Personal Finance: The Psychology of Making Money

If we look at the figures commonly used, we can see that while eight out of a hundred people will achieve financial independence, only one out of a hundred will be truly wealthy. If we use this as a guide, only between 1% and 8% of the population appear to have the determination to create wealth.

Unfortunately, more common in our society is what I call a “poverty mindset.” Our conditioning by well-meaning but uninformed parents, teachers and friends fosters this attitude. We are taught to believe myths such as “it's impossible to get ahead … you need money to make money … it's too hard to save …” and so on.

When it comes to creating wealth, you are what you think, and therefore those who abide by this poverty mindset rarely find financial success.

You too might be struggling with a poverty mindset — and you may have found this has negatively impacted the success of your wealth creation activities to date. If you're serious about achieving financial independence then you need to be serious about analyzing how you think.

Seven Wealth Creation Mistakes

To help you identify the money-making pitfalls and defeatist attitudes to wealth, I've listed the seven most common wealth creation mistakes that people make:

1. Lack of Knowledge

While this may seem an obvious problem, you'd be amazed at the number of people who jump into investments without understanding the full implications. From poor loans to risky investments that they thought were safe, the list of mistakes due to lack of knowledge is endless.

You've heard the saying “ignorance is bliss,” but when it comes to money, investments and your future, it'd be more correct to say, “ignorance is expensive.” Knowledge is the most powerful tool of the investor. It is the only way to make profitable money making decisions.

2. Lack of Foresight

This is probably the most common wealth creation mistake people make. It is the mistaken belief that one will always have enough time to prepare for one's retirement. In this mindset, it doesn't matter if you don't start now — there's plenty of time to worry about that later. However, as the years slip by, the chance of becoming financially free becomes more and more remote.

Lack of foresight applies to the day-to-day expenses as well as retirement planning. Bills are juggled constantly and there is never any spare money to cover unexpected expenses.

Lack of foresight can cause endless trouble, but at some stage everyone will have to think about his or her finances. Don't wait till it's too late for you and your family!

3. “Must-Have-It-Now” Mentality

This unfortunate mentality has grown to epidemic proportions in the last few years. It's a fatal mistake in the wealth creation process.

Credit cards are the single largest contributor to this problem. You may be familiar with the urge to buy something knowing full well you do not have the money to spare. This is where the “must-have-it-now” mentality comes to prey upon our natural optimism.

We are encouraged to think: “It's not very much really…” or “It may not drop to this price again…” or “I'll make sure to pay it off first thing next month.”

Any of these thoughts sound vaguely familiar?

The “must-have-it-now” mentality is very dangerous because not only are

investments neglected, but in most cases it puts you in debt, often at very high interest rates.

Just remember that the fatal mistake of deciding to buy everything now is likely to cost you much more than you first anticipated.

4. Borrowing for Things That Lose Value

This mistake is often an extension of the previous one. It's when we borrow money to buy things that either depreciate immediately or had no real value in the first place. Examples include playthings like cars, boats and TVs to using your credit card to pay for hotel accommodation and meals.

The debt may be easily affordable, but if the assets lose value, then the loan will be actively working against your wealth creation plan.

5. No Goals, No Plan

Goal setting has become a very popular topic in recent years with countless seminars and books being devoted to the topic. Don't be put off by all the hype, because goal setting is a fundamental part of success. It applies to all types of success, from Olympic athletics to successful investment.

After all, if you don't know where you want to go, how can you possibly hope to get there, least of all in the shortest time?

While this concept sounds simple and you may have heard it many times before, how often do you actually sit down and plan your goals and your road to achieving them?

Most people have never done it. This goes a long way to explaining why over 90% of all working people never attain the financial security they desire.

6. Confusing a Good Income with Financial Independence

Many high income-earners confuse a good income with financial freedom. The two are not the same.

Financial independence depends on having a substantial net worth that will be able to support your lifestyle in retirement. If you want to retire on an income of $30,000 per year, then $600,000 in net worth should be sufficient (if you earn an average return of 5% annually). However, if you are used to living on an income of, say, $120,000, then you will require at least $2.4 million in net worth to render yourself financially independent.

A high income is no guarantee of long-term financial success, unless it is used productively. A book called The Millionaire Next Door, written by Thomas Stanley and William Danko, gives some excellent profiles on the “average” American millionaire. The interesting thing is, hardly any of them live extravagant lifestyles and most of them do not earn astronomical amounts of money.

