:
- Create Expense Budget: If you do not have an expense budget, make one for yourself. Identify all expense line items and allot a specific Rupee (budget) to each of them. That will give you an idea about how much you can spend on each expense heads. Not only this, take your expense budget one step further. Start tracking all expenses.
- Save for Retirement: What an expense budget does is it allows us not to overspend. Hence we tend to save more. The extra savings that we make must be diverted towards retirement savings. Read more about retirement planning.
I’ll contribute 15% of my net income towards retirement savings. This is a good number. Please note that we cannot divert all savings to retirement account only. Hence, putting a cap of 15% is a good idea.
Stage A – Foundation Building
Stage A starts when a person begins to save more than what is being contributed as retirement savings. This is that stage where one must put to use their savings in three important areas:
- #1. Saving Tax: Tax planning has dual benefits. It prevents unnecessary tax-related outgo. Moreover, it pushes people to save and invest money for the long term. Fewer tax deductions mean more savings. Read more about income tax planning & the latest tax slabs. Also, read about how ELSS funds can save tax.
- #2. Buying Insurance: Insurance may look like a cost in its first instance, but in the long run, they tend to save lots of money. Start with having a suitable life cover using a term plan. These days when medical expenses are soaring, keeping a health cover is also essential. Another important insurance that is a must is motor insurance.
- #3. Buy Home: Common people like us often start with living in a rented apartment. But to build a strong foundation for the future, having a home for self will do good. But there are two control points: (a) buy an affordable home, and (b) always prepay the home loan.
Suggested Reading: Rent Vs Buy Home Decision Explained.
The above three steps will build a foundation. This is what we will call stage A. The next leap will be into the real world of investments – buying assets. We will call it “Stage B”. This is where our efforts will make us stand out from the crowd. Henceforth, whatever will be done, only a handful of people do it.
So lets see what’s in store for us in stage B.
Stage B – Prepare and Invest
After stage A is done, the next stage to enter is stage B. This is a busy phase. A lot of things are happening at this stage. Hence to reduce the clutter and confusion, it is better to act in the following steps:
Preparations Before Investing
- #4: Emergency Fund: Before one starts to invest, one must build an emergency fund. The minimum size of this fund must be at least six times worth of one’s income. An emergency fund can be built-in cash and gold. Please note that the larger is the size of the emergency fund, the better.
- #5. Become Debt Free: If one has spare money, two things can be done from it (a) invest money or (b) loan prepayment. Investment is a more popular choice, right? Why? Because investment makes our money grow, and hence we have more spare cash. There is another way of making more spare cash – by lowering our expenses. Paying off debt is one way of lowering our expenses. Read more about the process to become debt free in life.
Suggested Reading: If you are somebody to whom the concept of emergency fund building and becoming debt-free attracts, I’ll suggest you read a blog post. It talks about how people like us can practice money management in our life.
Before starting to invest money, let’s remember that we are doing everything to become rich. This is our top priority. But it is also essential to simultaneously manage life’s other future needs. Hence, we must divide our investment portfolio into two categories: (a) future needs, and (b) becoming Rich.
- #6. Debt + Equity: To manage future needs, I take a slightly defensive route. I prefer investing in a hybrid scheme offered by mutual funds. The bigger purpose is to build wealth in the long term. My focus is to continue accumulating mutual fund units for 15-20 years in a stretch. I would use both methods to buy units: (a) Systematic (SIP) and (b) Lump-sum investing using STP.
The wealth accumulated in this portfolio will be used to handle life’s uncompromisable needs like:
This is about one part of the investment portfolio. The second part will take care of our priority to become rich. Let’s talk about it…
- #7. Pure Equity: We’ll invest in pure equity. Direct stocks, multi-cap funds, and small/mid-cap funds will be our choice. I prefer investing in Stocks, but the trick is to buy only fundamentally strong stocks trading at an undervalued price. The bigger idea is to try and buy only multi-bagger stocks that will make our money grow faster.
