Thursday, May 31, 2007

How To Create Wealth

What is your wealth quotient? And, when do you know you have achieved "wealth?"

For the purposes of this article, wealth is defined as an income level derived from passive sources that allows you to live without depending on a job. Passive sources are any income source that throws off a positive cash flow, that you can bank or spend. For example, the cash left over from a rental property after all expenses are paid, is passive income. Likewise, interest from a certificate of deposit, or dividends from stock investments, are examples of passive income. With this definition in mind, the key to creating wealth is to figure out how to create and build passive income sources. To measure my progress in this area, I use a simple formula:

Passive income divided by your total living expenses = wealth quotient

Consider this example: If you had $1,200 per month in passive income from a real estate investment and your cash savings account, and $4,500 in monthly expenses to survive (house payment, household expenses, etc), your wealth quotient equals:

1,200/4,500 = .26

The ideal is to achieve a quotient of 1 or greater. The number .26 represents approximately one quarter of your desired quotient of 1 or greater. Change the numbers and watch what happens:

3,000/4,500 = .66

4,500/4,500 = 1

6,000/4,500 = 1.33

The key to long term financial success is to build passive income, and free yourself from the need to work or "earn" a living. In my opinion, when your wealth quotient reaches 1, you have achieved wealth. The rest is simply a matter of how much margin for safety and extra luxuries you wish to obtain.

Keep in mind that passive and portfolio income is typically earned from fully insured and maintained real estate that provides a positive cash flow, bonds and savings, dividends from Blue Chip stocks, and royalties from books, patents, and music you may own the rights to, and resudual income from a home-based business such as the one at

These rights to intellectual property, combined with the equity in real estate owned and various certificates of deposit, stocks, and bonds compsrises what is known as you capital base. As your capital base grows, you are able to generate greater amounts of passive and portfolio income (PPI). When your PPI exceeds your basic living expenses, you have achieved a level of wealth that enables you to make riskier investments in the pursuit of higher yields and return on investment (ROI).

The key here, which is a lesson I learned from both "The Richest Man in Babylon" and the school of hardknocks, is not to erode your capital base by making risky investments or spending the money that makes up the foundation to your wealth building aspirations. As my rough sketches illustrate, you should use only the proceeds above and beyond your basic living expenses (derived from your capital base) to make wealth building investments and/or purchase the goodies in life. If you violate this rule and consistently dip into your capital, you will need to keep your day job to feed your consumption habits.

I am not in any way advocating a spartan lifestyle—after all, the pursuit of wealth is only worthwhile if you are allowed to enjoy a higher quality of life for yourself and your family. The basic tenet of this report is that you should carefully manage your money to ensure your investment and wealth building goals are heading in the right direction. In the short term this may mean cutting back on the niceties, but the rewards later on will allow you to enjoy the good things in life above and beyond the norm. Robert Allen makes this point perfectly clear in his book, "Nothing Down," where he compares your pursuit of wealth to a rocket ship leaving earth towards space.

In the early stages, just after liftoff, your progress is slow and awkward, but as you gain experience and continue to build your capital base, your rocketship gains speed until it begins to break free of the earth's gravitational pull. Allen's analogy is a great lesson in wealth building and is well worth reading.

Again, this concept is vitally important to your acquisition of wealth. Follow the steps of creating multiple streams of income that ideally throw off positive cashflow to your hip pocket with minimal effort. These streams of income typically should come from interest from savings accounts, dividends from bond and stock investments, royalties from intellectual properties (copyrights, patents, and trademarks), rental income from real estate owned, and residual income from a home-based business. Use this positve cashflow to offset your living expenses, then use the excess (income above and beyond your living expenses) to feed your investment activities.

To learn more about creating wealth, visit my Creating Wealth Today website at

When your wealth quotient exceeds 1, you have achieved a moderate level of wealth. It's up to you how big you want to grow this number—after all, it's your wealth quotient.

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