Thomas J. Stanley’s famous book, The Millionaire Mind, was first published in 2000. Although I read it for the first time 10 years ago, the message was still resoundingly relevant when I wrote my book, The First Dancer earlier this year. Stanley’s book does not pander to people’s desires to hit the jackpot. It does not blabber about the trivia of financial technicalities and meaningless jargon; it presents vivid sketches of first generation millionaires and exemplifies key differences between the “Income Sheet Affluent” and the “Balance Sheet Affluent” millionaires—differences in terms of their mindsets as well as their lifestyles.
Before we talk about creating financial wealth, it is extremely critical to fully understand two things. First, it is never impossible to get out of any financial challenges you might be in. Do not think that financial difficulties are ordained upon you, or that you are not meant to be rich. If people with much less intelligence than you can amass stupendous amounts of wealth, so can you.
Second, it is not a particular financial strategy that would help you achieve wealth; but a mindset—a lifestyle. While strategies are time-bound and change with respect to circumstances, the mindset is an enduring characteristic of a person. It determines your attitude towards money thus giving it a high degree of permanence. If your attitude towards money and the resulting behaviour emanate from the millionaire mind, they would set you on the trajectory to become financially independent.
WHAT WE NEED IS A SHIFT IN MINDSET
Economic freedom comes at a cost. When you find yourself stuck in the rut, doing more of the same thing that got you stuck in that place will not get you out of it. The cost of economic freedom is a paradigm shift in your mindset. You have to question the assumptions that determine your market value, the norms that define the distribution of wealth, and the models that establish economic hierarchies. You have to be willing to question everything you have known to be true your entire life. Your employer will tell you that the monetary value of your skills, your education and your experience is a certain dollar amount. They will determine your worth by a yardstick of their own making. They will tell you the acceptable salary range for the position you applied for. And that sounds fair.
That sounds fair until you realize that your skills, education and experience are not the only determinants of your potential. Your human potential goes way beyond what your transcripts tell you, or the number of years that quantify your experience. How do you know your potential can be measured by a certain dollar amount? Who said your earning potential is $50,000 or $100,000? Why can’t it be $1,000,000 or $10,000,000?
Until you take back the right to determine your own financial worth, you will not be able to achieve economic freedom. Your income potential should not be limited by the ‘average salary range’ for your position. It should not be limited by anything other than your imagination. You are not average; why should your income be? But as long as your capacity to earn money is measured by the number of hours you spend working, your income potential will remain limited. A shift in mindset is necessary to break the limits. Achieving this independence is not possible without challenging the norms of the economic system in your mind; it is also not possible without converting your millionaire mindset into actionable steps that would form your financial habits over the long run.
WHAT IS FINANCIAL INDEPENDENCE?
I asked this question at a workshop, and invariably everyone in the audience said financial independence is having enough money to fulfill all your desires. Unfortunately, that answer is the product of the mindset we have unknowingly developed through our exposure to the popular media over the last many decades.
Financial independence is not about having lots of money. It is about not being dependent on others for your needs; whether it’s your employer, your parents or your lender. A person with a monthly household expenditure of $25,000 with enough means to cover it month after month is not necessarily independent if he depends excessively on credit or on his active employment to generate enough cash. He might even be in a negative cash flow situation and need to work extra hours to generate the extra income he needs to sustain his household expenses and lifestyle. Financial independence is about having your money work for you; not you having to work for the money.
A good example of a financially independent person would be Santonio, the owner of the small corner shop a block away from my office. Over the past months, I got to know a lot about Santonio’s mindset about money and his personal lifestyle. He does not earn enough to sustain a monthly household expenditure of $25,000 but then he doesn’t ‘need’ that kind of money to maintain a good lifestyle. In his mid fifties now, Santonio has no credit (except supplier’s credit limit); he has his mortgage fully paid off and drives a 6-year old Toyota Corolla that he bought on cash. He saves over 40% of his income and invests in rental real estate. The rent he generates from the properties he owns goes into another bank account, from where it is partly invested in medium-risk liquid securities. He has enough savings to not only pay for his daughter’s university education but also his grandchildren’s. He takes vacation every year and lives in a good neighbourhood. Santonio is financially independent, and he’s not only happy but content too. I’m sure he is not bemused at the end of every month looking at his credit card bills, worrying how to settle them only to get on with another consumption frenzy next month. His contentment and equanimity are not only palpable, they are contagious. To me, Santonio exemplifies the mindset of the financially independent.
