How Can Personal Finance Best Be Managed To Build Generational Wealth

Everyone can make money, but most will not keep it and never grow it due to their lack of control over their personal finance.

Managing one's personal finance boils down to being in control of how the money is flowing (the cashflow) and how the money is being put to work hard to grow one's wealth (the net worth).

The process is basic, but since it's never taught at schools, most of us think of personal finance as an overwhelming chore that we can never master, and hence we lose control of cash flow and never save enough to invest to grow our wealth.

"Beware of the little expenses. A small leak will sink a great ship." - Benjamin Franklin.

This article breaks down managing personal finance into:

• Managing cashflow; and
• Growing net worth.

The basics of personal finance should be taught early to kids who already have basic knowledge of mathematics. Teaching them how to save money at an early age makes it a habit when they become young professionals with their own income. This is the foundational step before learning how to grow their net worth.

Related: Understanding The Current State Of Your Finances

Managing Cashflow

Before we go any further with this article, please pause for a while and ask yourself those two questions:

• “How much money do you keep?”
• “When the end of the month approaches, do you end up with more month at the end of your money or more money at the end of the month?”

People too often are focused on how much money they make. As a consequence, they start to spend more to pay for more lavish lifestyles, and they lose control of how much money they keep.

In managing your monthly cashflow, you need to know where is your money going by examining both the sources of your money and how you are spending this money.

Most of us kick off our professional lives with a job and then we get stuck to the life-programming of expecting only an "earned income" from a job. What you are missing in this case, is "unearned income" potential, which passive income that comes to your bank account without the need to work for it. How to create multiple streams of income is a rather lengthy topic for an article, but this free ebook - The 4 Stages of Building Wealth - will unravel this topic to its nitty-gritty details.

Related: Free eBook - The 4 Stages of Building Wealth

Let's now jump to our spending patterns!

Expenses may be classified as either essential or discretionary spending. Households incur two types of expenses. Some expenses are either enforced by law (such as income taxes and health insurance) or are essential to keeping the household running (such as personal housing, food and clothing, and transportation costs). These expenses are essential, as the income-earner does not have the option of not paying them without incurring consequences. Simply said, such expenses are essential for survival and therefore may be defined as needs.

On the other hand, discretionary expenses are optional expenses that are not necessary to run a household. In other words, the income-earner can pay for these goods or services at his or her own discretion. Discretionary expenses are most often defined as things that are “wants” rather than “needs”.

Being frugal on how you spend your money is a prerequisite for saving money that can be invested in the future on assets that both pay you "unearned income" and build wealth. If you are not able to save any money, the rule of thumb is never to spend more than 10% of your total income on discretionary expenses. When I made this simple, yet wise, action, I was able to transform my life from being poor to become a wealthy person.

We tend to reward ourselves with spending on goods and services that might have a sentimental value but with a depreciating financial value or even zero financial value. Sticking to the rule of thumb, we need to pay first the essential expenses, and then attempt to keep discretionary expenses to a maximum of 10% of total income in the wealth-building process.

In parallel, you will need to focus on increasing your "unearned income". As your total income increases, the absolute value of the 10% allocated to discretionary expenses would increase. Then you could afford to enjoy spending on more goods and services that are non-essential.

Related: Free Course On How To Fill Up A Personal Financial Statement In Under One Hour

The People’s Republic of China is sometimes unofficially referred to as “the frugal republic”. Saving is a habit that’s deeply rooted in Chinese culture. The emperors and the royal families were no different. They often set good examples of frugal living. Emperor Xuanzong from the Tang Dynasty said to his son, Prince Suzong: “Blessings should not be squandered! The good fortune we have in life should be treasured.”

I cannot stress enough that we should cherish what we have and not carelessly waste it. If you manage to live by those virtues, they can guide you to develop good habits. I reiterate that limiting your discretionary expenses to a maximum of 10% and plan to save a minimum of 30% of your total income.

Growing Your Net Worth

Frugality is only half of the story. It is what a person will do with the saved money that will make a big difference in their finances. Even the Bible speaks about saving and investing: “The plans of the diligent lead to profit as surely as haste leads to poverty” - (Proverbs 21:5).

Money saved monthly as a result of a positive net cash flow can either go into non-income-producing assets or income-producing assets. It is the latter that will accelerate the path to wealth.

My wife used to be a wealth manager for one of the national leading banks. What her experience with hundreds of clients taught her, the wealthy keep on accumulating income-producing assets, which generate for them unearned income. The wealthy always ask themselves, What is the return on my invested capital? This is commonly referred to as ROI (return on investment). It is measured in percentage, and it is computed by dividing the unearned income generated from those assets over the capital invested from the investor’s own funds.

Related: Idle, Healthy, Or Wealthy Rates of Returns?

The higher the unearned income and the lower the invested capital, the higher is the return on investment. The wise investor will carefully select an asset based on its ROI before acquiring it.

The next question that comes to mind now is "which asset classes are income-producing assets?"

Type of Assets

Different individuals define assets differently. Many believe their cars, boats, or even home furniture qualify as assets, given that they may convert into cash whenever needed. Although those may be valuable items, they usually depreciate in value over time. Jewelry is another debatable subject. Most people classify jewels as assets, but their actual value when they are sold is equal to the amount of precious metal they carry in them, which in most cases is way less than the original price tag that included a major premium related to their design.

On the other hand, financial institutions segregate assets into two major classes, either:

• Income-producing assets, or
• Non-income producing assets.

It is the income-producing assets that count the most in determining an individual’s creditworthiness. They generate cash flow to their owners and generally appreciate in value.

In contrast, non-income-producing assets do not generate any cash flow, but they may still appreciate in value over time.

Related: Which Assets Build Wealth – Stocks, Bonds, or Real Estate?

For you to properly manage your personal finance, you will need to have full visibility on your cashflow (which is depicted in your Personal Income Statement) and your net worth (which is depicted in your Personal Balance Sheet). My free eBook - The 4 Stages of Building Wealth - has free templates to do so and helps you accomplish that in under one hour every month. That's a small time investment for the huge benefit of building wealth.

Related: Free Course On How To Fill Up A Personal Financial Statement In Under One Hour