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Why Do the Rich Get Richer?

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And how can you follow in their footsteps?

If you want to become rich, you need to think like a rich person. That means focusing your efforts on accumulating assets, rather than getting cash – or spending it. Your key to long-term wealth lies partly in building your holdings in stocks and properties that will make money for you.

Both stocks and properties can provide strong cash inflows via rental fees and dividends. As we accumulate more of these assets, those cash inflows grow, becoming what we call a passive income – money we don’t have to work for to earn. And with that passive income, we can buy more assets, further increase our passive income, buy even more assets … This positive cycle helps rich people amass their wealth.

In contrast, chasing the trappings of wealth – luxury goods and a lavish lifestyle – before you actually achieve wealth is the surest way to ensure you’ll never get rich. We Fools have two helpful maxims to remember:

  1. Live below your means

    Figure out how much you’re bringing in each month from your job. Then make a list of your monthly expenses. If you’re paying out more than you’re bringing in, you’re making a big mistake. Living frugally and spending less than you make leaves you a cushion of money to…

  2. Pay yourself first

    Every time you get paid, save at least a little of your spare cash to invest in the assets that can eventually make you rich. By sacrificing a little enjoyment now, you may be able to enjoy far more of it in the future.

Your first step toward enjoying your own positive cycle of wealth generation: Cultivate patience. You cannot expect to achieve your goal in a fortnight. It may take you years to develop a passive income stream. But by the time it fully matures, you may well have the assets to let it grow by itself, and enjoy some of its cash inflows without actually going to work.

As you work toward your own passive income stream, keep two things in mind:

  1. Make sure you only buy the highest-quality assets – well-run companies, or sturdy, well-built properties in appealing neighbourhoods. You want your wealth to grow in value, not shrink. If you can’t be reasonably sure that an asset provides this advantage, it’s not worth buying.
  2. For a larger margin of safety, try to buy your assets at relative lows. It’s tough to ever know whether an asset is expensive or not in absolute terms, but you’re more likely to get a good deal if you buy during a market downturn than a period of great optimism. Buying assets when they’re cheap improves the odds that you won’t lose money on them should the economy take an unexpected stumble.

With any luck, by the time you retire your passive income can support your daily expenses, to say nothing of occasional luxurious travel. But in order to reach that goal, you’ll have to start early, work hard, and stick to your plan for years to come.

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Disclosure: Johnny Chan does not own shares of any companies mentioned. Motley Fool Hong Kong is not licensed by the Hong Kong Securities and Futures Commission to carry out any regulated activities under the Securities and Futures Ordinance.