Radical Personal Finance, Episode 29. On today's show, the iron law of wealth building. I guess I should say the iron formula of wealth building. The only three topics, the only three variables that you can adjust to ensure your long-term wealth. Welcome to the Radical Personal Finance podcast for today, Monday, July 28, 2014.

I am your host, Joshua Sheets. Thrilled to be back with you. Feeling a little bit better, not quite back at 100%, but a little bit better. I couldn't stand to stay away from you any longer. I figured I got to get you a show, got to get you a show.

Today, we're going to have a show on wealth building, my favorite. It really was hard to be away. I really look forward to recording these shows. I enjoy doing it. I just love doing it. Being out and being sick last week to the point where a couple days I could barely even speak and usually I would roll over in bed.

What happened was that I just got run down as far as the amount of time. I was staying up too late, getting up too early. I got a lot of fun, exciting projects that I'm working on. When I should quit and go to bed, I just, "Oh, just a little bit longer, a little bit longer." A couple days in a row of going to bed at 11, getting up at 6, going to bed at 2, getting up at 6, going to bed at 12, getting up at 5, going to bed at 1, getting up at 7.

These don't work for me. You would think that at this point in my life I would be smart enough to say no and to go to bed and force myself to do it. I'm just trying to make progress on some projects that I've got going on. Well, anyway, I didn't do it.

I didn't do what I should have done, which was listen to my wiser self and go to bed. Today we are going to be ... We're back in the saddle. Last week was pretty challenging. There were a few days when I would wake up in the morning and I'd try to say something and I couldn't even make my voice go.

Then I'd go get a cup of tea and after a little bit I could get some sounds to come out. It's certainly sobering when you recognize that none of us are invincible. It's so easy to ... I sold a lot of disability insurance over the years and I'm convinced that I'm not invincible.

But in the past when I was talking about disability insurance I would never understand why people did not recognize that they weren't invincible. Then now I think it's experiences like this that help you to recognize that you're not invincible. You've got to take time, as Stephen Covey would say, to sharpen the saw, to go to bed early and get a full night's sleep and stay healthy and active because you can't help anybody if you're flat on your back in bed.

You've got to be up and active to be able to help anybody. So we're back at it today. Today we are going to be talking about my formula for wealth building, or as I grandiosely put it in the introduction, the iron formula of wealth building. I'm not sure if this is something that I made up or if this is something I stole from somewhere so long ago that I can't remember it.

I really have never heard many people talk about it this way, and I'm sure others have. There's nothing new under the sun. I don't expect to necessarily have an original idea, but I can't attribute it to anyone because I just kind of figured it out for myself. Although again, if I've stolen this from you as an author or something, forgive me.

But I learned this formula by doing financial planning it for myself and for others. And it's very simple, and it's all based upon the two financial statements that we've talked about. If you haven't listened to episode 22 and episode 26, episode 22 was an introduction to the balance sheet, and then episode 26 was an introduction to the cash flow statement, how to create them for yourselves.

I would encourage you stop and go listen to those shows. And before you listen to this show, create those two financial statements for yourself. So go to RadicalPersonalFinance.com/22 or /26 and you'll be able to hear those shows and create your own personal financial statements. And then look at them and think about them as we're walking through today's show.

Because in reality, I'm going to do nothing more than just simply walk through how these interact with each other, but show how this leads to wealth. So when you understand the workings between financial statements, whether that's business financial statements or personal financial statements, then it kind of solves all the things you're trying to solve.

And so here's what I would say, here's how I would prove that my formula for wealth works. First of all, how are we defining wealth? In this sense, we're talking about financial wealth. So financial wealth is going to be something that's going to show up on the balance sheet.

The balance sheet is made up of assets and liabilities. And the financial assets are listed with a financial number. So if you tell someone, I want to be wealthy, what that means is, if you're talking about financial wealth, what that means is we're going to increase the net worth that's listed on the balance sheet.

Now obviously, there are other kinds of wealth. I would consider someone who has-- I'm the youngest of seven kids. I would consider my father to be extremely wealthy, having the love of seven children, even if he didn't have a dollar saved. And I would encourage you to always consider those things, the financial and the non-financial aspects of life and of wealth.

But in today's show, we're going to focus mainly on the financial wealth. So being financially wealthy is defined as having a high net worth. That's it. Now high is a relative term. So we could insert $1,000 net worth, $100,000 net worth, $1 million net worth, or $1 billion net worth.

You can determine the scale that we're going to use. To the person who is just getting started in life-- I remember the first time I had $1,000 saved, that was pretty exciting. I remember the first time I had $10,000 saved, that was pretty exciting. Every stage along life is exciting.

And then to one person, they're first excited when they can save their first million dollars. But how does the money get to be listed on the net worth statement? How does it actually show up at the bottom? Well, it gets there off the cash flow statement. So the net worth statement is a snapshot in time.

And the cash flow statement is listed as over an accounting period. So if you look at your net worth statement, you have a date. So let's say today is July 28, 2014. You can do a snapshot. My net worth as of 3:01 PM as I record this show on July 28, 2014 is x dollars.

Now at 302, that may change if some of my net worth is invested in volatile assets, such as publicly traded stocks that I can go and I can check to see what their valuation is. And maybe at 303 or 315, that may be slightly different than it was when I originally made the balance sheet.

But it's good enough for now. But the cash flow statement is over a period of time. So the cash flow statement is showing over what the accounting wonks would say, an accounting period. Usually this would be either a year or a quarter. Those would be the two most-- and business would be the quarterly.

