While there is plenty of confounding variables that go into becoming wealthy, there are a few common threads that bind nearly everyone who is financially successful.
It’s quite rare that someone manages to simply stumble into wealth. Even among those who do, they often wind up losing mass amounts of it through mindless spending.
The reality is, understanding wealth is a huge part of amassing and keeping it. You have to know what you’re doing, plan for the future, and make smart decisions that make your money work for you.
We can see this with inflation. Background inflation rates typically fall between 1 and 2 per cent annually. This means even if you’re currently sitting on a fortune, that money is slowly losing its value.
To keep wealth, you have to continue to grow your wealth. You have to know how to balance your spending, your saving, and your investing.
A critical but often overlooked component of this is understanding the difference between an expense and an investment.
What is an Expense?
When people think of money flowing out of their bank account, they typically think of it as an expense. While that is often true, expenses are a bit more nuanced than that.
Technically speaking, an expense is money that you spend on a simple exchange that doesn’t provide financial returns.
Most people spend the majority of their money on expenses. They buy clothes, cars, groceries, all manner of things that they use for personal reasons.
There’s nothing wrong with this. At the end of the day, most people want to become wealthy so they can enjoy life. Most things that you purchase for pure enjoyment are expenses. Vacations or furniture for your den don’t help you make more money, but they can help you feel happier if those things matter to you.
But expenses need to be differentiated from other kinds of monetary transactions if you want to set a budget and gain financial freedom. This is true regardless of your current levels of income or wealth. As said stated earlier, one of the keys to maintaining wealth is to continue to grow it.
That’s where investments come in.
What is an Investment?
Like expenses, investments are a type of transaction where money leaves your hands. That said, they differ from expenses in that the money doesn’t simply disappear after the transaction.
Rather, investments aim to provide you with a financial return. You pay upfront in the hopes that whatever you’ve purchased will make you more money later.
There are several obvious instances of investing. Stocks, bonds, and the costs of small business formation are all clear examples. Nobody buys stocks for the pure joy of owning a stock. They do it because they hope that ownership will translate to more money than the initial cost of the stock.
There are less obvious examples of investments though. Purchasing an old car or an extremely rare piece of art can also be an investment. These items can grow in value as time passes, allowing you to sell them at a higher price than you purchased them initially.
That’s why it’s important to truly understand the differences between investments and expenses. They aren’t defined by the amount of pleasure they bring. They’re defined by their ability to provide economic returns.
How Should You Handle Expenses and Investments
Balancing expenses and investments is a vital part of maintaining financial well-being.
Too many people simply set budgets that only account for income and money spent, without making the distinction between investing and raw expenses.
But that strategy leaves you, at best, lucky, and at worst, backsliding.
Instead, you should set a budget that accounts for your expenses and your investments separately. For instance, committing to investing 25% of your income and spending 50% on expenses will ensure you have the freedom to enjoy your life while still setting yourself up for financial growth.
These numbers are arbitrary. The amount you have available to invest will vary wildly depending on your lifestyle and income.
The point remains though. Accounting for your expenses and your investments separately will tee you up for acquiring and maintaining economic stability now and into the future.
Conclusion
Financial competence doesn’t have to be excessively complicated. Gaining a simple understanding of money can help you build and maintain wealth without getting lost in the weeds.
Differentiating between expenses and investments is one of the best ways to increase your financial literacy.
Setting a financial plan that accounts for both investments and expenses will ensure your money works for you, helping you enjoy your life and gain financial freedom.