May 31st, 2008
Basics: The Wealth Equation
The last time we looked at “Basics”, I discussed the cash flow equation, which is:
income - expenses = cash flow
Now, once cash flow is positive (and the more positive, the better) the wealth equation is also simple:
(cash flow + sensible safeguards + wise investments) x time = wealth
Simple, but not necessarily easy. Once your cash flow is positive, it’s time to do some smart things with your money and let time do its thing.
What are these smart things?
Sensible safeguards: these are your emergency fund, term life insurance, long term care insurance, and disability insurance. You don’t want to toss money away, but you also don’t want to under insure. Keep a reasonable amount (many say a minimum of $1,000, others say six months of salary–personally, I split the difference and say three months of take home pay) in a money market account with check writing and an ATM card (Capital One Direct is the one I use). If you have dependents, get term life insurance; you may also want to consider disability and long term care insurance.
Wise investments: what we’ve been discussing on this blog forever. Passively managed, no load, low cost, tax efficient index funds and exchange traded funds. High quality bonds and bond funds. Traditional and Roth IRAs, 401(k)s, and their equivalents. Reasonable asset allocations. Investments made at regular intervals. Diversification, diversification, diversification.
Time: you know what this is, and the more you have the better.
Wealth: the dollars you end up with at the very end.
The one other thing that you need will be discipline. We’ll cover that later, but in the meantime, remember that formula. It’s a simple, get-rich-slowly, tried and true over time formula that will help you reach your goals–it’s helped me build a six figure portfolio in less than half a decade!
Well put, especially your description of wise investments.
Great post; especially like the formula: (cash flow + sensible safeguards + wise investments) x time = wealth
You mentioned discipline and time is included in the post, however I’d say patience and the stomach to go through some ups and downs (based on your risk profile) are certainly important. Many investors stumble with these two and preparing yourself for the fluctuations and the wait helps tremendously.