And for us, maybe we're talking about the annual or the monthly, depending on which one we're looking at. So I don't care which one you use. I usually prefer annual numbers. But the way the money gets onto the balance sheet is it has to show up at the bottom of the cash flow statement as surplus.

So remember, the cash flow statement is inflows minus outflows equals a surplus or a deficit. That's it. So in order for the money to show up on the net worth statement, we've got to create a surplus from the cash flow statement. And if we're going to build wealth from one accounting period to the next, let's say one month to the next, then we've got to make sure that there is a surplus at the bottom of the cash flow statement.

So what this leads you to is understanding that inflows minus outflows equals surplus. Surplus leads to wealth. Then that uncovers really the only three levers that we can adjust, the only three levers that we can press on to affect the ultimate wealth that we wind up with. And those levers are we can adjust the inflows, we can adjust the outflows, and we can adjust what happens with the surplus.

Let me talk about deficits for a moment. This is no different if we're talking about deficits. So let's say that we did run the cash flow statement. We have inflows minus outflows equals a deficit. Well, we can only adjust the inflows or the outflows to reduce the deficit. And that's going to be step one.

If we have a deficit, we have a problem. But we need to look at it and say, is this a temporary deficit or is this a structural deficit? And I'm sorry for using all the big words, but I'm trying to use the accounting words to kind of disconnect and decouple this from this financial conversation from all the normal emotionally charged words that exist around money and people's finances.

Now the idea of we're going to go on a budget makes it a little sound a little bit less difficult to say we're just going to reduce the outflows than it does to say we're going to go on a budget. So I try to use the accounting words or the more precise words sometimes just to drive the point home.

And then if you want to go and use the emotional words, that's fine. But if there's a deficit, we've got a problem. So we look and say, is this a temporary deficit or is this a structural deficit? So example, you are a college student going to college. You're not working for income.

You are studying in your classes and you are borrowing money on student loans to pay for school. Do you have a temporary deficit or do you have a structural deficit? You have a temporary deficit. You're a college student. So we know that that's going to change. We know that something's going to change.

This would be what an entrepreneur would face when an entrepreneur is starting a business and they're beginning their business. They know they're probably going to be operating in a deficit for a period of time. And deficit is not necessarily a problem as long as it's a temporary deficit, whether this is applied to individuals or to nations.

It's not necessarily a problem that a country has a deficit if it's a temporary deficit. The United States of America has had deficits in the past and has deficits currently. But then the problem is only if they're structural deficits. If they're just temporary, hey, for this period of time, our expenses have exceeded our income, then that can be fine.

Again, I'm in the middle of starting some new businesses. My expenses are exceeding my income. This is not necessarily a problem unless that is going to be a long-term thing. But if it's a structural deficit, my expenses are consistently exceeding our income and there's not a clear event on the horizon at which those times are going to change, now we have a problem.

We have a more significant problem. And so if it's a deficit, what do we have to change? Well, we can adjust the inflows or we can adjust the outflows, and probably we're going to do both. So that's probably going to be the most effective plan is to adjust the inflows and adjust the outflows.

What is Dave Ramsey's plan? Work extra jobs, adjust the inflows, cut all your expenses, adjust the outflows. So all we're doing is adjusting inflows and outflows and we have a deficit. So let's set aside the issue of deficits because I'm going to cover that in its own show as far as what to do.

But one more thing on deficits. Even when we cut deficits and even the way that we cut deficits, it's all going to come back to this inflows, outflows, and surplus. A rational approach to looking at deficits should say, well, guess what? I'm going to refinance my debt to get it at a lower rate.

Well, that cuts my outflows because it reduces my interest expense. I'm going to choose to pay off my debt because by paying off my debt, I'm going to get a greater return on my surplus because there has to be surplus to pay off debt. I'm going to get a greater return on my surplus by paying off debt than I would if I invested it elsewhere.

We'll talk through that as far as the financial and non-financial considerations of that. But ultimately, it all just comes down to inflows and outflows. Let's assume that there's a surplus now. And let's ignore debts and deficits and all that stuff for another day. The three levers that we have to push are inflows, outflows, and the investment of surplus.

Now I'm going to add another kind of sub-lever. We can adjust the size and the characteristics of our inflows. We can adjust the size and the characteristics of our outflows. Or we can adjust the size measured in rate of return and the characteristics of our investments. And into those three kind of adjustments, I can fit every single financial planning article, book, essay, anything that, you know, suggestion, advice, anything that people have to say.

Because a lot of it is just differentiation. If you understand that wealth is only going to come by intelligent investment and growth of surplus, then you see through the smoke and mirrors of one person saying, "Cut expenses, cut expenses, cut expenses. Inflows don't matter." And the other person saying, "It's stupid for you to worry about cutting expenses.

Make sure you just focus on your inflows and earn more money." No, mathematically, they both matter. And the person who's just saying, "Cut expenses," would do better if they had focused on cutting expenses and increasing inflows. And the person who says, "Expenses don't matter," no, mathematically, they do. But you would do better if you increased your inflows and you decreased your outflows, decreased your expenses.

So I'm not mad about all this stuff. I just laugh when I see people make these statements. Now, what they're usually focusing on is the, what they're usually focusing on is going to be the behavioral characteristics. So for example, maybe somebody is much more motivated to say, "It's important to me that I drink my Starbucks coffee every day.

And in exchange for that, I'm going to go ahead and work more at another job." But work more at another job, that may be fine for some person. But for another person to say, "I don't want to work more at another job, and I'll just cut my Starbucks coffee." Neither of them is wrong.

