An important concept in building ones’ wealth is capital.
In today’s world, you need some dough to carry out an existence, unless you’re totally self-sustainable which is awesome from an environmental/frugal standpoint. But for most of us mere mortals, even those living the most extremely frugalicious lives, you need some money to cover basic expenses. Luckily, we can earn that money in exchange for services.
Okay, this is an important concept to really, really, really, really…really understand if you’re living the “average” life and want to convert to a more sustainable one.
Humans are born ready, willing and able to work (Not straight from birth unless you’re a Spartan, but you get the point) – this is human capital. This is something that, as an individual, you have a finite amount of (Be it ability, knowledge, physical labour, etc.).
On a long enough timeline you will have exhausted all of your human capital that you have.
“Oh no! What should I do then?”
Well, luckily in our market-based society, we are able to exchange human capital for financial capital, aka money.
This adds up to a simple equation:
Human Capital ➡️ Financial Capital (Makes sense, right?)
So if we have limited human capital, we must have limited financial capital! If you go about spending all that money you just earned by trading in some of your very finite, illustrious human capital immediately on brand new luxury cars, lattes at Starbucks and the like, you’ll eventually have nothing left. Nada.
“You’re freaking me out dude!”
There is however, an alternative. It’s called saving.
Let’s say you hypothetically don’t spend everything you earn (Hallelujah! Giving up that paycheque-to-paycheque life!). Let’s say you put aside a percentage of your financial capital that you have earned.
That financial capital can be invested in all sorts of things (stocks, bonds, real estate, etc. it’s really quite limitless what you can invest in these days.) to earn more money!
Turns out companies will pay you for cash. This is because companies have potential projects they’d like to invest in but may not have the cash to support putting it into place. Companies can use money from savvy investors, like yourself, to get those projects going. In return, the company will PAY YOU. Congratulations, you have allowed your money to work for you, creating more money for you. What a lovely concept.
(Quick note on the above example – This is the same concept as people living off credit cards, just in reverse. That is, people are borrowing money from a credit card company to use immediately. In return, credit card companies want a return for lending you that money, usually in excess of 20% per year…yikes. This is a HARD NO. Keep your credit card balance down and use it only to build credit rating and rewards within your means.)
Financial Capital ➡️ Financial Capital
“WHOA! So by putting aside some of the money I am earning into investments, I can have that money earn more money?”
Yup, then that extra amount can earn more, rinse & repeat. This is compound interest (To be discussed at a later date).
What is amazing, is that this can occur in perpetuity (That means forever). This solves the problem of you having finite human capital. So when you run out of the goods to give at your job, you’ll have a big enough retirement reserve.
What is big enough? Enough so that the investment income earned can provide you with sufficient money for you to live off, for the rest of your life. Get it? Excellent!
Ahhh…the good life!