How To Make Your First Million
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The stepping stones to making your first million are actually the foundation blocks for achieving financial freedom — something most of us are striving for. While it requires a tremendous amount of luck to become very wealthy, anyone can achieve financial freedom.
The secret is not how much you earn or how much you have but rather how much you spend. If you can control your spending and live a sustainable life, you can achieve financial freedom relatively quickly.
Three steps to financial freedom
I believe there are three steps to financial freedom, these steps need to be followed in a specific order to be sure of reaching your goal. I will explain each step in more detail, however it is worth noting that very few people manage to achieve the first two steps by retirement age. Living with too much debt is the primary reason that most people fall behind the few who get it right.
Your steps to financial freedom:
- Be debt-free
- Have an emergency fund
- Ensure your income from assets covers your expenses.
1. Be debt-free
Most of us will need to borrow money early in our careers. Usually we need debt to buy our first vehicle and home, some people might also need to borrow to start a business. Debt can be a wonderful tool for wealth creation if it’s used to buy assets that will appreciate in value at a good growth rate.
This can be called good debt and should be used wisely. However you also get bad debt, which is usually incurred on your credit card, overdraft or via a personal loan and is used to buy items that have limited resale value. Many people use debt to buy clothes, shoes, furniture, holidays and entertainment.
This is pure wealth destruction as this debt is enormously expensive and you are only deriving a short-term emotional benefit from these purchases. If you cannot buy these goods with cash, you simply should not buy them at all.
2. Have an emergency fund
Once you have eliminated all your bad debt and have a limited amount of good debt, you should start building up your emergency fund. This is money that is available at short notice to cover unforeseen expenses. If you don’t have an emergency fund, how will you pay for damaged car tyres or pay an insurance excess when your geyser bursts at home?
In most instances, you will need to use your credit card or some other form of debt. This only sets you back again as you now need to pay off debt before you can get ahead. I think an emergency fund should be three to six months’ of your expenses. If you spend R20 000 per month then your emergency fund should be worth R60 000 to R120 000. This money can be stored in your access bond, a money market account or savings account.
3. Have investments that can generate enough income to cover expenses
You should only start building up your investments once you have finished the first two steps. Unfortunately there are no investments that are guaranteed to grow faster than the interest charged on a credit card or overdraft. This means there is no point building up your savings and investments when you owe money on your credit card. You should aim to build up an investment portfolio that is 20 times the amount of your annual expenses.
If we assume that you spend R20 000 every month, this is equal to R240 000 per year. If you want to be financially free, you will need at least R4,8 million of investments. I would also suggest that you have extra capital to cover additional, unplanned expenses, so you should aim for R5,5 million. This money should be invested in a range of investments that include cash, bonds, property and shares.
With modern investments you can buy all of these different types of assets in one portfolio. This could be in the form of a balanced unit trust or share portfolio with exchange traded funds (ETFs). The best way to build your investment portfolio is by developing a savings habit where you spend less than you earn every month so that you can save the difference. Ideally you should save at least 15% of what you earn every month. For those who are really serious about achieving financial freedom even earlier, aim for 33% of your earnings.
Many entrepreneurs will struggle with this as they (correctly) argue that their capital is best invested within their businesses. I agree with this view in the early stages of a business’ life. However, once the business starts to stabilise and generate sustainable profits, the business owners would do well to draw a portion of the profits and invest them outside of the business.
This is a form of risk management where you can create an asset that is unrelated to your business. The ideal combination would be a great business investment that continues to generate real wealth while you have an investment portfolio that provides income certainty. This allows you to continue managing your business with relative freedom while ensuring that you and your family have relative financial security.
What you spend determines your future
It is pointless allowing your lifestyle costs to escalate at the same rate as your income escalates. If you do not control your personal expenses so that your income increasingly exceeds your costs, you are not creating the savings momentum required to build up your investment capital.
This is a problem faced by many high income earners who spend large amounts on vehicles, leisure properties and other lifestyle assets. I believe that you should have a balance in life, you should derive enjoyment from your efforts but it should be balanced with the need to build your asset base so that you can maintain a lifestyle in the years ahead.
Spend time on investments with your spouse
Financial stress is one of the biggest causes of divorce. It is noteworthy that many people who have achieved financial freedom at an early age are married and work in partnership with their spouse when it comes to financial decisions.
I think it is nearly impossible to create wealth if you and your spouse are not on the same page with regard to spending and saving. It’s the same as two horses trying to pull a heavy load but one horse is moving in the opposite direction to the other. The end result is that a lot of effort is expended but no progress made.
Don’t be afraid to get your hands dirty
We all know the stories of the tech billionaires who spent a few months working in their parents’ garage and managed to create sufficient wealth to feed a small country for decades. These are great and inspiring stories but they represent a very small percentage of the people who have tried to achieve the same result with no success.
People who embrace more unfashionable businesses offering services that people need on a daily basis are more likely to achieve sustainable financial success. For example, everyone needs a plumber, electrician, painter and handyman from time to time.
I realise there are very few parents who will brag to their friends that their school-age son is planning on becoming a plumber but there are many plumbers who have achieved financial independence comparatively early. Their contemporaries who became doctors and lawyers might have had more aspirational careers but many of them are still forced to sell time every day to cover their lifestyle costs without being able to build their savings. As many business owners will tell you, it may not be glamorous owning your business, but it can be enormously rewarding when you start to build an asset of value that can be sold.
This is especially valuable if the business can sustain itself without the daily input of the owner or founder. Personally, I would be advising young people to start focusing on careers that will enable them to build the skills to own their own businesses one day.