In fact, the authors found that many high-income earners spend every dollar they have on consumable and material possessions, leaving little or no room for savings and investment. Most high-income earners did not have high levels of net worth and would be unable to sustain their lifestyle if their employment halted.

The point to remember is that a good income is of absolutely no use unless you use the money productively to enhance your financial position. If you always live the “high life” it can make some of your goals much more difficult to obtain.

7. Bad Attitude about Finances

Wealth creation is 80% attitude and 20% skill. One of the most common mistakes people make is having the wrong attitude about a successful wealth creation plan.

The trouble is, many people equate saving and investment with some type of obscure punishment, like washing the dishes or mowing the lawn. These people do not understand the basics of wealth creation. They would prefer to spend money on consumables rather than build up long-term wealth.

Put in perspective, people who have a “poverty mindset” will continue to make the same wealth mistakes over and over again. If you really want to attain, retain and enjoy your wealth, you need to adopt a “wealth creating mindset.”

Five Key Elements to Implement

As you can see, the average person is much closer to a poverty mindset than they are to a wealth mindset.

Because many of us are raised this way, it's hard to change the way we think. If you want to introduce wealth into your life, there are five key elements you need to address in order to implement lasting change.

1. Change Your Behavior

The most basic and obvious thing for you to do is change your behavior, which usually means altering your spending habits. It may mean writing up a proper budget and sticking to it. It may mean investing your money rather than leaving it in the bank and watching it dwindle away.

If you haven't achieved wealth yet, it's because your behavior has been preventing it. Having said that, behavioral change in itself will not be enough to guarantee you a wealth-creating mindset. You may change your behavior so that you save and invest, but if you're still worried about money and bills, then you still have not achieved a positive wealth-creating attitude.

2. Expand Your Capabilities

If you are going to adapt to new practices and save and invest, then it stands to reason that you are going to have to extend your capabilities.

This means learning new skills and new ways of doing things.

Every wealthy person I know would understand the following statement: “I generated extra income this month by writing five out-of-the-money October Call contracts against my share portfolio.” Are you prepared to put in the effort to learn new ideas like this?

To achieve your goals you must acquire new knowledge and information. Finance columns such as this one, books and seminars will expand your skills. You're going to need them in your wealth creation plan.

3. Alter Your Beliefs

For successful wealth creation you need to believe in yourself and believe that wealth is attainable, indeed inevitable. This is the most important part of the wealth creation mindset.

Many people believe deep down that they either cannot succeed at generating wealth, or that prosperity itself is wrong. These beliefs will cripple your efforts and you need to change them. You need to adopt positive beliefs that will support your developing skills and actions.

Adopt a positive outlook on your finances. Look for opportunities and take positive action. However, don't let money preoccupy everything you do. Keep your life in balance.

4. Adjust Your Values

This change links to your beliefs but takes them one step further. Your values and priorities must change — for the better. You must value money for what you can do with it, not for it's own sake. Money is nothing by itself; it needs you to give it definition and purpose.

Your set of values will dictate a large part of your life and the success and happiness with which you live. Don't leave yourself short-changed. Adopt values that reflect your purpose, your goodness and your true self.

5. Prosper in Your New Identity

The last requirement is to prosper in your new identity. In other words, relax and enjoy your newfound wealth-creating outlook on life.

Achieving your financial goals will give you self-confidence, satisfaction and joy. Enjoy the journey!

Putting it into Practice

Your mindset will affect the way you act and react to certain situations and opportunities. For example, someone with a wealth creation mindset loves the idea of attending seminars and expanding their knowledge. They are of the opinion that if they learn one new thing from the seminar, it was a success.

Conversely, someone with a poverty mentality is likely to tell you a hundred good reasons why the seminar is likely to be a rip-off and why you shouldn't go. Can you see the difference? It is a profound one and it is why it is so important for you to cultivate a wealth-creating mindset.

Some people reading this may dislike this “wishy-washy” psychological stuff and want me to hurry-up and get to the “real information.” These people do not realize how important these concepts are. In essence, the “real information” is virtually useless to you unless you have the belief and determination to make it work, especially when hit by unexpected setbacks, which are inevitable.

My challenge to you is that if you “know this stuff” and your life hasn't changed, then you're doing something wrong. I'd suggest you still need to do a little work on your determination to create wealth and on your outlook for the future.

I've focused on the psychology of making money because it is a crucial part of one's development as a successful investor. If you want your life to get better, then you have to be the one to do it. You cannot become wealthy without a can-do attitude.

Having now addressed this significant aspect of creating wealth, next week I shall begin looking at the kinds of investments you can make.

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