This may be the most important financial lesson you will ever receive. I know that since I received it, my perception of money, work, and life has never been the same. When I was exposed to this concept I was finishing up school and beginning my career as a Civil Engineer. My life plan was to work 30-40 years in that field and eventually retire to a nice lake house. Thanks to this concept, I spent my summer this year, at age 23, at a lake house.
I was in my cubicle working away, while listening to a podcast on wealth mindset, when the podcast host referred the best-selling book, "Rich Dad, Poor Dad." I had already been referred to this book countless times from people within the Network Marketing industry, the Real Estate industry, and exceptional business minds in general so, I decided it was time I checked this book out. I highly recommend it to anyone and everyone regardless of age, profession, or current financial situation. While the whole book is phenomenal I want to focus on one main takeaway. The takeaway that has led to the most success for me personally. That takeaway is the cash flow quadrants. So let us dive in.
This graphic below is very similar to the one used by Kiyosaki in the book and is a great visual for what I am about to explain. Glance over it now and refer back to it as I go into more detail throughout the article. As we can see there are 4 quadrants, each depicting 1 of the 4 ways that you can earn income in a capitalist economy.
Quadrant #1: The Employee
The first way to earn income is as an employee. This is the way that 99% of people earn their cash. They trade their time for dollars and use the majority of their wage to pay for their cost of living. Unless you inherit a multi-million dollar business the day you graduate from school or have a huge trust fund in your name, this is where you start out in life. Everyone starts here, slaving away, clocking in and clocking out to chase that dollar. No matter if you are flipping burgers or CEO of a Fortune 500 company, if you trade your time for dollars from an employer, then you are earning an income in Quadrant #1. You can do great for yourself as an employee and work your way up to phenomenal income levels, but if you never create income streams from Quadrants #3 and #4 you will…
Well I think Warren Buffett said it best:
“If you don’t find a way to make money while you sleep, you will work until the day you die.”
J.O.B. is actually an acronym and it stands for, “Just Over Broke.” Employers will typically pay you just enough so you don’t quit and employees will typically work just hard enough so they don’t get fired.
Quadrant #2: The Self Employed
Quadrant #2 lies below #1 on the graphic above. This is the self-employed quadrant. This is where your doctors, lawyers, independent sales associates, small business owners and many more reside. Once you join the promised land of Quadrant #2 you are now officially your own boss! Wicked! No more asking for time off. No more dress codes. The life right? Well there are still some things lacking here. In Quadrant #2 your income is still directly dependent on the hours of life energy you are willing to trade for cash.
There is no leverage here. You simply ‘own’ a job rather than ‘have’ a job. As an employee if you stop working or if you get fired your income goes to zero. As a member of the self-employed you might not have anyone to fire you, but your income still goes to zero if you stop working. So while this may be appealing to some people who want that independence this is still not where we want our income to come from forever. We don’t want a life where we must always trade our time and our life energy for the almighty dollar. We want to move over to the right side of the graphic. Quadrants #3 and #4 are where the wealthy reside, and in my opinion, where a great sense of freedom and happiness can be found.
Quadrant #3: The Business Owner
On the right side of the graphic we now have true leverage. We can earn an income whether we work any given week or not. In quadrant #3 we have the business owner. This person owns a system or a group of people working in a system. This organization or system earns the business owner an income independent of his own personal energy expenditure.
If structured correctly this business will pay the owner residually, whether they are still actively involved in daily operations or not. When this is accomplished the business is an asset that can be bought and sold. As an employee you get paid 100% on the efforts of 1 person, YOURSELF! As a business owner you get paid 10% on the efforts of 100 people. I don’t know about you, but business ownership sounds more appealing. I would much rather work hard to build something that pays a residual income to my bank account every month than have to work every day for a paycheck.
For those of you that are unfamiliar with residual income I’ve defined it below.
Residual Income: cash that flows to the owner of a business, product, or intellectual idea long after the up front work required to create it.
Trust me, you want to create streams of residual income for yourself. It is a beautiful thing to get paid every month for something you did months or years ago.
Quadrant #4: The Investor
The final quadrant, Quadrant #4 is quite possibly the most financially rewarding quadrant. This is the investor quadrant. This is where Warren Buffett resides. He worked hard for decades and saved money from quadrants #1 and #2 and then began to invest that money wisely. With continued investments, compounding interest, and a lot of time, he eventually reached a point where he had so much saved up and invested that he could easily live off of his investment returns and his accounts would still continue to grow without him adding to it. This is true, complete, financial independence. Your money works for you and by investing it wisely you no longer need to work for money or create any new income streams. Buffett and his family live extremely comfortable lives using the returns of his investments to cover their costs. And his net worth is so high that the wealth will continue to grow and provide for generations of Buffett's to come.
