How do you feel when seeing a well dressed lady or a groomed gentleman in their Italian or British luxury car? A moment of admiration mixed with a bit of envy? Darn, that person has scored rich, you might think. They probably inherited a huge sum from a rich uncle, work in investment banking, or won the lottery. They could also be fantastic athletes, managers, or work in some other high paying profession. But there is also a possibility that they made the right saving and investment calls.
Warren Buffett started from scratch
Why is it that some people are richer and possess greater financial power than others? Those who are able to save and invest to afford such a luxurious car were likely to be born rich, right? Most of us, however, can only dream of inheriting such great wealth that allows a carefree life. We earn a salary that allows us to put some money aside. So how can we become as well of as the Maserati driver in his nice suit? Why not do it like so many before us: hard work and smart decisions, particularly smart investment decisions. Take Warren Buffett, for instance. He built his empire from scratch.
While Warren Buffett is an extreme example and a one-in-a lifetime phenomenon, many others have fared rather well, reaping their benefits of their hard work and smart decisions. So when I am saying that you can do just as them I am not referring to the richest 1% or any other extreme part of the population. Many of them do indeed have grown their wealth over many generations and those belonging to that group have indeed merely inherited wealth from previous generations. Yet, they are only a fraction of the population. When I say that you can do as them, I am referring to the many out there who just like you and me do most likely not belong to the richest percentile of society. There are still millions of people on this planet who have grown their own fortunes that are substantial enough to allow them a pleasant lifestyle. So why should you not join them on their golden shores of financial independence? It is on you to take action and design your own path to a life of wealth.
The luxury car
Imagine two nice luxury cars waiting at a traffic light. Their drivers: two well situated business men enjoying the leather and high-end interior as they are anticipating the green light. Both earn a comfortable annual salary of $/€/£ 150,000. At first glance, the two appear similar. Yet, there is more that divides them than they have in common.
But while one paid cash for the car, the other is heavily indebted. The first one managed to pay cash for it, because he bought the car only once he was able to put down the $/€/£ 100,000 for his dream car, whilst other has never been willing to cut back on his spending and never bothered to acquire any knowledge about the functioning and mechanisms of finances. While the latter enjoys his car, his monthly installments take a massive $/€/£ 1,500 chunk out of his monthly income, and that is for the car alone without insurance, fuel, or taxes. This does not only limit his ability to accumulate wealth, it also dampens the pleasure of his luxury ride.
While the wealthy, who paid cash, does no longer earn any interest on his $/€/£ 100,000, the other, who is financing his car, has to pay interest for the pleasure of driving his luxury gadget. For the wealthy it is simply a question of having fewer workers on his galleon of wealth, whereas the other never had a gallleon of wealth to start with and is unlikely to ever achieve the dream of having his money work for him and produce more wealth.
There is another significant difference between the two: their mentality. The willingness to go into debt to finance a luxury article that adds little value (for some it adds enormous, lasting pleasure, and thus positively affects their wellbeing, but for others it is a short-lived pleasure and frequently a status symbol). Studies showed that children who were able to delay gratification (wait for a bigger reward later in comparison to having a smaller reward now) were stronger and more successful individuals professionally and even displayed better levels of health. This difference in mentality is what explains the wealthy buying a car once it no longer hurts his finances and the other one seeking gratification immediately and never being rewarded by being financially successful measured in terms of wealth.
Delayed gratification and financial success
Even though the monthly payments might seem like a smaller financial commitment than a massive lump sum, the mathematical truth is that it is the bigger financial commitment. There is only two exceptions to this rule: 1) if you own a company and are able to deduct your monthly car financing rates from your company income to lower your taxes or 2) if you can earn higher returns from your principle (e.g., the $/€/£ 100,000) than you would have to pay in monthly installments.
A brief example: if you were to earn a 5% return on his € $/€/£ 100,000 over the next 3 years, while only paying 3% in interest to finance the luxury dream car, you would be better off financing your car. The reality, however, is that credit interest is usually significantly higher than the interest that may be earned from a stable saving or investment vehicle. A quick internet search will show that the minimum ratio between the two is 1 : 3.5 (e.g., 1 % saving : 3.5 % credit). Hence, for every €/$/£ 1 you have not used for the purchase of your dream car, you are actually losing €/$/£ 2.5.
But most importantly, it is the mentality of being able to postpone satisfying an urge and realizing that by doing so and applying financial sense, the later reward will be twofold: 1) fulfilling your dream while also having 2) greater wealth. With the financial knowledge the luxury car may not only be a dream but a reality in the not too distant future without losing your financial freedom.
The science of personal finance - or learning a new language
Even with a footballer’s salary, the main driver for wealth is the insights and knowledge into your personal finances that will determine the level of wealth you will accumulate and change your life for the better. Maybe some might feel this is the most difficult part, but once you succeed in getting a grip on the science of personal finance, your wealth journey is wide open.
The beauty of it all is that, if a potential investment appears too complex, even after studying it, it is likely not worth investing in. Similar to speaking a language: one can only fully appreciate and respond to what a beautiful woman or man says to you when mastering the language. Finance is no different. But the good thing: finance is a lot simpler to master than learning a beautiful language such as Italian. And like languages, it is nearly impossible to know and understand all areas of finance, just as it is unrealistic to expect to be fluent in five different languages. Stick to the two or three that you are most interested in and learn them inside out.
Money produces money
It’s commonly said that one needs money to make money. And this is where all those millionaires have started. The first step to joining the millions of other millionaires is to accumulate enough financial employees and not spend money on immediate urges such as luxury cars. When there is enough wealth, your financial workers will do the work for you. When you think about it and jot down your expenses on a piece paper, you will always discover areas where cutting back on your spending is possible.
When I talk to friends about our saving rates of around 39%, people are often in disbelief. Particularly those who live in cities and areas that are cheaper than Paris and those who only pay a fraction of the high taxes we are exposed to. France is a country that is rather socialist in nature. Whether one considers this good or bad is up for debate, but with the extremely high taxes, I ensure you that both saving, and particularly investing, become a real tricky business.
But why is it that our savings rate raises the occasional eyebrow when talking to others? For a starter we live in Paris and for anyone who has ever visited or lived in this city, it is darn expensive. According to a recent report by the Economist Intelligence Unit, Paris is the 2nd most expensive city on our beautiful planet. And yet, millions of people survive in this tremendously expensive town. Some might be millionaires, others billionaires, but the majority is not that well off. Still they set aside money each month and save to eventually be able to jump off the ship of financial dependence, for most a salary.
But the high cost of living in a major city applies to people all over the world. Those who live in cities like New York, London, Oslo, San Francisco, or Sidney all have to deal with high expenses. In smaller towns and cities these expenses are significantly lower and allow for even more saving potential. But the fantastic thing is that people are able to live good lives, save, and invest with salaries far from that of a footballer or CEO.
So before getting the newest gadget, think again. If you wait just a bit, put your money to work. Don't be delaying your wealth building, become the the one paying cash for your luxury car knowing that your money is still producing money for any other desire you might have. So if they can do it, so can you.
