The mindset almost everyone has today is they will be financially stable and healthy if they can work hard enough to be rewarded a nice salary, promotion or raise.  That the more money they make the more they will be okay.  I am not saying that this is not true, because if you make a nice salary and spend your money wisely you can very well be financially stable, healthy and even create great wealth in the process.  However, you can take that very same salary and spend the money much differently and you can end up being financially unstable, unhealthy and get yourself into more bad debt than you can handle.

These two different financial paths are a reality for everyone, everywhere and every day, no matter how much money one makes.  The unfortunate thing is that the financially stable path is often the one less travelled.  And the simple reason why is because we live in a society of consumer spending.  Where driving a nice car, having the latest smartphone or iPad, having the latest flat screen television, or having any other of the latest toys out there, seems to be more important than creating, building and keeping wealth.  Travelling the financially stable path takes hard work and discipline.  The mindset to travel that less taken path is often getting into the habit of not buying that “something” because you need to put the money elsewhere.  And that is at the very least a savings account, or even better, towards assets like paper investments or real estate.

Let us look at two examples of what I am talking about here:

Couple A

Couple A has a net yearly salary of $75,000 when you put both their yearly salaries together.  This $75,000 is after tax dollars, so it is their disposable income (or the money they have to spend) on a yearly basis.  Let us assume they have no children.

Here are their expenses:

• Cell phones (2 cell phones) = $150 per month or $1,800 per year
• Home cable, internet and telephone = $200 per month or $2,400 per year
• Cleaning lady = $140 per month or $1,680 per year
• Car lease payments (2 cars) = $800 per month or $9,600 per year
• Car insurance (2 cars) = $150 per month or $1,800 per year
• Home insurance = $115 per month or $1,380 per year
• Home mortgage ($400,000 single family home) = $1,800 per month or $21,600 per year (note that I have included property taxes to the amount)
• Home maintenance = $225 per month or $2,700 per year
• Home electricity = $250 per month or $3,000 per year
• Credit card and/or cash spending (restaurants, shopping, gas for cars, night’s out, vacations/getaways, etc.) = $3,000 per month or $36,000 per year
• Total monthly expenses add up to about $6,850 or $82,200 per year

Now, let us make a quick calculation of the cashflow Couple A generates.  Their net revenue (or net salary) is $75,000 per year, which turns out to be $6,250 per month.  Their expenses are $82,200 per year, which is $6,850 per month.  When we do a simple subtraction of their expenses from their revenues, we come up with a cashflow of -$7,200 per year or -$600 per month.

So Couple A has a monthly cashflow of -$600 and they have not saved or invested a single dollar.  Therefore what you see is what you get and they keep living on a negative cashflow without any extras, creating and building bad debts.  They probably think that their $400,000 single family home is an investment, but this could not be further from the truth.  You see, the only thing that can be considered an investment when looking at their personal residence is appreciation and capital gains.  And they cannot take advantage of this unless they borrow from the equity in the house, or altogether sell it.

Let us first tackle the option of selling it.  Regardless of how much they sell the house for, they need to answer this question: “Where are they going to live?”.  Okay, so they sold their home for $450,000 a number of years later, but now they have nowhere to live.  That money they just made on the sale will go onto another home.  And their home is not the only one who has appreciated throughout the years, so they will most likely end up buying a home of equal value or even more expensive.  Then factor in the purchase costs and so forth, and they are right back where they began, except now they have a home they purchased for $450,000 with a negative cashflow and no savings or investments.

Now we will take a look at the other option of borrowing the equity from the home.  Every month they paid their mortgage was like putting money in the bank as a portion of the payment went towards repaying the capital.  Then take the appreciation throughout the years and they can borrow a nice amount against their home to do something.  This is a great opportunity to buy something that can create wealth, such as a rental property for example.  Unfortunately they will do what most people do, and that will be to pay down their bad debts (remember, they are living on a cashflow of -$600 per month) or simply go on a vacation.  Paying off their bad debts is a great idea, but living on a negative cashflow is simply living like they are chasing their tail, as they pay off some of their bad debts they add to it every month.  This situation will never stop for as long as they keep living and spending the way they are.