USING YOUR INCOME STATEMENT TO BUILD YOUR BALANCE SHEET
You use your balance sheet to achieve financial independence, not your income statement. The primary purpose of your income statement is to build a strong balance sheet. Any income that is in excess of your monthly expenditure goes into your balance sheet. Just like anything in life, building a balance sheet takes patience. You have to live well below your means. Every time you feel the urge to spend, ask yourself the following three questions:
- Do I really want it?
- Do I need it?
- Do I need it right now?
If the answer to any of these questions is ‘no’ make no effort to justify the purchase in your head. Every cent saved is a cent earned in your income statement and will go into your balance sheet as retained cash. Someone I have known for many years has an interesting way of making sure she is working towards building her balance sheet. At the start of every year, she creates a balance sheet for the next 12 months. She writes down the assets and the liabilities she would have by the end of the year, starting with what she owns and owes today. This gives her a goal to work on. The idea is simply to increase your income generating assets and reduce your income depleting liabilities every year so that you are able to reduce dependence on your monthly income. Come next year, you repeat the same process.
UNDERSTANDING TYPES OF INCOME
We depend on money for basic sustenance. We all assume that to earn money we have to work. While that is partly correct, working for money is not the only way to earn money. That is just one kind of income—earned income. Let’s take a step back. What is it that you really do when you work to earn a salary? What are you exactly doing when you wake up every morning, put nice clothes on, drive to work, juggle multiple priorities and work your ass off to meet impossible deadlines? What you are really doing is using your human capital to produce income.
You are using your intelligence, your health, your education and training, your creativity, your experience and your skills to produce income for an organization. You take a part of that income away each month as your salary. Most of us believe that this is the only way to earn money—using our human capital to generate income. Since actively using human capital is our only perceived source of income, we assume that all our expenses will come out of this income. That is the single most glaring financial mistake we all commit. Using our human capital is just one way to earn money; it is not the only way. In terms of classical economics, there are three primary factors of production—land, labour and capital. Using your human capital is just one of the three factors—the labour. So what are the other ways to earn money? The other two ways are to use your land and capital to generate income; these incomes are called passive and portfolio incomes respectively.
- Earned Income – using labour
- Passive Income – using land
- Portfolio Income – using capital
In order to achieve financial independence, you have to diversify your sources of income. You have to de-risk your total income from each individual factor that generates it. For example, your earned income depends on what you do, which in turn is a factor of who you are—how intelligent you are, how healthy you are, how skillful you are, how educated you are etc. De-risking your total income would mean depending less on what you are to earn your total income. That would mean, spreading the risk across other two income sources—the ones that depend on what you have. If you have a real estate that generates you an income through rent for example, you will continue generating income whether or not you retain your health. Your income will no longer depend on who you are or how much you work. This is called passive income.
In the same way, when you put your money to work and generate more money, you are generating portfolio income. Your capital is the factor of production creating income for you. Examples of portfolio income would be your dividend income or your interest income on your fixed savings.
The idea is to reduce dependence on earned income as time goes by, so that your land and your money work to create income for you while you do not have to use your health, intelligence, skills, education and experience to generate money. Instead, you put these precious resources to better use. You do things that really matter, like spending time with your family, traveling around the world, writing a book or building a charity. Once the bulk of your total income starts coming from passive and portfolio sources, you can spend your time doing things that you really love to do and get your earned income from that work. No wonder a public speaker going around the world delivering lectures does not have to worry about the next project deadline or the next monthly closing. He has the time needed to do what he has passion for. He does not live to earn money; he maximizes his human capital to do things that matter more.
I see people focused so much on maximizing earned income that the thought of doing what it takes to create the other two types of income doesn’t even cross their minds. If they are not satisfied with their current salary, all they can think of is working harder for the next promotion, switching jobs, upgrading their skill set through training or getting a diploma or certification. That is so because while they might be aware of the other two sources of income, they consider them out of reach. They think that earning passive income and portfolio income is something for the rich guys, not for the ordinary folks like them. That is nothing but a fallacy. What they are forgetting is that there is one other resource they have which they aren’t converting to money at present. Once they start using that resource to expand their earned income, they would have the capital needed to invest in passive and portfolio income sources. That resource is called time. In my book, I talk about ways to convert you time into excess earned income (savings) so that you can then use your savings to diversify into the sources of passive and portfolio income (investments).
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