What is the definition of being rich? I guess most people would agree being rich means having a lot of money and other material goods and showing your status in every possible way. My definition of being rich is slightly different. Before we define what being rich and being affluent means, we must first define some other terms (this is my personal definition; for official definitions, check any dictionary):
Asset: something you own which brings you money, even if left unattended for certain period of time. Can be material or immaterial. Must usually be maintained / taken care of over long periods of time, but the cost for doing this (including your time) is much less than income it generates over time. Examples: securities (stock, bonds), business shares, rental property.
Liability: similar to asset (can be same thing under different circumstances), but the big difference is: it does not bring you any money. Some thing (material or immaterial) you own, which costs you money over time. Can have maintenance costs and / or just loses value over time. Example: your car, boat, etc.
Active income: income directly proportional to your time invested. Only paid under condition you perform your service. Example: your salary, lawyers hourly fee (even expensive ones!), etc.
Passive income: any income not directly connected to your services performed. Income from assets. Examples: dividends from securities, rent from rental property, royalties from book rights, software, music or other intellectual property you own, etc.
You can now probably start to see where I am getting with this. It’s all in the difference between active and passive income, assets and liabilities. Depending on circumstances (basically what you do with it) same things can either be assets or liabilities. Your car, truck or van is a liability (even if you drive it to work), but can be an asset if you use it for your business (in that case you and your accountant already know this). Situation with income is similar: if you get paid for your services, this is active income, even if the sums involved are huge. Even famous athletes and show-business people who are paid tens or even hundreds of millions of dollars per year are only receiving active income – in exchange for their time invested and services performed. Their contracts are clear: they get paid if and only if they perform as agreed.
Passive income on the other hand is getting paid several times for work done once in the past. For example, if you write a book, your publisher can either pay you a fixed amount (regardless of the book’s success) or you get royalties for every copy sold. In the second case, if the book is a success, you can receive passive income from royalties for a long time. You are taking a risk here – trading a secure, fixed active income for unknown possible future passive income. Famous example of taking a risk and choosing a possible passive income over secure fixed active income is George Lucas – for directing his famous movie Star Wars he waived his fee in exchange for licensing rights for the movie. This decision earned him hundreds of millions of dollars over the years and I am sure a number of Hollywood executives were extremely angry and wished they would rather pay off Lucas…
OK, lets sum all this up and define what being rich means:
Being Rich: most of rich persons income (if not all) is passive income – from their business, material or immaterial assets, royalties, real estate, securities, etc. They are always trying to acquire more assets with better return on investment. They buy limited amount of liabilities (compared to assets) – always for cash; they only use credit to buy assets.
Being Affluent: most “rich” people who appear in popular media and are seen as rich by other people are not really rich, they are merely affluent. You are not rich if:
– Most of your income is active income
– Most things you buy are liabilities – even if you think they are assets (your house, etc.)
– You use credit to buy liabilities
Affluent people might earn a lot, but they also spend a lot. Flashy cars, boats, luxurious mansions are not a sign of a rich person – merely an affluent one. Often they live above their means (spend more than they earn) and are getting further and further in debt. But since their fortunes come from active income, they can have a lot of trouble when income is gone (=end of career, etc.). Bankruptcy and even more severe consequences are not uncommon.
Rich people on the other hand always live below their means and put aside part of their income for investments into assets of various kinds. They take calculated risks. They use credit and other leverage to acquire assets.
To sum all this up: being rich starts in your head – you need to have a rich person’s mentality. It’s not about how much you earn, what your dollar value is or how many things you have, it’s about how you manage what you have. Even if you have little, but are acquiring assets which will generate passive income instead of wasting your money on liabilities, you are on the right track. If you persist, you will succeed.