It's not about how much money you make, but how much money you keep. Let me introduce you to the most important wealth formula, the net worth formula. An asset is anything, whether tangible or intangible that you own, which brings you money. A liability is anything that takes money out of your pocket. Let's say you purchase a new car with $20,000 of cold hard cash. It's well known that cars depreciate in value, the second they're driven off the dealer's property, and their value continues to go down as the usage on the car increases.

It's pretty easy to see why a car is a liability. Despite the fact you can sell it later, there's very little chance that you'll sell it for more than you ended up spending on it, especially when you consider things like maintenance expenses. Let's now assume that you buy a pinball machine for $1,000 and put it in an arcade you own it cost $1 each time someone wants to use the pinball machine on average, it's played 150 times per month. Now remember that while you paid money for the pinball machine up front, an asset is something that produces future cash flows. If 150 people play per month that's $150 in revenue after one year, you'll have made $1,800. That's a profit of $800 in only one year, and you can expect the pinball machine to continue to put money in your pocket in the future.

Clearly, a pinball machine is an asset. Let's say you purchase a house, a house is most people's biggest asset and biggest liability in Scenario number one you live in a house? Is this house a liability or an asset? Will it generate future cash flow or reduce future cash flow? Most people take out mortgages to buy their homes, meaning they get a loan from a bank and pay it back over 15 or 30 years. What effect does this have on your net worth?

It all depends on how much equity you have. equity is your houses market value minus the remaining mortgage. We know you'll be spending $750 a month on mortgage payments but that doesn't Collect expenses for utilities, cable and internet furniture or maintenance. And don't forget taxes. While you can sell the house later, it's not guaranteed that you'll have the luxury of selling your house at a good time, despite the fact the housing market trends up over time, if you're living in the house long term, you're pouring money into that house monthly, it is not generating cash for you in the long run. Even if you do sell at a premium, it's very difficult to calculate whether the total cost of owning your home long term will have a positive effect on your net worth in this scenario, your house has value but I'd argue that it's a liability because it's likely to reduce future cash flows.

In Scenario number two, you rent the house to other people with three bedrooms, you're able to charge three college aged students $800 per month, each for a grand total of 20 $400 a month. That gives you $650 in monthly profits, which you can save, invest or use to make repairs on the house. Oh yeah, and let's not forget that you're still Building equity except this time someone else is paying off your mortgage in this example, while you're still making payments on the house, the houses generating cash flow because you're renting it out and letting someone else pay down the mortgage for that reason the house is now an asset. So when you look at your expenses, are you acquiring assets or liabilities? What do you own that's helping you make more money, maximizing your assets and minimizing liabilities is the key to building wealth. A major component of that is staying on top of your spending.

Let's talk about budgeting a crucial building block for increasing your net worth if you weren't $10 million each year? Would you consider yourself wealthy? Many people would say yes, in reality, I haven't given you enough information to answer the question. A large income doesn't make you wealthy. That's only one half of the equation. Remember that your net worth equals assets minus liabilities.

If you earn $10 million each year and spend $15 million each year you're broke. Having a budget is the foundation to financial freedom. Budgets help people make sure their income remains higher than their expenses. What we do with that profit separates the wealthy from the rest. I recommend tracking your expenses on a monthly basis. At the very least, are you using a budget If not, you no longer have an excuse.

Take advantage of this budgeting tool starting today.