The Only Introduction to Personal Finance You Will Ever Need
Money is the medium by which earthly success is measured. With money comes a lot of power to do good. And money is plentiful for those who understand the simple rules that govern its acquisition.
This is why a good understanding of money is necessary. And here, I will attempt to help you get a deeper understanding of money so that you know where you are and what lies ahead of you.
You see, there are three types of income: Earned income, passive income, and portfolio income.
- Earned income is the income you’re paid from doing a job; either as an employee or a self-employed person like a freelancer, editor, or web designer.
- Passive income is the income you earn from any asset you own; like your real estate, books, courses, or business. It includes the income you earn from your rental property or net business value. View it as your buying and selling income.
- Portfolio income is your interest and dividend income. It is the income that comes purely from your investments, including royalties paid for your products and services.
Take a minute to digest the above.
Now, expenses generally take money out of your pocket. Recurring or monthly, they are called expenses; but long-term, we call them liabilities. This includes loans in their numerous forms which many young people are fortunate to have little of.
This brings us to the first, important rule:
it’s not about how much you make but how much you keep.
A young person aspiring to wealth must answer:
1. How much of your money do you keep? Then do all he can to increase this percentage.
This equals: (Income-expenses)/Income x 100%.
2. Does your money work for you? This is the percentage of your TOTAL income that is from passive or portfolio sources. If you are like most people, you have nothing or very little from this source. You are an employee or a glorified self-employed person. And again, your goal is to continually increase this.
3. How do you decrease your taxes (if you run a business)? And how much goes to housing and other liabilities? This requires you to get a tax expert. And an ideal housing expense should be less than 30% of your total income.
4. Finally, how do you increase your return on assets? This is usually done by reallocating your invested assets; that is, by optimizing your business to create another income stream or new value addition, or by putting the children of your interest returns into another investment.
Now to be wealthy:
your ultimate goal is to purchase assets that generate passive and/or portfolio income in excess of your monthly expenses.
Paraphrasing, your passive income should be able to comfortably settle your monthly expenses and leave you some.
Once your passive income exceeds your monthly expenses, you are infinitely wealthy because “your assets are working for you.”
So based on this pattern, you are:
- Poor: if you use your ordinary earned income to pay expenses without any asset or passive income (even if you owe no debt)
- Middle class: if you use ordinary earned income to pay expenses but you have extra to buy more liabilities that create more expenses… (e.g new washing machine which means increased power usage and home maintenance costs)
- Rich: if you have enough assets that create enough passive income to pay your expenses.
Therefore, it doesn’t matter how much you earn, what matters is your income (preferably from assets) and expenses. Do you have enough and spare?
This reminds me of John Rockefeller’s words:
A man’s wealth must be determined by the relation of his desires and expenditures to his income. If he feels rich on ten dollars, and has everything else he desires, he really is rich
Also, note that it is your passive income from assets versus your expenses, not your portfolio income. This is because investments solve a purpose: they contribute predominantly to your net worth.
And when you begin your journey, you will need a digital will — a virtual document to keep track of all your investments and make informed decisions…
…but that is a lesson for another day.
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Reference: Get Your Financial House In Order by Robert Kiyosaki.
