I while back I stumbled over the Cash Flow Quadrant. A friend showed me, and he had learned it from the Rich Dad World academy/community. It is kind of cool because before I learned about this quadrant, I thought that my house was an asset. However, as time passed by, I understood that a house doesn’t put money in your pocket, it takes money from you pocket and give them to the banks and the governments. Ye, most of the houses out there are owned by the banks. And when the loan is repaid, you have probably paid double the original purchase price of the house (because of the interests). Something to think about. I did exactly that, just with a slight difference: My house came with a rental unit and that will cover all my interests’ payments and more. My house is an asset! Please remember that anything paying you is an asset and anything not paying you is a liability! Try to acquire as much assets as possible if you want to become financially free. Anyways, lets get a rough idea of the cash flow quadrant!
THE CASH FLOW QUADRANT
The cash flow quadrant was mainly created for people to understand how the rich people think. You know with the “think like the rich” mindset you will not only be better prepared, but you will take more control over your everyday habits like how you think, how you learn new things and how you “just-do” things.
The cash flow quadrant (picture above) describes four different people in the world. And then there are also four different types of income as you probably figured. Number 1 being the employee who lives on monthly paychecks. Number 2 would be the self-employed which run a small business. Number 3 which is the business owner, and the number 4 which is the investor.
Furthermore, the left side consist of employees (Employee) and self-employed (Self-employed) individuals, and the right side consist of individuals who receive their income from business they have created on their own (Business owner) or the business they might not have created but invested heavily in (Investor). So, what comes next is easy to understand. Each and everyone of us resides in at least one of the four categories and essentially where we fall within the quadrant. If you work for other people or for yourself, you fall in the left-hand side of the quadrant which the middles class usually do and belongs to the many. If you put the money to work or have other people working to earn you money you have a seat in the right-hand side of the quadrant. In the latter side, you find the rich people in the world and are amongst the few. Which one are you? The many or few? Or which one does you want to become? These are always good questions to ask in early stages of life!
INCOME TYPES
Now, we have three types of income: passive income, earned income and portfolio income. I believe that many of you that read this article do know the differences, but I will write some sentences about the three types just for you to get a clear understanding.
Passive income is usually cash flows from investing in companies that pay out a monthly or quarterly dividend or a real estate unit that you rent out. Could also be royalty income from patents or license agreements. Most of the passive income that is earned in the modern world is through real estate though (tax benefits).
Earned income is usually income derived from a job you do for a company. Worth mention is that it is here you pay the most tax to the government. Earned income is by far the hardest way to build wealth – I hope I did not crush anyone’s dreams right now. It is simply the hardest way because it is here you pay the most tax, that’s it. There will never be any other income that is taxed so hard as the monthly paycheck.
Portfolio income usually comes from investing in different stocks, bonds, mutual funs and the like. These kinds of investments are used by many of us and are better to build wealth with. Compound interest play a big part for your success here!
ASSETS AND LIABILITIES
So, the understanding of these two concepts is crucial in determining if a person become rich or not. Assets generate money and liabilities generate expenses. Remember the difference! Remember in the start of this article that I wrote that your home is not an asset? Your home is more like a liability because your home does not generate any money for you (unless you are smart and have a rental unit within that home), it generates expenses. Even if you own that home without any loan, you still pay for insurance, electricity, property taxes, utilities, maintenance, and the like. Therefore, money is being taken from you and not given to you. However, when you sell with a profit then it becomes an asset.
Therefore, you should be focusing on assets like stocks, bonds, and mutual funds. Real estate units like single family homes, condos and small one-to-four-unit properties. Or go big and focus on commercial properties. Mainly because the latter creates tremendous amounts of passive income that will make you insanely rich. You should even try to invest in businesses and enterprises, they also create passive income in terms of dividends if they have delivered positive results.
IN CONCLUSION
As one can understand earned income is not represented in an asset class since it is the passive income that will make you rich over time. So, the key here is to replace your earned income with passive income. Then you will eventually move from the left-hand side to the right-hand side of the cash flow quadrant!
I hope you enjoyed this way of thinking. When I first heard about the cash flow quadrant, I totally got it and therefore I have been building passive ways of earning my income. You know, if you follow a simple set of rules, you will become insanely rich over time!
Cheers
-Olebulls