To achieve financial independence as an investor you simply need the passive income produced from your investments to exceed the amount of money you require to live. A general way to estimate how much you need to invest is to take your yearly expenses that you require for your desired level of happiness and multiply it by 25. This will give you a rough estimate of how much you need to have invested to cover all of your costs and still continue to grow your net worth.
So, if my yearly living expenses are $30,000 and I multiply that by 25 I will see that I need an investment account of $750,000 to support my standard of living without working any more. This is a rough estimate but it will get you close. If my number is $750,000 I know that if I get up to about $800,000 invested that my accounts will continue to grow even after I remove the cash I need to cover my cost of living.
Many people think you need to be a multimillionaire to achieve this kind of financial independence. That is simply not true. You just need to save and invest 25 times your yearly living costs. You do not need to be a professional investor like Buffett to achieve this. Many people, from tradespeople to highly paid executives, have achieved this financial independence through hard work, dedicated saving, and investing in simple index funds. In fact there is a growing group of people that are achieving this long before the normal retirement age of 65. It's possible to reach this point in your 40’s, 30’s, even your 20’s.
Check out http://www.mrmoneymustache.com/ , my favorite blog, for a community of millennials who are achieving financial independence at early ages by following the principles laid out by Mr. Money Mustache himself who retired with his wife at age 30.
Franks Journey Through the Quadrants
Let us take Frank for example. Frank starts off as an employee at Wendy’s, flipping burgers. He works hard and is always on time so they promote him to manager. A move up no doubt and an increase in salary, but still an employee in Quadrant #1. He still has to put up with a supervisor he doesn’t like and he still has to ask permission to take a vacation with his family. He’s fed up, so Frank decides to set out on his own. After years of saving up he opens his own burger joint across town. He hires his first three employees and gets to work.
With only 3 employees Frank must be the owner, the cashier, the occasional grill-man, the trash-man, the cleaning crew, and the bookkeeper. This is hardly business ownership as it is defined in Quadrant #3. Really he is just a member of the self-employed in Quadrant #2. He has no leverage and he has to really hustle to keep his business alive. This is how most entrepreneurs start. Those who succeed figure out that they must graduate from Quadrant #2 to Quadrant #3.
So Frank eventually gets things off the ground. He hires employee number 4 to be the cashier, employee number 5 to man the grill, employee number 6 to take care of trash and cleaning, and he hires out his bookkeeping to a freelancer. He now is strictly the owner. His business is bringing him income no matter how much he decides to show up to the store or if he even shows up at all. He can now take that well deserved family vacation and continue to earn residual income while he’s on the beach. This is true business ownership with leverage. Frank is now a member of the illustrious Quadrant #3.
Fast forward 10 years. Frank has now become financially independent through his business. He has enough passive income every month to cover his cost of living and then some. He starts to have a bunch of extra cash piling up in his accounts. So he simply invests in other burger joints by giving young guys, that are in the same shoes he used to be in, the $100,000 they need to open their burger joint and in return he gets 10% of their profits every week. So he invests his $100,000 and his money goes to work for him. He now makes an extra $10,000 a week with no effort whatsoever. This is quadrant #4.
Another way that Frank earns cash flow in Quadrant #4 is by taking some of his excess savings and dumping them into stock market investing, through index funds, where his money will grow for him over time. In this way he has leveraged his dollars to earn more dollars for him independent of any effort that he puts forth. All he has to do is set up the investment account appropriately, dump his savings into index funds, and watch the money grow.
There are millions of stories like Frank’s. Where an average blue collar worker learns skills and works hard. Leverages those skills and becomes an entrepreneur. Then builds a business around those skills and passions. And eventually finds himself financially free. This process is possible for EVERYONE. It just requires some sweat and ingenuity. Just find a way to begin earning income from Quadrant #3 or Quadrant #4. It can take many trials and errors to create sustainable income streams from businesses or investments. So it is important that you don’t waste any more time and you start working on developing income streams from one or both of these quadrants ASAP. The longer you wait, the longer you delay financial independence, and the longer you will have to trade your precious time on this earth for cash.
