When trying to better your life one of the biggest factors to what you are able to do is the amount of income you have. The standard way of living for most of us is going from paycheck to paycheck, with barely anything left over. It’s not the only way to make a living and it’s certainly not how the wealthy or institutions operate. They operate by creating multiple streams of income.
Here we will discuss the 3 main types of income you can earn so that you can start to build a plan for yourself. The 3 different income types are residual income, portfolio income, and earned income. Relying on only one type of income creates a perpetuating scenario of lack. When you earn money and just pay off debt or purchase stuff then there will always not be enough money.
When you instead put a portion of your income into additional forms of income generation you are then able to create wealth and prosperity, especially when it’s residual.
Residual income
This is the most sought-after type of income by anyone that knows anything about building wealth. In large part creating wealth is impossible without this kind of income and throughout history, the most common example used is real estate. Residual income is money that you receive multiple times after the initial period of work. There is still some management required afterward so it’s not truly passive but some call it passive income.
Rentals, storage units, Airbnb, etc: many property types exist in real estate which can all be used to generate residual monthly cash flow. Some people enjoy being a landlord while others don’t, which is why there are property management companies.
business: building a successful business can be one of the best ways to create residual income for a while and can then become a great capital gains event when you sell it for a large lump sum. Whether the business is product or service-related isn’t important. What is important is that you create a real company and not just a job, or self-employment. Big difference when you just own the job vs when you have other people in the roles needed to continuously run the company.
Portfolio income/capital gains
Money that is received via the stock market, usually in the form of your 401k, IRA, etc. This can also include royalties that come from investment properties as well. The 2 most common ways to continually increase your paper portfolio income are by contributing every paycheck or every month, and by purchasing high-paying dividend-paying stocks.
By choosing dividend-paying stocks you can opt to get cash paid directly to you or purchase additional company shares. The second option is probably the most beneficial initially if you are contributing a couple hundred or a couple thousand dollars at a time. Unless you have a large one-time payment option to then get cash flow from, you may benefit more from more shares (though you could argue that a one-time lump sump purchase may be better spent on an annuity, life insurance purchase with real estate investments, or purely from real estate).
Some may argue that it’s better to purchase an ETF that tracks high-paying stocks is more cost-effective, and perhaps it is however I argue that it requires you to be more informed yourself. If you love learning about the markets and different options within them then go for it, but recall that when investing make sure you are only playing with money you can afford to lose.
Other investment types
Bonds: A fairly safe and well-used option for businesses, governments, and banks. Bonds generally have two ways of paying you and that is either in interest twice a year or by selling them for more than purchased.
Cryptocurrency: a newer sector of investment that is entirely digital. The blockchains that they run on are quickly becoming far more sought after by businesses than the news would have you believe. Very volatile just as the stock market can be, however, the blockchains that each run on have tremendous real-world use. The most common ones are bitcoin, ethereum, cardano, and recently dogecoin(which was made as a joke though it’s being converted at the time of writing to be more useful as a digital means of exchange) just to name a few.
Earned income
This is the most common form of income that we are familiar with, also called job income. For most, you get paid 2-4 times a month after working one or more weeks first at an hourly rate. Some terms that further differentiate earned income are the following:
Gross income: this is the total amount of income you earned during the pay period before state and federal taxes or other deductions like health insurance or 401k contributions.
Net income: this is the amount you can deposit or the amount your paycheck is.
Adjusted gross income: you will see this term on your taxes and can be found on line 7 of form 1040 for W2 employees. If you use a different form then its location may be different or unneeded.
Taxable income: how much you are required to pay on taxes depends a lot on the deductions you can claim vs the amount of income you have. Your tax bracket can be affected by many factors like marriage status, dependents, if you took standard deductions or not, and many other types. (Contact a tax advisor if you are unsure because it can be quite complicated)
Types of earned income
Salary
A salary is a set amount of income usually on an annual basis which obviously gets broken up all the way down to a paycheck basis. This is typically reserved for management and company owners, though it can also include just about any role. Typically it does not include sales and non-degree-related fields. Those positions usually get commission or hourly wages.
Wages
Hourly wages are the most commonly offered income option for those joining a company. This is the w-2 employee who normally does not have a degree or for simplicity’s sake contracts created by the company is how it usually works out (an example of the latter here would be trade positions such as electricians, HVAC, and the like who are trained but get hourly because based on location wages may be higher than their home location).
Commission
Sales positions or contract work as it’s sometimes called allow for a high upside on income potential, however, it can also be stressful during the lows. As is often the case with sales there are seasons so to speak when sales are at their peak and the rest of the year they are lower. Generally speaking, you get a percentage of each sale. When I was a car salesman it was 25% of the profit so if the price was $12,000 and the company expenses were $10,000 then the 25% was out of the $2,000 or $500, and that is assuming the buyer did not negotiate or demand lower.