Let us now take a look at a different way of spending the same amount of money.

Couple B

Couple B has the same net yearly salary of $75,000 when you put both their yearly salaries together.  This couple is in the same situation as Couple A, whereas they have no children.

Here are their expenses:

• Cell phones (2 cell phones) = $150 per month or $1,800 per year
• Home cable, internet and telephone = $200 per month or $2,400 per year
• Cleaning lady = $140 per month or $1,680 per year
• Car lease payments (2 cars) = $800 per month or $9,600 per year
• Car insurance (2 cars) = $150 per month or $1,800 per year
• Home insurance = $175 per month or $2,100 per year
• Home mortgage ($600,000 4-unit rental property) = $750 per month or $9,000 per year (note that I have included property taxes to the amount)
• Home maintenance = $200 per month or $2,400 per year
• Home electricity = $350 per month or $4,200 per year
• Credit card and/or cash spending (restaurants, shopping, gas for cars, night’s out, vacations/getaways, etc.) = $3,000 per month or $36,000 per year
• Total monthly expenses add up to about $5,950 or $71,400 per year

Let us see what cashflow Couple B generates.  Their net revenue (or net salary) is $75,000 per year, which turns out to be $6,250 per month (exactly the same as Couple A).  Their expenses are $71,400 per year, which is $5,950 per month.  When we do a simple subtraction of their expenses from their revenues, we come up with a cashflow of +$3,600 per year or +$300 per month.

So Couple B has a monthly cashflow of +$300 and though it seems as though they have not saved or invested a single dollar, they opted to purchase a 4-unit rental property and live in it instead of buying a single family home like Couple A did.  This means that Couple B has three tenants helping them pay their mortgage.  You see, the entire mortgage on the 4-unit property is about $2,000 per month, but the rent from the apartments is about $2,000 per month.  With the payment of the property taxes Couple B generates about -$750 cashflow per month on the rental property, which is their share of what they need to pay on a monthly basis to keep the rental property in operation. This means they are paying off a $600,000 mortgage with a $750 per month payment.  And the capital they are repaying on a yearly basis is about $13,200 or $1,100 per month.  Remember, this is like putting $1,100 per month in the bank!

While Couple B has a cashflow of +$300 per month or $3,600 per year, they are also creating wealth at a rate of $1,100 per month or $13,200 per year in the form of equity.  The same vacation that Couple A went on using their home equity (or line of credit), Couple B will simply use the cash they generated throughout the year from being efficient with the money they spend.  And the $13,200 per year Couple B accumulates in equity will grow to $66,000 in five years, not including appreciation.  Using this $66,000 equity they would be able to look for another rental property of about $264,000 (if we use the $66,000 as the 25% needed for a down payment of the purchase price).  And within five years Couple B has no bad debt (remember they have a positive cashflow) and they have $864,000 of rental properties in which their tenants are paying the mortgages for them.

If you notice, the only thing I changed from the expenses of Couple A and Couple B is that Couple B has a 4-unit rental property, so their home insurance, maintenance, electricity and mortgage reflects those changes.  Everything else on both expense lists are exactly the same.  So imagine the possibilities if Couple B refines the other items on their expense list!

The above examples are simplified, but they give you an idea of how to look at things from another perspective, from another mindset.  Remember, it is not how much you make, it is how you spend it.  And the above two couples show you how the same salary can be spent two different ways, and yet the results are completely different.  We can clearly see that Couple B is creating wealth while Couple A is living paycheck to paycheck.  If Couple B keeps it up and continues creating wealth, their cashflow from their rental properties will rise, and eventually this cashflow will be enough to live on, giving them the opportunity to choose whether to work or not, as they would be financially free to do what they choose.

Again, I am simplifying all this, but the basic idea is there.  The mindset you need to have to begin creating wealth is there.  And the fact that someone makes a big salary has nothing to do with how wealthy they are.  The biggest factor in all this is how you spend your money.

Remember, do not work to live.  Work to accumulate assets that will make you live.

The Freedom Spinner