They're both right. The only three things that we can adjust, the size and characteristics of inflows, the size and characteristics of outflows, and the size or rate of return and characteristics of the investment of the surplus. So everything falls into that. So when I think about financial planning, or someone asks a question, I immediately think, "Where am I on this formula?

Inflows, outflows, or surplus? What am I dealing with? Inflows, outflows, or surplus? Inflows, outflows, or surplus?" And this just helps me to kind of isolate what we're focusing on. You can't do it all at one time, I don't think. You can't really do it all at one time. But you can focus on these things concurrently.

You can do one, and then you can switch your attention to the other. The human brain can do a lot of planning in these concurrently, even if we can't necessarily do them both at the same time. I want to introduce two other concepts. Or not introduce, but then bring in two other concepts that we can then apply to this formula and then walk through a number of examples of how we can use this.

Now that we've created the personal financial statements, how we can use this way of thinking about this formula to help us to guide our own financial plan. So if I were doing this for a client, I could use this formula with a client. Or this is one where doing it for yourself is really powerful.

So the other two things are compounding and leverage. So the first thing is compounding. Everyone knows about, or I hope you know about the importance of compounding. I shouldn't assume. I should do a show on compounding and just to show why it's so valuable. But compounding is, as Albert Einstein, didn't he say, there's a quote, an Einstein quote that says, "Compounding is the eighth wonder of the universe." Something like that.

But the idea of compounding is very simple. And I prefer to use non-financial examples. But the focus of compounding is if you plant one grain of corn in the ground, then that grain of corn will grow, assuming that that seed is fertile. That grain of corn will grow into a corn stalk, which will produce one head of corn, or one ear of corn, which will have many more kernels than the one that you put in the ground.

So I mean, that's a powerful example. If you do that each year, if you do that in the first year, you have one kernel of corn, you get an ear of corn. You shell that corn, now you have many hundreds of kernels of corn. You plant those many hundreds, now you probably have many hundreds of thousands of kernels that result.

That's how compound interest works. Compounding works in every area of life. So we want to look at that formula and we want to say, where can we apply compounding? So most people think of applying compounding to the investment of the surplus of their wealth. So they say, well, if I'm going to invest the money, I'm going to invest the money in stocks and it's going to grow over time.

Yes, it is. But where else can we apply compounding? Can we apply compounding in our inflows? So can we apply compounding to the way that we earn a living and to the salary that we earn, to the amount of money that the marketplace rewards us with? Can we apply the idea of compounding to that?

And can we compound that at a faster rate otherwise? And I'll come back to that in a moment and review that in depth. The second thing of the concept is leverage. So leverage can work for us or leverage can work against us. And compounding can work for us or compounding can work against us.

If we're deeply in credit card debt and we have a substantial credit card balances on which we're paying relatively high interest rates, then we have leverage working against us because we're in debt and that leverage is compounding against us where the interest on those credit cards are compounding as time goes on.

But we can also apply leverage to other areas of life. We can apply leverage to our inflows, apply leverage to our outflows, and apply leverage to the growth of our investments, of our surplus. And we can do this in both financial and non-financial ways. Then we can get compounding working on our side.

So if you understand these flows, remember there's no net worth that's going to grow without having an excess, a surplus, coming from the cash flow statement. So we've got to grow the balance sheet based upon the cash flow statement. So look at some examples here. And I want to use a couple of examples that most people may be thought of and then give some more out of the box examples that you may not have thought of.

Why is it that many people recommend going to college? You read stories and many people are recommended to go to college because going to college increases your lifetime earnings. If you read the charts, the charts are all crystal clear that the total amount of lifetime earnings on average across the population is based, has a direct correlation to the level of education.

So a high school dropout has the lowest lifetime earnings. A high school graduate has the next amount of lifetime earnings. A bachelor's degree certificate for university has the next highest, then a master's, then a PhD. So the charts are very clear. And so the idea, most people are doing this maybe subconsciously, but they're applying this formula and the way that these things work, they're applying these formulas to their financial planning suggestion.

And they're saying, you should in the beginning of your career, assuming that college is going to have an impact on your income, with that assumption, you should in the beginning of your career, you should run a deficit if you need to. So you're going to run a deficit in your budget where your outflows are higher than your inflows in order to grow your salary higher.

And then you're going to have the advantage of that salary will be growing and compounding throughout time, throughout your lifetime. So you're going to apply financial leverage through the use of a student loan. And you're going to do that so that you can raise the amount of your inflows.

And then by raising the amount of your inflows so substantially, you're going to wind up to be wealthier over time. So by converting it into the formula, you can understand where the problems come in. So problem number one comes in, what if the deficit is too high? And so what if the leverage is too high and it doesn't result in higher earnings?

This is a problem many college students and college graduates face. I borrowed a bunch of money, I owe $100,000, and I now have a career that's not resulting in higher inflows. And because my career is not resulting in higher inflows, then I don't have sufficient inflows to cover the amount of the debt.

Or if I do have sufficient inflows to service the debt, I don't have any surplus on top of it. And so I'm constantly left right scraping bottom. And this is an unpleasant place to be when it comes to financial planning. So you can see what you need to make sure of if you're going to do that, if you're going to use leverage, financial leverage, to go to college.

And you're going to borrow money and you're going to take on that deficit. You need to make sure that you're going to do that in a way that it's going to actually result in higher inflows. So people are intuitively using this formula when they're making the college decision. Now why do we pay off consumer debt?

