The term “Net Worth”. What exactly is that? Net worth is simply the sum of assets minus the liabilities. This, however, simply does not state the whole story. Each year, Forbes magazine shows the distribution of net worth for the United States.
The Forbes graph shows that 86% of the people make $250,000 or less each year. Yet, this constitutes only 26% of the net worth pie. Only 10% of the population makes more than $350,000 per year, yet that 10% is controlling 68% of the net worth of this country!!
These statistics are not meant to upset you. I would however like you to keep them in the back of your head as you read through this guide. So you understand how most of the money is made in America.
Most people make their income linearly, which means they have a “Linear-income”. This simply means that for every hour they work they get an X amount of income.
With a linear-income a person must keep working if they want to keep getting paid. In the United State the average person works a 40-hour workweek not to mention all the other time spent away from the home due to having to work. Let’s say that the average is 50 hours per week.
If you consider that the average person gets 2 weeks of vacation, you will see that 2500 hours per year are spent on the job. Take those hours over the typical 45-year work span, and you will have worked 112,500 hours!!
If you could go back and average all the income over that 45-year period, you might find statistics like this:
o Average Annual Salary of $30,000 is equivalent to $12/hour before taxes and a mere $7.80 after taxes (assuming a 35% rate of taxation)
o Average Annual Salary of $40,000 is equivalent to $16/hour before taxes
o Average Annual Salary of $50,000 is equivalent to $20/hour before taxes
When you look at the examples above, there is a pattern that might catch your eye.
For each $10,000 more made per year, you can add $4/hour to your hourly rate of pay. I can almost guarantee you that if you follow this type of system to make your money, you will have a very difficult time becoming wealthy.
Everyone has heard of diversification, especially when talking about finances. If you choose stocks, you are told to diversify. Why? Because it is too risky to put all your eggs in one basket – this is simple logic.
And yet, if you look at most people today they almost always have “all their eggs in one basket”. What I’m talking about of course is most people have only one way of getting income: their job.
Most people have ONE paycheck that goes into a bank and then comes out of the bank for a variety of fixed expenses. The only diversification in this picture is the number of ways the money flows OUT of the bank! If your cash flow fails due to sickness or inability to perform the given tasks, you will lose all of your assets.
So, what’s better than linear income? Why it’s residual income of course!
Residual Income is income that keeps coming in month after month, year after year, from work you do just once. An example of this is income received from stocks or government bonds.
It keeps coming and you don’t have to work for the government. Another example is a royalty paid over the rights of an invention or a song. You keep receiving income for that song and you don’t have to keep singing every time to collect. The best way to build your financial freedom is by securing residual income from many sources.
Now, to clarify, not all residual income is passive income. In fact, most residual income has some “residuality.” Don’t try looking that word up in the dictionary – it is my own creation.
The residuality of an income source refers to the extent that you have to put effort into establishing a cash flow. Some forms of residual income are labor intensive in the beginning, some in the middle and some at the end. I do not believe in completely passive residual income – you should always have control and take charge of all of your income sources.
Regardless of the residuality of the income you choose, the benefits of residual income are excellent:
o Control your own income
o Creating security
o Being able to set your own priorities
o Great tax advantages
Remember that I said it was important to diversify. First, you need to develop three sources of residual income. This will provide you with a variety of ways to feed your asset base.
What exactly is an asset? For the purposes of this book, an asset is something that has positive cash flow and goes up in value over time.
Then make sure your residual income equals three times your original linear income. Yes, three times. This will provide you with a cushion.
The last part of the of the rule concerns taking transitional steps towards creating residual income. You are not going to be able to replace your linear income with residual income all at one time, so taking transitional steps will be necessary.
I suggest looking at your lowest necessary bill. Let’s say it is your phone bill at an average of $50/month or $600 per year.
In order to earn residual income of $600/year, you might consider purchasing a $12,000 municipal bond earning 5%. How will you purchase this bond? By taking 10% of your gross income off the top and placing it into a “mini-asset category” until you can get the $12,000.
Once done, you will not have the payment per month and that money can then be put into your asset category as well. Stocks and bonds, as you can see, are very capital intensive, but over time, will be able to pay all your fixed expenses.
I hope you enjoyed this blog article.
To your financial success,