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How to build wealth

I’ve been thinking about what wealth creation is about at its core. What are we actually trying to do when creating wealth? Simply put, it is about collecting assets.

But before we start with assets, we need to touch on liabilities. Liabilities are debts and debt is simple: credit cards, home loans, store cards, vehicle finance and the like; anything that costs us money is a liability. Some we need (home loans); others we use to meet our wants (a fancy car).

Debt is usually incurred to fund lifestyle expenses and while that works today, it cramps our future lifestyle as we end up paying a lot more for whatever it is we purchased via the interest we pay.

Furthermore, the interest payments reduce our ability to save and invest. Now, assets are the other side of the equation; they are things we own that pay us money. But not all assets are actually good assets. A car is a wasting (depreciating) asset as its value is constantly decreasing and it doesn’t bring us money at all (it actually costs a lot to run). Ideally, we should therefore get a cheap car so it does not depreciate as much and running costs are lower.

What we want is an asset that actually pays us, in other words works for us without us having to do anything. This is where shares on the stock market come in.

Large companies are bought and sold on the stock market and we can buy a small slice of these companies. These quality assets make profits, some of which will then be shared with us by the owners of the company via our shares.

These profits come in the form of dividends paid twice a year (in most cases) to the shareholders. You see we own a slice of the company (asset) and as such we own an equally-sized slice of all future profits.

These shares make us money by paying dividends (the sharing of the profits), but also because the value of the company goes up. This happens when the company is doing well and more people want to own some of the company via its listed shares. If more people want to own some of the company’s shares, we have higher demand for the same number of available shares and this higher demand pushes the price of the shares higher. So we could sell them for a profit, but as a rule I like to keep them as an asset on my balance sheet and take home my slice of the profits.

Those profits or dividends will start small, maybe 2% to 5% of the initial price you paid, but as profits increase and the company grows, so will your slice of the profits. Soon you’ll be receiving handsome dividends from your assets.

The problem is that far too often we focus more on the liability side of our balance sheet. We buy things that are depreciating assets, or worse, we buy things that are simply not assets. Worse still, we fund them with debt.

So the place to start right now is to review what you own and what debts you have. Make a decision to focus on spending as little as possible on depreciating assets and liabilities and using as little debt as possible. When we start doing this, we’ll find more money left over every month and we can use that money to start buying assets in the form of shares on the JSE.

This article originally appeared in the 8 October 2015 edition of Finweek. Buy and download the magazine here.

 

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