Well, we pay off consumer debt to free up cash flow and save on interest expense. So by paying off consumer debt, we free the cash flows, so we lower the outflows, and then both, I'm not sure what the word would be, both nominally and across the board, both in the aggregate and then both on the specific because we lower the interest expense and also across the board because we lower that cash flow expense and we have our freedom of cash flow coming back with us.

So, I mean, that's it. That's the whole point of paying off consumer debt is because as long as we have the consumer debt, we have assets that are going down in value, so that's not working. So we need to build a surplus up and we need to increase the assets that are going up in value.

And the only way we can do that is if we can generate a higher surplus. We pay off the consumer debt to generate surplus in our budget to build wealth. So I hope this is not too repetitive, but I want to give some more examples because with these concepts of inflows and outflows and rate of return and then compounding and leverage with these tools, I think you can build some amazing futures.

We can build amazing futures for people. Now you can't escape math. The math still works. It works whether you want to admit it or not. Acknowledging it doesn't really matter. It doesn't matter whether you acknowledge it. It's still going to be -- the math is still going to be there functioning.

So it's better to not fight it and just understand it and then focusing on optimizing. So if you're looking at your personal cash flow statement and your personal balance sheet, what you're going to do is apply the system of thinking and you can optimize each and every part of the equation.

So let's start on the cash flow statement. You can optimize your inflows. Now remember, I added two variables. You can optimize the size and the characteristics of your inflows. So first of all, you can optimize the size. Most people -- I did a show in the past. I think it was called You're 100% Responsible for Your Income, which is kind of funny.

It seems to be one of the more popular shows of the ones that I recorded a year ago. It was one of those that I just sat down and just dashed off in a day. And I'm kind of embarrassed of its popularity because I just sat it down and just did it off the top of my head.

But that was one of the most listened to episodes of the show. But in that -- I believe it was in that episode, I talked about the importance of increasing your income, of compounding your income. And I talked about Brian Tracy's 1000% formula. And the fundamental idea behind the 1000% formula is that if you'll focus on compounding -- on growing your income at a compounding rate, you can do some amazingly amazing things with your wages.

And so let me run some numbers here. Let me give you an example. So what I'll do is I'm going to just use a financial calculator, which by the way, if you're not familiar with using one, get good at one because you can answer all these questions like this yourself in about 10 seconds.

So let's just show how compounding works with income. So what I'm going to do is I'm going to apply an annual compounding rate to a level of income. So let's start -- let's say that we have a 25-year-old just starting their life. And let's say that just coming out of college -- and actually I'm going to play with some of these scenarios.

So we have a 25-year-old just coming out of college. And this 25-year-old takes an entry-level job making, let's just say, $40,000 a year. At least 40 because it's easier for me to remember as my number. So we're going to put in $40,000 as our starting value. And let's compound this over 40 years.

So we're going to put a 40-year time period in. We're not going to put any payments in. And we're going to -- let's just use a 3% annual compounding rate. If you'll start at $40,000 and you'll compound your income at 3%, then at 65, when you retire -- just stick with this scenario -- when you retire, you would be earning $130,481 per year.

And that 3%, that would be about an inflation rate. Now if you can bump that up to a 4%, and look at the difference, now you're earning $192,000 that final year. That's an extra $60,000. But remember, that's in one year. So that was an extra $60,000 at 65. It was probably an extra -- I could go and make the chart, but I'm not going to do it.

But it was probably an extra $59,000 at 64. And an extra $57,000 at 63. And an extra -- you get my point. That's an extra hundreds of thousands of dollars. Now let's say that you could compound your income at something like 7%. Well now at 65, just the difference between -- actually, that one's too scary.

Let's go back to 6%. So if you could double that compounding rate, and you could go from earning 3% per year to earning 6% per year increases. You would go from earning $135,000 a year at 65. So we're going from 40 to 135 in the first example, 3%. You would go from earning $40,000 a year to earning $411,000 at age 65 each year.

So now at age 65, you've got an extra $250,000. And at 64, you had an extra $230,000. And at 63, you had an extra $220,000. And at 62, you had an extra $210,000, et cetera, et cetera, et cetera. So if you're really looking for the most powerful thing that you can compound, forget about the investments.

Focus on the income. Because just the growth from 3% to 6% -- growth from 3% to 6% -- that is an incredible difference between $130,000 and $411,000. Now, could you do 6%? I think anybody could do 6% if they want to do. I think that -- remember, with Brian Tracy's formula, which to me makes all the sense in the world, you're going to be increasing your income at 26% annually.

And what would that mean? Let's just do -- I wonder if this will break the calculator. If I put in 26% annually, then that means that you're earning $413 million a year at age 65. Now, you say, "That's not possible," right? But are there not people who have done that?

There are people who are earning $413 million a year. Now, maybe the formula does break down. I think that is kind of a dramatic example. But 10% per year? Now we're at $1.8 million a year? Look at the difference of no matter where you start. If starting at 25, no matter where you start, just earning $40,000 just by focusing on compounding your income, compounding your inflows.

So what do you need to do? I think you probably need to enhance your skills. Because we're paid exactly what we're worth in the marketplace. On a financial basis, the income that you earn right now is exactly the appropriate income to what you should be earning based upon the skills that you're bringing to the marketplace.

So the only way to change that income is to increase your skills and to enhance the value. And then to find somebody, find the marketplace and the marketplace, whether that's a new employer or whether that's the customers that value what you've created, to find somebody who values that so that you can command a higher wage to earn higher inflows.