Commission can come from selling other people’s stuff like the car example above and it can also be from selling your own stuff. Examples can include writing an ebook, paper book, art, songs, videos, courses, and the list goes on. For the most part, selling our own stuff is done on a short-term basis with stuff we no longer need at a garage sale or the like. If you combine creating something with an outlet like eBay, Etsy, Amazon, and youtube a part or even full-time self-employment situation could be created.
If you are striving to create financial independence this can help create stability during the process. Some say a job is a must, while there are plenty of examples of individuals that quit their job and go full tilt with their business. I’ve done it both ways and I’ll say that from personal experience it can be very challenging either way you go for various reasons.
Pros and cons to earned income
Think of earned income in the following way: someone else has a business idea and has created a process of providing that value to people in a regular fashion and as an employee of that business you get paid a small portion regularly. This is why jobs can be seen as steady because all the hard work of figuring out a product or service, marketing, advertising, establishing trust, etc, have all been done by someone else and you have to do is go in and manage the day to day operations on a very small scale in one role.
The downside to a job is that you can become complacent and jaded to trying to do anything else. This is further exemplified because when not at our job most of us have this notion that outside of job time it is playtime. Or as movies and such portray it, being rich means that all you do is spend your time playing around. This then makes it hard to spend free time learning new skills or starting a business unless we know for sure it’s going to work out because why waste the time if I can have fun right now otherwise.
Wealth building
In the book, Rich Dad Poor Dad Robert Kiyosaki talks about the four quadrants of income: employee, self-employed, investor, and business owner. In order to build wealth, he discusses how you must move into the last two categories to truly become wealthy and the most commonly used source is real estate.
Now that doesn’t mean that you have to use real estate yourself, just that it’s the most common that’s all I’m saying. The next most common thing is having one’s own business and/or also investing. The traditional idea is not what I mean by investing because it’s actually gambling. If you think handing your money over to a fund or money management firm is investing then you are actually being led astray, because that’s not how the wealthy build wealth.
Instead, the kind of investing I’m referring to is that of putting your money to work for you with very specific knowledge, understanding, and personal management of said capital. For example, Warren Buffet takes his money and purchases businesses that he thinks are undervalued and then builds that capital over and over again.
How to transition from an employee
What you personally are interested in and enjoy will have a large impact on how you wish to go about creating your own business, what it is in the first place, and also what you invest in. Here are some guidelines you can follow if you don’t know where to start.
1. Budget for wealth building
How do you spend money currently? Is there much left over? Generally speaking, most of us learn or at least get in the habit of spending what we earn within 90 days of getting an increase in pay. Of the money we spend it usually goes to buying stuff that is purely consumptive in nature, meaning it is just another thing in the house with no potential to generate more income on its own. Start by changing some of the money that you spend on say entertainment and instead put some of it away for investment purposes. In the beginning that investment money could go towards books to learn more about investing, business building, YouTubing, etc. This may be in the way of books, courses, or perhaps even short college courses.
2. Education
Learning is the first place to start. Learning what you don’t know about or perhaps even may have been taught to be against is the first step in getting a full knowledge of how finances work. The book previously mentioned is a great start, some others include Killing Sacred Cows, Become Your Own Banker or Live Your Life Insurance and The Wealth of Nations. These are just some starting ideas, what you personally need to learn about is going to differ based on what you will choose to do later.
3. Pick something and start
From personal experience, I can say that there are a LOT of options you could pick through. I have gone through many different opportunities and I’ll say that dabbling has been the most destructive thing. To avoid starting and stopping and repeating this cycle choose something you enjoy, think about if it’s something you can see yourself talking about with others for 10+ years, if it’s not then skip it. Look at the options based on what YOU want to do not based on what you have heard others say would be a good idea.
- Persistance is key
The next part is to do something towards your continued growth on a daily or at least weekly basis. Nothing is worse than starting something, telling others you want to do this or that, and then fizzling out shortly afterward. Challenges will crop up but the key to long-term success is putting those feelings of doubt aside and doing it anyway. Did you see progress in working out because you always felt like going to the gym? No, absolutely not, in fact, I’m sure many times if not most of the time when the time of the day came to do so you looked for every excuse you could but after 5, 10, maybe 60 minutes of doing the task that day the resistance fell away and you pushed through.
- Continue to learn
Some time ago I had the thought “What if putting the theory of success I currently have requires that next book to bring it into reality”?
This thought helped me to renew my habit of reading new books and bringing in new perspectives from others to better my own viewpoint. This has helped tremendously in persisting to write for this website as well as working towards my goal of being a profitable life and health insurance agent.
What will you do today and this week towards your own progress?