wealth building

To live frugally below your means is the way to build wealth.

You hear about frugal living all the time, but do you know what does it mean? More importantly, do you know if you are living below or above your means?

To live below your means is to live a lifestyle you can finance with money left over. It’s all about cutting your expenses so you have money left for savings. It means to live with contentment and buy only what you need. It gives you the ability to build wealth while living a reasonably comfortable lifestyle.

However, it is easier said than done to live below your means in this credit-based, possessions-flaunting society. We see temptations everyday and everywhere, and as a result many adults spend not only what they have now, but also what they hope to get in the future. This is why there are so many adults and families with credit crisis.

They are certainly not living below their means. Now, let’s see if you are living below your means using the simple formula below.

How to Determine If You Are Living Above or Below Your Means

 

No matter what your age and income is, there’s a simple way to find out if you are living below your means – by calculating your expected net worth. This method was developed by the author of The Millionaire Next Door, Thomas J. Stanley.

It was developed from years of surveying various high-income and high net worth individuals, and it was originally used to determine if someone is wealthy given his age and income.

Multiply your age with your pretax annual household income from all sources except inheritances. Divide by ten. This, less any inherited wealth, is what your net worth should be.

The Millionaire Next Door, Thomas J. Stanley

For example, if Mr. Anthony is 40 years old, makes $100,000 per year, and has investments that provide another $15,000 realized income, he would have a total annual realized income of $115,000. His calculation will look like this:

$115,000 x 40 / 10 = $460,000
Mr. Anthony has an expected wealth of $460,000.

On the other hand, if Mrs. Bruce is 61 years old and has a total annual realized income of $235,000, her net worth should be $1,433,500.

Given your age and income, how does your net worth match up? Do note that if you are a young adult in the 20s, having a lower net worth than expected is not alarming. You are still in your wealth accumulation phase and should expect to reach your expected net worth in 10 years time after you have started working.

As you work towards your 30s, you should have at least accumulated your expected net worth.

The PAWs, AAWs and the UAWs

 

Where do you stand along the wealth continuum? Let’s examine each of the categories and see where you are:

  • PAWs, or Prodigious Accumulators of Wealth
    Individuals in this category worth twice the amount of net worth expected. They live well below their means and channel a significant amount of their income to investments and wealth building.
  • AAWs, or Average Accumulators of Wealth
    Individuals in this category are worth around their expected net worth. They generally live below their means and channel some of their income to investments and wealth building.
  • UAWs, or Under Accumulators of Wealth
    Individuals in this category worth less than half their expected net worth. They live above their means and channel a very small portion, if any of their income towards wealth building. In some cases, they may even have huge debts and have a negative net worth.

If you are a PAW, congratulations! You have mastered the art of living below your means and managed to accumulate significant wealth considering your income and age. You are close to achieving financial freedom or you are already financially independent.

PAWs are builders of wealth – they are best at building net worth compared to others in their age/income category.

If you are an UAW, you need to examine your spending habits and think about several important questions. Are you living above your means? Is your income not sufficient to finance your lifestyle? Are you in debts? What are the changes you can make to improve the situation? How can you eventually retire?

Then again, if you have just entered the work force for a few years, being an UAW is not alarming. You need time to build up wealth and reach your expected net worth. Just make sure you have money left over each month and channel them into investments and wealth building.

If your main problem is not having sufficient income instead of overspending, you may want to consider starting a side business using your free time.

What It Takes to Live Below Your Means

 

Conditioning your mind is the first step to start living frugally and prevent unnecessary purchases. If you find yourself having issues with impulse purchases and overspending, ask yourself these questions before you make purchasing decisions each time:

  • Do I really need this?
  • Do I already have something that will do just as well?
  • Am I sure this purchase will provide good value? Is there any better alternative?
  • Do I have the cash to pay for it?
  • Am I willing to sit on my decision for at least 1 day before purchasing?

Ultimately, living below your means is a way to build wealth, reduce stress level, create more options in life, and have a peace of mind when it comes to finances.

The secret to frugal living:

Buy what you need, want what you have.