So I would say it means increasing your skills. And whether that's simple things like reading books in your field, attending conferences in your field, reading your industry magazines so you understand what's going on in your field, listening to the podcasts in your field, learning how to speak in public and speaking at the industry conferences in your field.

And whether that means those things, whether it's field knowledge, whether that means enhancing your personal skills such as increasing your emotional intelligence, increasing your communication skills, learning how to inspire people, learning how to lead people, learning how to help other people be more effective. Whether that means changing industries, whether that means changing employers.

You see these stories from time to time that come across and they say how much more somebody makes by transitioning from one employer to the next. If you want a 30% raise, it's probably easier to find a different employer and then negotiate a 30% raise with that different employer than it is to get your current employer to give you a 30% raise in a year if they're accustomed to giving you 3% raises.

So this is how we affect the size of inflows, just one idea of many. Now you could also address the characteristics of inflows. So characteristics of inflows may be the characteristics of your job. Do you work a job that's agreeable to you? Are you working in a field that's agreeable to you?

Are you working in an industry that you care about, that you like? Is there a need to change to another industry? Do you work in an industry that you don't like that -- well, if you work in an industry that you don't like, you might as well go work in another industry that you don't like and then go and get paid more for it.

Or can you switch from the industry that you like -- excuse me, that you don't like to an industry that you like even if you need to have a pay cut? That's fine. It's your decision. There's nothing wrong with reducing the number. There's nothing wrong with it. But understand it because you're probably -- if you're working in an industry that you're more interested in, it's probably going to be easier for you to compound that number than it would be if you were -- than it would be if you were working in an industry that you didn't care for.

And then leverage. How can you apply leverage to your income formula? Well, maybe the leverage that you could apply was the financial leverage to borrow money on student loans so that instead of making $40,000 out of school, you made $80,000. So let's reset this as $80,000 and now let's run our 3% inflation rate, our 3% growth of income.

Well, if you start at $80,000 -- I did something wrong. Okay, there we go. So if you start at $80,000 and you can grow your wealth -- you can grow your income at 3%, now by starting at $80,000, now that final year you're earning $260,000. So remember, we're measuring this against our $40,000 base mark and this would make sense because we're intuitively -- we have intuitively doubled the salary.

So what we've done is we've applied, you know, some sort of financial leverage maybe to build -- to get a degree in a field that is financially rewarding. We've applied financial leverage and we've doubled our income every year going forward. That's why the college financial numbers are so difficult to escape is that, you know, if you can double from $40,000 to $80,000, that's a doubling every single year.

So even if you had to borrow $100,000, you know, just do this math in your head. If you had to borrow $100,000 for a college degree but you came out making $80,000 instead of $40,000 and even though my first example I imagined that you did have a degree, imagine now that you don't and imagine that the $40,000 was for the non-college graduate, well, the difference in earning power would be $40,000 per year.

So 40, 80, 120, take out some taxes, let's say three years you've broken even on your investment in that degree. And then every year from then on, you now can command a higher salary if you learn something in school and you can deliver on that. So that may be one thing.

You may be able to apply some sort of financial leverage through the form of a loan. You may be able to apply some other kind of synthetic leverage. So for example, could you work in an industry or in a field where you could apply some kind of synthetic equity or other leverage to the field?

So maybe you don't have the money here to, you would really love to make your business, you would really love to earn your money and build your business based upon managing rental units that you operate for yourself. But the reality is you don't have any money to pay for those rental units.

Well, can you go out and find some other people who already have rental units and hire yourself on as a property manager? And then now you're leveraging their $100,000 investment and you're just taking a 10% cut of the rents. So this would be a good way to apply leverage to your inflows.

So consider that. Consider if changing the size, how can you change the size and the characteristic of your inflows? What are your personal likes? Are you working in a field that's best suited for your skills? Optimize both of those factors and optimize the inflows. Now the ultimate optimization might be to get to the point where your investment inflows are higher than your salary inflows.

I think this is really the ultimate optimization. This is what financial independence truly is, is when the dividends and increases from the companies that you own are higher than your outflows. Well now you are financially independent. What a beautiful place to be in. So now we're addressing the size and the characteristic of our inflows.

So if you have that as a set target, that my goal is to build my assets to the point where my investment inflows are higher than my personal outflows, if you have that as a goal, you'll reach it. Most people don't have that as a goal. They've never considered that it's even possible because they never even consider that there's anything to do other than work as a salary.

So move on to outflows. Optimize the outflows. So here again, you're going to adjust the size and the characteristic of the outflows. So the size, are there any outflows you could easily cut? Could you just simply say, I don't want to spend that money anymore. I'm not gaining value from that.

I'm not gaining value from-- I don't know what to pick on. I'm just not gaining value from this category of expenses. I'm going to remove it from my life. Now, then again, could you say, well, I'd like to go ahead and spend money in this category, but could I optimize it in some way?

Instead of spending money on rent to a non-family member, could I rent from a family member? So at least then I'm benefiting a family member in this transaction. Instead of paying for food that is raised in a way that I don't think is appropriate, can I buy food from sources that I do want to support?

Can I allocate my outflows in a way that support my values? So can you optimize the size of the outflows? And this is where skills planning comes in. That's what Jacob talks a lot about in his early retirement extreme book. Can you adjust and bring in the skill advantage to reduce the amount of outflows that are necessary?

So whether this is something as simple as clipping coupons for your favorite breakfast cereal to as complex as a comprehensive income tax plan to shelter the majority of your money from income taxes, all of this is about optimizing outflows. And you have to optimize outflows in order to build wealth.

