4.6 The Golden Equation of Wealth

In the previous chapters, we have covered the different components of the golden equation of wealth. To give you a hint, they are income, savings, investments and expenses. The equation is:

Each element in this equation has its importance and, therefore, needs to be pondered over individually. For income, you must look for multiple sources that are sufficient and stable. Being an inflow of money, it is the only growing, positive component in the equation.

Expenses have a negative connotation but are, at times, unavoidable and unpredictable. Your income should be sufficient enough to cover their unavoidability and unpredictability. Even the expenses that are discretionary may be required to improve our standard of living. Therefore, we can’t ignore them too.

That brings us to investments, the third component of the equation. Though investments would cause outflows of income, their goal is to provide optimum returns, which will enhance the income component. In other words, your investments must provide returns good enough to allow discretionary expenses.

The last component of the equation is savings. Though savings is a positive component, it doesn’t provide returns. Therefore, savings should cover your emergency expenses. The rest of the income can take care of other expenses. 

One of the most successful wealth creators and the Chairman of Berkshire Hathaway, Mr Warren Buffett, has famously quoted, “Don’t save what’s left after spending; spend what’s left after saving.” If we apply this principle to the equation stated earlier, the equation will change to the following.

                  Income – Investments – Savings = Expenses

Mathematically, both the equations are the same. But the second equation emphasises the sequence of priority that needs to be assigned to each component to maximise our potential of wealth creation.

So, remember the golden equation and start investing today!