We all would like to buy a stock that becomes a multi-bagger in a short time. Unfortunately, this does not happen easily in the real world. This is the biggest challenge in becoming rich. There is no quick fix to this hurdle. The way out is to evolve our stock-picking skills (Tip: Learn about the concept of intrinsic value).
Once a good stock is purchased, stick with it till it becomes a multi-bagger. Generally, for me, a 2X or 3X multiple is enough. I sell those holdings and use the sale proceeds to “buy assets” that generate quality passive income. I’ve written a detailed article on the concept of passive income. If you like to know more about it, please check the link.
#8. Passive Income Sources
This is where the main action is happening. What is the action? The sold equity (shares or MF units) is used to buy assets capable of generating passive income. The quantum of passive income decides if one has achieved financial independence or not.
To become rich, one must first achieve financial independence. We can also say that becoming rich is an advanced version of financial independence.
Let me show you the difference between a financially dependent, financially independent, and a person getting richer.
Who is a financially dependent person? One who needs profit from business or salary from a job to manage his/her needs of life. What is shown above is symbolic of financial dependence. The passive income is not sufficient to manage all needs of life. Hence, he/she will need an outside income source (like a salary from a job).
Financially Independent & Becoming Richer
The above infographic is symbolic of a financially independent person. The asset base is generating enough passive income which can take care of a person’s financial needs of life. In this stage, the person need not do a job or business to earn a salary/profit. This is financial independence.
In this stage, if passive income minus needs of life are also yielding some extra cash, we can say that the person is becoming richer. The bigger will be the size of extra cash, the richer will be the person.
Assets Yielding Passive Income
Following are the three most reliable passive income sources that a common man can buy to reach the stage of financial independence and beyond:
- Real Estate Property: Here the goal is to buy a rental property whose rental yield is at least 3.5% at the time of purchase. This is one asset type that generates the most reliable passive income. Check this property investment guide for more clarity about how we common men can invest in real estate.
- Dividend Stocks: It is comparatively easier to identify a dividend stock whose dividend yield is 3.5% or higher. But the problem with dividends is that it is not as predictable as rental income. So the trick is to try buying stocks of blue-chip companies having a good dividend history. Buying these stocks at an undervalued price may fetch a dividend yield of 3.5% or higher.
- Interest Yielding Assets: People also have an option to buy risk-free assets to generate passive income. In India, a risk-free plan can yield an interest income of 6.5% or higher. Read more about monthly income generation from here.
In the above listed three investment options, you might have noted that yield from a rental property or dividend stocks is discussed as 3.5% levels. While the risk-free option is said to generate a 6.5% return or higher. So one might ask, why bother investing in real estate or stocks? Following are the reasons:
- Capital Appreciation: Both property and stocks appreciate in value with time. Suppose you bought a property worth Rs.40,00,000 in the year 2010. Today the same property may be priced at Rs.85,00,000 or higher. Good stocks may yield much faster capital appreciation. Please note that the price appreciation is happening in addition to the rental/dividend yield.
- Yield Enhancement: In the case of a risk-free option, the interest yield generally depreciates with time. But rental and dividend yield grow with time. People who bought shares some 10/15 years back, for them it is common to have yields in the tune of 10% or higher.
Hence, net return from a property and stocks is much higher than a risk-free option. Read: How to calculate return on investment (ROI) in Excel.
This blog post presents a roadmap that explains how a person can become rich. What is the thing to note about the roadmap? Only spending money will take us nowhere. To become rich, one needs to organize one’s finances. How to do it? Save more and invest the saved money.
But a focus on investment alone will not get the job done. It is essential to lay a strong foundation before starting to invest. Moreover, the investment must be segregated between life’s priorities and the idea of becoming rich.
Follow the process to enable oneself to buy more such assets that yield passive income. Why passive income? Because to generate passive income, one need not work. People will have more spare time to think innovatively and hence can invest more intelligently.
The higher will be the passive income, the faster one will reach the milestone of financial independence and hence will become rich.
In case you have some feedback/query on the topic, please post it in the comment section below. It will be my pleasure to read and reply to your thoughts.
Have a happy investing.