You have to optimize them. You have to have lower outflows than inflows in order to build the surplus. Not going to be possible for you to get rich and build real wealth if that's not the case. But your plan is going to be your plan. So don't buy this nonsense that some people say, ah, don't worry about expenses.

Expenses don't matter. Expenses matter. And they matter a lot at the beginning. They matter a ton at the beginning. I'm planning a show-- and maybe this week, it may not be-- but I'm planning a show on the concept of new cars, used cars. I don't want to destroy this myth about the new car versus the used car for wealth building.

But one of the key things that's going to be a component of that show is to understand when this matters. If you're at the beginning of your career and you buy a $30,000 car that depreciates in value by 15%, that is a huge-- each year, that is a huge number.

That's $4,500 of depreciation this year. That's an expense-- excuse me-- it's a massive expense that is very difficult for a small budget to recover from. Now on the other hand, if you're 70 years old and you've got a multimillion dollar income, does $4,500 of depreciation matter that much? It really doesn't.

So the key is to understand how big are these numbers in a relative fashion to your specific cash flow statement, to your specific outflows. And then can you apply the ideas of leverage and compounding-- can you apply the ideas to any of the outflows? So for example, compounding-- can you lower the outflows by doing better tax planning?

Because of the fact-- for example, investing in an IRA. Let's say that you want to invest $5,000 through an IRA. Well, you can leverage this by-- let me stop, sorry. Let's say that you want to invest $5,000. You can leverage this by leveraging through an IRA. So then let's say that at your tax rate, maybe you have to earn $6,500 to be able to pay taxes and then invest in a taxable account with the $5,000.

Well, a good way to apply leveraging here would be to go ahead and put the money into an IRA. And then you can gain as it goes up. And what you can get-- my example breaks down because I'm combining two concepts, and I hope it makes sense. I recognize this is not mathematically perfect.

But you can get-- in essence, you get to experience by leveraging the tax savings, you get to compound not only your original investment, but also the savings on the taxes. And you get to compound what you would have had to pay otherwise. So you get to compound not only your original investment, but an example-- I shouldn't have used $5,000.

I should use, say, $3,000, and you've got to invest $4,500. So now you can invest on the tax savings and your original principal. And that can compound over time. And that's a tremendous leverage point that you can look for. And this can be applied in every area. Can you leverage your good relationships with your neighbors to share a Wi-Fi signal between each other so that one of you doesn't have to pay for the full thing when you've got a perfectly good signal coming in right across the street?

Can you leverage your county library system so that you spend less money at the bookstore? Can you leverage-- I mean, there's a variety of things. And everything is going to come down to adjusting the size of the outflows and then optimizing those outflows. And then finally, we get to the surplus.

And we get to the point of saying, well, how can I affect the rate of return, the size of the surplus-- excuse me-- the rate of return that I get, which is the size that it will grow at? And I'm trying to stay consistent with my size and characteristics.

But this one is different. So how can I adjust the rate of return that I'm earning on the surplus? And how can I adjust the characteristics of my investments? So if we think of it in that way, then we're constantly going to be applying our lens to say, well, I have surplus.

What's going to be the best use of this surplus at this point in time? And so the best use of this surplus at this point in time may be at one point in time going to college and paying for the college tuition fees so that I can increase my income if that's the reason that I'm going to college.

At another time, it may be I went shopping. And my wife and I eat scrambled eggs and sausage every morning for breakfast. And the sausage was on sale. And I bought eight-- I think I bought eight packages of sausage. Because I don't know when the next sale comes around.

I figure it comes around at least every couple months. And we probably eat a package a week. So at least then I got a couple months worth of sausage in the refrigerator. So maybe something as simple as saying, I'm going to make sure that I spend my surplus on the things that I'm going to use anyway and get them when they're at a price leading discount.

And so this is one of the major areas. If you study how to save on groceries, this would be one of the major things that you can do, buy on sale. Well, you have to have cash to be able to buy on sale. So it may be every bit as appropriate for me to say, I'm going to use my surplus.

I'm going to do that and stock up on food when it's cheap. Or I'm going to use my surplus and I'm going to buy stock when they're cheap. Or I'm going to use my surplus to do insulation in my attic, to install energy saving screens on my windows to lower my air conditioning bill, or whatever you guys do up north where it's cold.

I don't know what you do. Or maybe buy a wood stove or put in better windows to have solar again. I don't know what you guys do up there. So whatever it is, I can apply the same thinking as saying, how can I optimize the surplus? How can I optimize the rate of return that I'm earning on the surplus?

Now notice how the rate of return that I'm earning on the surplus is going to come back over and affect my inflows. So let's say that my decision is, Joshua, you say that since the history of well-run equities markets, they've generally returned 10%. But you know what? That's not good enough for me.

How can I do better? Well maybe have a business idea. So a business idea, a good business idea, may easily make far more than 10%. And so this would be where I could, if I ran my calculations, just for fun I will here, let's say I have $40,000. This is my earning income.

And let's say I had a goal. Let's put this in as $40,000 present value, no payments, 3% growth over 40 years. So 3% growth over 40 years comes out to be $130,000 of income. So let's say you said, well, 10%, I want to compound that at more. Where can I do that?

Probably in your own business. So the right investment in your own business, where you can apply leveraging and compounding and unique skill and knowledge, and if the business is successful, could increase your income at a massive percentage rate. Maybe it could be 10,000%. That's the way that you go from the $40,000 incomes to the $4 million incomes.

