The health of our personal finances can remain a mystery if we don’t ask the right questions. By default, human beings tend to focus on the present and believe that whatever situation they are in at the moment will last forever. And that isn’t always the case.
You may have a good job and earn a high salary, but tomorrow that income could stop, whether because you are fired or because the company goes bust. You may have a profitable business bringing in large amounts of money, and then, for whatever reason, sales start to fall over time and you are forced to close.
The health of our personal finances
I’ve seen people boast about their large net worth, and over time some of them discovered that their wealth was not liquid and, on top of that, was losing value. Ultimately, the road to financial freedom and personal wealth runs through building assets, and the more liquid our assets are, the healthier our finances will be.
(Read: what liquid and illiquid assets are)
So one of the most important questions for measuring the health of our finances is as basic as asking ourselves:
How much money am I receiving without having to work for it?
In other words, how much passive income are my assets bringing in? How much money do my assets earn me without my having to be there? If I fell ill and had no job, how much money would I keep receiving every quarter, every six months or every year?
You haven’t reached true financial freedom until the amount you receive from this passive income is enough to live on and cover your everyday expenses without having to work.
See also: How to protect your savings if the banks collapse (a “corralito”)
And that amount should grow every year, so we know we’re on the right track.
You may own two houses, but if they are empty, what you really have is fairly illiquid wealth that costs you money every year instead of earning it. If those properties are rented out, on the other hand, the home stops being a liability and becomes an asset.
Likewise, shares, beyond their use for speculation, tend to be one of the best assets when we invest in companies that pay good dividends. Many shares pay dividends every quarter.
For people who are building their personal wealth, the advisable thing is to reinvest those dividends in more shares, so that the dividend payments keep getting bigger, while we can already get an idea of how much money our shares (a very liquid asset) bring in each year.
And of course, our biggest asset will always be our own business, even with the risk that it goes bust: without a doubt, most wealth comes from companies.
We explained the two most common types of diversification for building wealth in a previous article.
So the road to financial freedom should, in a way, focus on building assets, and by assets we generally mean starting your own business, although you don’t necessarily have to be an entrepreneur to reach financial freedom, as long as you keep looking for alternative sources of income and building assets that, over time, generate the passive income you want.
It’s that simple. How much money do you receive from your assets without having to work for it? That is your financial health.
Further reading
- The principle of wealth creation explained in a simple chart
- The pyramid of financial success
- 34 lessons about money
Featured image: Unknown author, Public domain, via Wikimedia Commons.
