Building wealth takes time and knowledge. There is no get rich quick method. There are a few ways to begin building wealth.
Passive Income vs. Active Income
Active Income is based on your own personal efforts to make money by exchanging hours for dollars. It is the income that comes in when you are actively earning it, but ceases to exist when you stop your earning activity.
The Rat Race
I first read about the rat race in Robert Kiyosaki’s book Rich Dad, Poor Dad. In it he describes the cycle of working for money that leads to nowhere, kind of like a rat running on his spin wheel inside his cage. Working for money and exchanging hours for dollars is the hardest way to make it out of the rat race, and often it’s near impossible. This is because once you are in the rat race you spin your wheels to try to maintain or advance your lifestyle and you often create more debt to do so.
Those in the rat race may not know how to get out because they do not know how to use assets and they keep creating liabilities. If you have not read the book Rich Dad, Poor Dad by Robert Kiyosaki, I recommend it as a must read just to get your perception of assets and liabilities correct.
How to Get Started
Most people are not ready to stop working for money. In the meantime, you can begin building cash for your portfolio. In the book The Richest Man in Babylon by George S. Clason, one of the characters, Bansir, seeks help from Arkad, who is the richest man in Babylon. Arkad advises the man to pay himself first. Each time he makes income, he should set aside 10% of that income. That way, when an opportunity to invest comes his way, he will be ready. Bansir follows Arkad’s advice and was able to invest in a business venture that provided him with passive income. It is very difficult, if not impossible, to grow a profitable portfolio without income. Setting aside 10% of every dollar you earn will allow you to grow your investments consistently.
Passive Income is income that not based solely on your ongoing efforts. It may be a recurring income stream from a one time job, like royalties for a singer, or recurring income from a business that you own. When you can stop trading hours for dollars and receive dollars even without giving up hours, you will have passive income.
Dividends can help you to make passive income. Some companies issue their stock with a dividend attached. If you own the stock, they will pay you directly in cash, or additional shares, from the earnings that they make for that quarter or year. If you have the right stocks you can also benefit from price appreciation.
The stock price and your overall portfolio will increase when the company does well. And even if the stock price declines, you will still receive the dividend as long as the company does not cancel it. Some investors will not purchase a stock if it does not come with a dividend attached.
Bonds are also a way to generate passive income. You can use coupon paying bonds to increase your cash flow. Your initial investment will not grow however, like an initial stock investment might, but it will also not shrink on the downside. Most investors use a combination of passive income sources to diversify their risk.
It is highly risky to depend on the cash flow from a bond or a dividend paying stock only. When you are evaluating a bond for your portfolio, you will want to check the company or project that guarantees the cash flow for the bond. The bond will be rated for its riskiness based on several factors.
There are two main ways to build wealth, by using active income or by using passive income. Those using active income to build wealth will find that there they do not possess enough hours to trade for the wealth that they want. They will continue to spin their wheels in the rat race until they give up in frustration. The smart investors that learn to use passive income to build their wealth will see their net worth grow with less and less work on their part. Building a profitable portfolio with passive income investments is the key to building wealth.