It's in your own business. You don't get that working in middle management. You don't make $4 million working in middle management at a medium-sized company. You get that by becoming the CEO of a large public traded company, or you get it by starting a local scrap dealer, a local plumbing company that you grow to be a bunch of trucks.

So I don't want to repeat anything that I've said. So I think this is about all I've got on this topic. But I guess I just want to point out to me, the cash flow statement and the balance sheet are beautiful, because they illustrate everything that I can do.

And for you, they will illustrate everything that you can do. And somehow, maybe I should figure out a way to sell this a little bit better. But you don't need to listen to my show every day. All you would do is create a cash flow statement and a balance sheet, and look at it and say, how can I optimize the size and the characteristic of these inflows, outflows, and the rate of return that I'm earning on my surplus?

That's it. Those are the only three, maybe six levers that you have to do. But that's what ultimately everything's going to come from. Now are there other financial planning things? Yes. Well, how does insurance play into it? Well, insurance is protecting my inflows, or it's protecting my outflows. So if I'm-- Sam, I mentioned disability insurance.

So if I'm buying disability insurance, I'm buying disability insurance so that if my inflows are interrupted due to disability, that I can replace those inflows from the insurance policy. If I'm buying property and casualty insurance, a fire policy on my house, I'm protecting myself so that if my house is disrupted, I'm protecting my budget from the need to come up with an extra $200,000 to rebuild my house as an outflow.

So it all works in on this calculation and on this formula. I find this to be useful. I hope that you also find it to be useful. To me, it kind of dispels a lot of the differentiation that everyone's trying to constantly say, look, I'm different. And I'm just like, you're not different.

You're focusing on inflows. You're, ah, you're focusing on outflows. I got it. Ah, you're working on an investment trick here. OK, I see this. And so there's a dramatic, there are dramatic gains that can be made by seeing these things comprehensively. And my wish is that we all started to view everything we do in a comprehensive manner and that we all were able to think these things through and help one another by thinking comprehensively.

I also just want to free you from the idea that this stuff is set in stone for you. It's not. You can choose. You can choose to change. You can choose to adjust. You can choose to affect any of these variables that you want to affect. I had an idea earlier, and I think I've got a moment to do it.

Let me just take a second and adjust this. And let me show how, you know, you can have the choice. So I was using earlier $40,000 as my proxy income. So let me just put this in here. $40,000 is my income. But instead of starting at age 25, let's say someone starts earning at age 18.

And so they start earning at 18. And so now my number of years from instead of 25 to 65, instead of 40 years, it's going to be 47 years. Well, at 65, this person is now earning $160,000 instead of the $130,000 that the person starting at 25 was doing.

So this would be, if we were doing a rational college calculation, if we were doing a college calculation and we discovered that our starting wage out of college was going to be $40,000, but we could get a starting wage prior to college of $40,000, then we would need to factor in the seven years of lost productivity.

And I know that's a little aggressive. It should be four or five years. But my point is that the extra seven years of compounding resulted in an extra $30,000 of wages at 65. So, you know, but you have the choice. So what if you compound instead of at 3%?

You started at 4%, and you started at 18, and you said, OK, I'm going to compound at 6%. Well, now at 65, we've got $618,000 a year. Let's say you put this at 8%. Now at 65, we've got $1.5 million a year. So there's amazing differences that can be had.

I don't know which of those things are going to work for you. If you're 18, pay attention to those numbers. If you're 48, that's not a lot of help to you. But make your financial statements, and you'll still be able to figure out what will actually work for you.

So I think that's most of what I want to share on this topic. And I do have one more idea, and then I'll leave you with a challenge. Remember that we're only really here talking about the financial statements. And there are a lot of other non-financial statements. There's a lot of other aspects of life that is non-financial.

You know, a good question should be, as far as if we have a surplus, how should we-- how should we-- How should we reinvest the surplus? Should we save it in the bank, or should we move our family across town to a better neighborhood or across the world? Now, that's going to convert it into an outflow, so it's not a surplus any longer.

But maybe, should we use the surplus to adopt a child and invest into the life of that child? Or should we use it to buy a van we can use for our side business? Or whatever the options are. Remember that it's not going to be, ultimately, the money things that any of us are really going to look back on and count most dear.

There may be a few of us that look back fondly and maybe view a certificate of stock that was our first stock we ever bought, or that we keep some memento of our past financial goings on, whether that was the mortgage cancellation notice of our debt. But most of us are going to have a wall full of family pictures.

And we're going to have those non-financial things that matter. And that's what we're going to be focusing on. The great things in life are really not that expensive. I've been blessed. I'm sometimes shocked. My wife and I just talk about what an amazing life we live. And I'm not saying that in a-- what's the word that means-- there's a word that means excessive.

I'm not saying that in some kind of-- anyway, I'm not saying that to-- it's true. We live an amazing life. It's really not that expensive. There's a beautiful sunset wherever you are. And the beautiful sunset is really no more beautiful from the $30 million mansion as from the public beach next door.

So just consider those things, is that the great things in life are really not that expensive. They're really not. And consider how can you optimize not just the size, but also the-- not just the amounts, but also the categories and the characteristics of all the inflows and outflows. And my challenge for you is this.

And I just remembered, I want to play a piece of audio for you before I go. In fact, I'm just going to end with that audio and I'm not going to play the closing music. So stay tuned. It's about a three-minute audio from Jim Rohn, who was just an amazing-- had an amazing ability to put things into-- to make-- turn words into poetry and turn them into poetry that affected people's actions.

