One of the keys to becoming wealthy and creating wealth is to understand the different ways of generating income. It is often said that the lower and middle classes work for money while the wealthy have money for them. The key to wealth creation lies in this simple statement.
Imagine, rather than working for money you have rather made every dollar work for you 40 hours a week. Better yet, imagine that every dollar works for you 24/7, or 168 hours / week. Finding the best ways to make money work for you is an important step on the path to wealth creation.
In the United States, the government agency of the Internal Revenue Service (IRS) responsible for collecting and applying taxes classifies income into three main types: active (earned) income, passive income and portfolio income. Any money you win (other than perhaps winning the lottery or receiving an inheritance) will fall into one of these income categories. In order to understand how to get rich and create wealth, it is essential that you know how to generate multiple passive income streams.
Crossing the Chasm
Passive income is income generated by a trade or a business, which does not require the participation of the employee. It is often investment income (i.e. income which is not obtained by working) but not exclusively. The central principle of this type of income is that it can be expected to continue working or not. As you approach retirement, you are certainly looking to replace earned income with passive, unearned income. The secret to creating wealth earlier in life is passive income; positive cash flow from assets you control or own.
One of the reasons why people find it hard to move from earned income to more passive sources of income is that the whole education system is actually pretty much designed to teach us how to do a job and therefore depend on it. largely of earned income. It works for governments because this type of income generates large volumes of tax, but will not work for you if you focus on how to get rich and build wealth. However, to become wealthy and create wealth, you will have to cross the abyss by relying only on earned income.
Real Estate & Business - Sources of Passive Income
The type of passive income does not depend on your time. It depends on the asset and the management of that asset. Passive income requires taking advantage of the time and money of others. For example, you can buy a rental property for $100,000 using a 30% deposit and borrow 70% from the bank. Assuming that this property generates a net return of 6% (gross return minus all operating costs such as insurance, maintenance, property taxes, management fees, etc.), you generate a rental return net of $6,000 / year or $500 / month. Now subtract the cost of the mortgage payments, say $300 / month, and we come to a net rental income of $200. It is a passive income of $200 for which you did not have to exchange your time.
Business can be a source of passive income. Many entrepreneurs go into business with the idea of starting a business to sell their stake for a few million dollars in 5 years. This dream will only come true if you, the entrepreneur, can make yourself replaceable so that the generation of future business income does not depend on you. If you can do it, you've created a source of passive income. To become a real source of passive income, a business needs the right type of systems and the right type of people (other than you) who operate these systems.
Finally, since passive income-generating assets are generally actively controlled by you, the owner (for example, a rental property or a business), you have a say in the day-to-day operations of the asset, which can have a positive impact on the level of income generated.
Passive Income - A Misnomer?
In a way, passive income is a misnomer because there is nothing really passive about being responsible for a group of income-generating assets. Whether it's a real estate portfolio or a business you own and control, it is rarely, if ever, truly passive. You will need to be involved at some level in asset management. However, it is passive in the sense that it doesn't require your direct daily involvement (or at least it shouldn't anyway!)
To get rich, consider creating a leveraged / passive income by increasing the size and level of your network instead of just increasing your skills / expertise. So-called smart people can spend their time collecting diplomas and certificates, but wealthy people spend their time collecting business cards and building relationships!
Residual Income = A Form of Passive Income
Residual income is a form of passive income. The terms passive and residual income are often used interchangeably; however, there is a subtle but important difference between the two. These are revenues that are generated from time to time by work done once, i.e. recurring payments that you receive long after the initial product / sale has been made. Residual income is generally in specific amounts and paid at regular intervals. Here are some examples of residual income: -
- Royalties / income from publishing a book.
- Renewal commissions on financial products paid to a financial advisor.
- Rentals from a property rental.
- Income generated in multi-level marketing networks.
Use of Other People's Resources and Other People's Money
Using other people's resources and other people's money is a key ingredient required to generate passive income. Others' money saves you time (a key limiting factor of income earned in wealth creation). In a sense, using other people's resources is wasting your time. When it comes to raising capital, companies that generate passive income generally attract the largest share of other people's money. Indeed, it is generally possible to get very close to the return (or at least the risk) that you can expect from passive investments and banks, etc., will often finance passive investment opportunities. A good business plan backed by solid management will generally attract angel investors or venture capital money. And real estate can often be acquired with a small down payment (20% or less in some cases) with the majority of the money borrowed from a bank in general.
Tax Benefits of Passive Income
Passive income investments often provide the most favorable tax treatment if properly structured. For example, companies can use their profits to invest in other passive investments (real estate, for example) and benefit from tax deductions in the process. And real estate can be "exchanged" for larger real estate, with taxes being deferred indefinitely. The tax paid on passive income will vary depending on the individual's tax bracket and the business structures used. However, for illustrative purposes, we could say that an average effective tax of 20% on passive investments would be a reasonable assumption.
In summary:
For good reason, passive income is often seen as the holy grail of investment and the key to creating and protecting wealth over the long term. The main advantage of passive income is that it is recurring income, usually generated month after month without much effort on your part. Building wealth and becoming wealthy should not be about extracting every bit of your energy, your own resources, and your own money, because there is always a limit to what you can do. Harnessing the efficient generation and use of passive income is a crucial step on the path to wealth creation. Start this part of your wealth creation journey as early as possible, that is, now!