On your journey to financial security, it’s important to recognize that all dollars are not created equal. There are many ways to amass large sums of money over time. You might be a highly paid executive, a world class information security professional, or become involved in well-paying fields like law or medicine. Successful entrepreneurship is also a proven path to success. In fact, if you examine the Forbes 400, you’d find that most billionaires made their money through starting successful businesses.
Before we dig into how to build your money machine, it’s important to classify the different types of income. Financial professionals will list them as active and passive income. I prefer the more blue-collar terms of hard money and easy money.
We’ve all heard people talk about their hard-earned money. Most of the time it’s in reference to how the money is being spent. What does it really take for income to fall into this “hard-earned” category?
Take the example of someone that earns $100,000 per year earned at their job. In all likelihood, they work at least 40 hours per week for the majority of the year to earn this income. There are usually secondary costs associated with earning this money. If you’re a professional such as a physician or attorney, you have the cost of clothing along with annual fees for licenses and permits.
If you’re a construction worker there’s the price of your tools and the truck required to haul them around.
The clothing, permits, vehicles, and license fees aren’t the biggest expense. Not even by a long shot. It also doesn’t matter if you work in an office building or at a construction site. The thing makes hard money truly hard is what it costs you in time. It doesn’t matter if you earn $500,000 per year in your profession. The fact your time is personally required makes it hard money.
Not so fun fact: Hard money is also taxed at higher rates than any other form of income.
Put simply, easy money is any realized income that results from activities that do not require direct action by you. Easy money is what people are referring to when they talk about money making money. It’s the holy grail of income. It’s how the wealthy keep and grow their wealth over time. An especially nice aspect of easy money is that receives much more favorable tax treatment than hard money; i.e. you pay a much lower tax rate on it.
Your Money Machine
It’s important to realize that pretty much everyone starts out making hard money. The trick to becoming wealthy is regularly parlay a high percentage of your hard-earned income into easy money producing assets. There are many ways to generate easy money but I wanted to spend a few minutes discussing the ones I have personal experience with.
If you’ve read any of my other posts, you knew this one was going to make the list. In my mind, the only thing better than owning and operating your own business is being an investor in someone else’s. While it’s true your upside is lower with this approach, it frees up something much more valuable than money. Your time.
Ownership in good dividend-paying stocks provides regular income without any regular effort on your part. Dividends are normally paid on a quarterly or annual basis. Typical dividend yields range anywhere from 2% – 5%. In most good companies, the dividend amount is also raised annually. This income is normally taxed annually at capital gains rates which ranges anywhere from 0% – 20%.
Master Limited Partnerships (MLP) are one of my favorite types of investment and a core security of my personal money machine. Most companies of this type are midstream pipeline companies like Kinder Morgan, Energy Transfer Partners and NuStar Energy. Ownership in these partnerships are sold in units. For all practical purposes, a unit is analogous to a share in stocks. They’re how ownership is represented in the MLP space. Income sent to a unit holder is called a distribution which is analogous to a dividend in stocks.
MLPs typically pay very attractive annual distributions. Usually 5% – 10%. These distributions are not taxed upon receipt. The IRS considers an MLP distribution to be a reduction in cost basis from the initial investment in the MLP. What this means in English is that income from an MLP isn’t taxed until the MLP is sold. It’s essentially a form of tax-deferred income that can be spent or reinvested now without penalty. For a buy and hold investor, they’re a great way of generating income.
REITs or Real Estate Investment Trusts are great way to realize the income advantages of owning real estate with less of the headaches. A REIT is company that owns, operates or finances real estate properties within a given market segment. Common segments for REITs include, apartment housing, shopping malls, warehouses, office buildings, and commercial retail properties.
REITs typically pay higher dividend rates in comparison to more traditional companies. This is largely due to the IRS requirement that they return 90% of their taxable income to shareholders. Dividend rates of 4.5 – 9% are fairly common in the REIT space. Because the income produced by REITs doesn’t receive favorable treatment by the IRS, they’re best held in a tax-deferred investment account like an IRA. About 15% of my money machine income is generated by REITs.
Books, Royalties and Products
This is a newer area for me. I recently released my guide on starting an information security career. It took a few weeks to write and edit. Still, it has the potential to become an additional stream of income that will also hopefully be of help to people considering a career in the information security space.
A good friend of mine is a software developer who receives monthly income from an application he wrote over 10 years ago. It took him several months to write, debug and distribute the software but now it’s been his personal money machine for over a decade. Microsoft became the giant it is today following a formula similar to this. Create the work once and profit from it for many years into the future.
Passive Income Takes Time
For most people, building your personal money machine will take time. Consider that 1 million dollars invested in dividend paying securities will conservatively produce an income ranging from $30,000 to $50,000 per year. Certainly nothing to sneeze at. 1 million sounds like a lot but the fact that you only have to make it once serves as motivation to really pursue the goal.
If you’re fortunate to have a high paying hard money career then great. You can build your money machine that much faster. Regardless of your income make it your goal to always look for ways convert your hard-earned income, into easy money-producing assets.
Always think in terms of increasing your net worth.
A great FREE tool I personally use for tracking my portfolio is Personal Capital. When you click this link to sign up for your free account, both you and I will receive $20. Every little bit helps right?
Full Disclosure: The links on both the Essential Reading and my Books Reviews pages contain my Amazon affiliate code. If you purchase a book using that link I get a few pennies. Doing so does not change the price of the book for you. In addition, at the time of writing this post, I own a position in NuStar Energy (NS).
Legal Disclaimer: The information provided and accompanying material is for informational purposes only. It should not be considered legal or financial advice. You should consult with an attorney, CPA or other professional to determine what may be best for your individual needs.