He's certainly been a huge help to me over the years and I want to honor his legacy and just play a moment-- a three-minute audio clip. But I'll give you a challenge. If you haven't done these financial statements, I know that this is not generally the type of stuff that's done in financial podcasts.

But I really believe that this is a really useful tool. And if you haven't done this, just create these for yourself. Create a simple balance sheet and create a simple cash flow statement. But here's the key. Don't just create it and then just, you know, tuck it away in a drawer.

Look at it and ask yourself if it's reflecting your values and if it's reflecting what you're doing. And give it some time with kind of a-- I don't know, maybe a journaling exercise to sit down and say, you know, what can I do? How can I optimize my inflows?

And are they optimized? What could I do to increase them substantially? Or pick a category. If it's outflows, you can go through every category of your budget here. And sometimes, you may wind yourself-- you may wind up-- excuse me. May wind up in a perspective where you are doing a fancy financial planning tool.

You're doing a fancy tax plan or something like that. The stuff that I'll talk about more, you know, more on this show. Or it might be that you're just saying, "Why am I paying money for this car that I just don't care about? Why am I paying money for this thing?

I'm going to do something different. I'm going to sell it and move to another neighborhood." I just challenge you. You can coach yourself through this stuff once you have the statement in front of you. And look, in your situation, I want to talk about lots more ideas, but how can you apply leverage and compounding in all of the right ways without all of the negative ways?

So get rid of the compounding credit card debt that's compounding against you. And start compounding your income at a higher rate than it's ever been compounded at. And try to apply some sort of synthetic leverage to your-- some categories of your expenses. You know, people do this with-- just another example of what I mean is like with travel hacking, where people say, "Well, I'm going to go ahead and use-- I've got to buy money, but I'll use airlines credit cards, and I'll buy all these free mile programs.

And now I'm going to leverage my skill with this to get more money for the dollar than I would otherwise have gotten." So I hope that you'll do that. I hope that you'll do that. Oh, and the last thing, I almost forgot. I wanted to mention about the shows on Thursday and Friday.

I hope you enjoy that. I tried to bring a little bit of-- I enjoyed the Alan Watts audio, and then also the talk from Cal Newport. And just want to point out one thing about the Cal Newport. I think it's a valuable balance. But notice that there's nothing in those two talks that is contradictory of one another.

Is that you really do have to build skill. You know, Cal was right. But you know what? If you want to just say, I want to do what I'm passionate about and ignore the skill, if you're willing to forego the potential financial loss, there's no reason why you can't make that choice.

And what annoys me about a lot of things-- and I'm sure Cal would-- I've never spoken to him. I'm sure he would admit it-- is that we generally only hear of the rich people. But you know what? There are a lot of people who don't have a lot of money.

They're not Steve Jobs. So they're not speaking at college graduation commencement ceremonies. But they are living the lifestyle of their dreams. And they're doing it through the application of skill. So as Cal said, if you have 10 interests, pick one and get really good at it and build skill at it.

But you know what? If you do know what you're passionate about, figure out a plan to get there. That's what this show is about, is having a customized plan that's really going to help you to get there. So that's the show. Stay tuned for the Jim Rohn audio. I hope that you've enjoyed it.

Thank you for those of you who've been leaving reviews for the show on iTunes. I'm sorry that I've been sick. I'm doing the best I can today. But if this show fell flat, give me a little bit of mercy. But I'll do my best to keep on coming back this week with world-class financial planning content.

And I just challenge you. Do something with this show. Create those two financial statements for yourself. And start watching them. And start coaching yourself through every one of your decisions. Enjoy the rest of your Monday. First question is one of the major questions of the world. Why? Why should you try?

Why read that many books? Why go that far? Why earn that much? Why share that much? Why learn all that? Why get up that early? Why put yourself through that much? Why try for all that? Good question. Why? One of the best answers to why is the second question.

Why not? What else are you going to do with your life? Why not see how many books you can read? How far you can go? How much you can earn? How many friends you can make? How much personality you can develop? Influence you can have? How many things you can accomplish?

How far you can go and what you can see? Why not? You got to stay here till you go. Why not? The third question is why not you? Why not you? Some people have done the most incredible things with limited start. Why not you? Some people have done so well.

They get to go. They get to see it all. They get to do it. They get to be there. They get to have it. They get to enjoy it. Why not you? Why not you watching the morning mist rise over the mountains of Scotland? Exploring the mysteries of Spain, soaking up history in London.

Why not you? You got to take a stroll through the palace of Versailles. Why not you? You got to have lunch in one of those neat little sidewalk cafes in Paris. I mean, Denny's is okay, but you got to try Paris. Someday you got to gaze directly at the Mona Lisa.

I can show you where to find the most exquisite seashells in Miami and the Bahamas. I know where they are. Why not you? You got to shop on Fifth Avenue in New York. You got to stay at the Waldorf Astoria. Have dinner at Lou Chow's. Slice roast goose on a bed of apple stew.

Why not you? You got to drink in an Arizona sunset. You got to see the world. You got to read the books. You got to do the enterprises. You got to be involved in commerce and love and travel and experiences. You got to do it all. Why not you?

You got to know the results that come from splendid discipline. There's nothing like a view from the top. And the last question is, why not now? Don't postpone your better future any longer. Get at it tomorrow with new vigor. Start to make changes, have conversations, make contact, and do it now.

And if you will, I have a feeling one of these days we'll be hearing your story.