Get Your Income From Quadrants #3 and #4
Okay so hopefully you now have a solid understanding of the cash flow quadrants, what they mean, and what it takes to earn cash from each one. So now the question you need to ask yourself is which quadrants am I earning most of my income from now and what can I do to get myself entirely onto the right side of this graphic? It should be obvious why this is so important. A job can disappear. If you're self employed an injury or an illness could cause your income to go to zero. But if you’re in Quadrants #3 and #4 you are nearly untouchable. You and your family are set up for financial success and security. Even if you love the job you work at as an employee and plan to work it forever, it is imperative that you establish streams of income from Quadrants #3 and #4 just in case. And for most of us earning more and more while working less and less would be pretty nice...
Do not get overwhelmed by this and say things like, “I’m not a business person, I don’t know how to invest, I’m happy being an employee.” That mindset is exactly what keeps 99% of people working like slaves until the day they die. The fear of learning something new and taking a few risks keeps people stuck in the endless rat race, living paycheck to paycheck, and having more month at the end of the money. Gaining leverage and earning cash flow from the right side of the graphic comes in many different shapes and sizes. But everyone can, should, and must find a way to earn money while they sleep.
“If you don’t build your dreams, someone else will hire you to build theirs.”
So what are your options? How do you join Quadrants #3 and #4? Well there are a few tried and true methods that have worked for centuries. As a businessperson you can start your own business, purchase an existing business, or franchise a chain. As an investor you can plow your savings into stocks & equities, bonds and insurance, real estate, and venture capital. These tools have been used by the wealthy to get wealthy and stay wealthy for centuries
The dawn of the internet, however, has made joining the wealthy even more accessible to the average person. Online stores, freelance businesses, and network marketing were not options 60 years ago. Being your own investment broker with Vanguard or Etrade was not possible before. New investment vehicles like peer-peer lending and crowd sourced funding make investing possible for low net worth individuals. Business in the sharing economy, like a thriving vacation rental business through Airbnb or a rental car empire through Turo, were simply not possible before.
In today’s day and age there is no excuse. Everyone can, should, and must begin to create income streams from businesses and investments.
My Journey Through the Quadrants
The first time I was exposed to these cashflow quadrants, I knew immediately I could waste no time. I knew I had to find ways to get into business for myself and start investing. The longer I put this off the longer I would be dependent on someone else for my income.
At the time I was a full time Civil Engineer designing roadways, waterlines, sewers, and other infrastructure. I worked Monday-Friday from 8-5 and I was paid a salary in return for the time and energy I gave the company. This job paid a phenomenal salary for a 22 year old but it was still just that, a salary. And I couldn’t possibly envision myself keeping up this trading of time for dollars for the next 40 years of my life. So I got to work on other ventures.
I tried and failed to start a traditional business with some very talented friends of mine. The effort, up front investment, and knowledge needed were 10x what we had at the time for and my partners and I eventually decided, after months of effort, that we may be barking up the wrong tree. I knew personally that I wanted to get out of my J.O.B. as fast as possible. And a traditional business was going to take years possibly to get off the ground.
Luckily I had an incredible opportunity in front of me for years that I just hadn’t seen. So much of success in business and life is seeing the right opportunities at the right time. The opportunity for me was the network marketing business model. I had watched countless people, in my life, create full-time incomes, six figure incomes, and even seven figure incomes for themselves with this model. I just didn’t see it as an opportunity for me until I knew about the cash flow quadrants and understood what the business model truly was.
This business model allows any average individual the opportunity to go into business for themselves for just a few hundred dollar investments. The upside income potential is legitimately unlimited. It allows one the opportunity to earn an income from Quadrant #3 on a part time basis until they grow their income enough to leave Quadrant #1 behind and live off of the residual income from the network marketing business.
In a later article I will break down this industry and business model in more detail and give the long version story of how I got started and what it did for me. But long story short is I built my business on the side for a year and half while working as an engineer and was eventually able to quit my J.O.B. and live off my growing residual income. This gave me more time to travel, to read, to finally start this blog, and so much more. The freedom it has allowed me is incredible.
This freedom should not be delayed. You too can have this kind of freedom now, whether you are 20 or 60. You just have to be willing to work for it. It is not easy to grow income streams from businesses and investments. That's why most people remain in Quadrants #1 and #2. But it is POSSIBLE for anyone. Just find the right vehicle for you and work hard at it until you too can leave your J.O.B. behind for good!
Moving forward I plan to continue to grow this residual income stream and systemize things so that the business can continue to grow with or without my constant focus. I also plan to dump more and more savings into investment vehicles like Vanguard Index Funds so that one day (well before age 65) I can be completely financially independent thanks to quadrants 3 & 4, a goal that I think everyone should have!
If you would like to chat about the details of how I was able to leave behind my J.O.B. schedule a virtual meeting with me. I’d love to connect with you and share my experience!