Many successful entrepreneurs have quit their cushy $100,000 a year job working for big companies like Wall Street and never looked back since. In this article, we’ll go over the 3 types of income you should know about that no one ever taught you or that schools don’t usually teach.
After college, when you enter the workforce and get your first adult job, you think “Yes, I made it!”. Well, all or most of our lives, we’ve been taught that hard work + good education + good-paying job = equals success.
You’ve heard “as long as you get good grades go to college and earn a good salary, your life will be Awesome”. What we learn in school, is about subjects like algebra biology history, literature, but really nothing about how money actually works.
Everything about the education system and society is designed to train you to become a good employee. As Robert Kiyosaki put it best,
“Workers work hard enough to not be fired, and owners pay just enough so that workers won’t quit.”
― Robert T. Kiyosaki, Rich Dad, Poor Dad.
And basically just blindly follow this formula of hard work good education +, a good job, equals success. So many people after college have awesome jobs making six figures and think that’s it.
However, after a while, when you start to question things, you realize how many trade-offs you make at your job. For example:
- spending most of your waking hours at work,
- not having any time or energy to do other things that you want to do with your life.
- No time to travel everything
- Having a bad sleeping or eating schedule
Basically, your social schedules all revolve around my job. So even though you make good money, you really don’t feel like you have any control over your time
What does it really take to be financially successful happy and fulfilled?
As GaryVee says: “The truth is that finding happiness in what you do every day is so imperative.” – Gary Vaynerchuk
When you realize that there has to be a lot more to life than just getting a good-paying job, your mind opens. If you like your job, then fine, but if you don’t, your life can be miserable.
And here is what you quickly realize: Not all income sources are created equal, yet most people focus on the WORST type of income, meaning the type of income that is taxed the MOST, the most TIME-CONSUMING to earn, and has capped income potential.
Read until the end to learn about the differences in how these three types of income work.
Type of Income #1: Earned Income
Earned income is a paycheck income, income from your job, and is the worst type of income. It’s the only type of income that we’re taught to go after when we are in school (i.e., get a job).
Earned income = wages, salaries + tips, bonuses, commissions etc.
Earned Income is the worst one to work for because it’s the most heavily taxed type of income and it’s the most time-consuming to earn.
Even if you have a good six-figure job, you will realize that tax laws favor business income and investment income.
You will always end up paying the most taxes if you go for Earned Income. An investor or a businessman earning $200K/year vs an employee earning $200K/year end up with way different amounts because of taxes.
Here is the lesson:
Your paycheck or earned income is always subject to these taxes: federal income tax, Social Security & Medicare tax, State tax, and city tax, depending on where you live.
So if your salary is $100,000 a year, which sounds great on paper, your actual take-home pay is going to be more like $60,000 a year.
What most don’t even know about earned income is that the more money you make, the more promotions you get, the more taxes you’re going to keep paying because earned income always follows a graduated income tax schedule => higher salary translates to higher tax bracket.
Example: If you are a single head and you live in NYC, the highest tax bracket is about 51% in total taxes on your paycheck income. So on a $100K salary, removes 51% of that and give it to the government.
Compare this to how the tax code treats investment income. There are a lot of reasons why income from an investment is superior to paycheck income one specific example is dividend-paying stocks. Many stocks pay what’s called a qualified dividend, which you’ll typically get deposited into your account once a quarter, while you sleep.
These investment dividends are taxed at 15% in the lowest tax bracket and 20% in the highest tax bracket, compared to 51% on earned income if you’re in the highest tax bracket.
The math is simple.
This is how the rich get richer and make most of their money through capital gains on investment income: IT’S about the TAX CODE.
Type of Income #2: Business Income
The second type of income is business income, which is money that you get from the profits of a business that you own and operate.
It gets even better with business income. Note that:
- the corporate tax rate is 21% flat, compare that to an income tax rate of 37% if you’re an individual.
Furthermore, the way businesses pay taxes is that they pay taxes on their income after their expenses (NET income). This is actually the opposite of how you as an employee have to pay your taxes.
As an employee, you get paid your income, then you get taxed on that income (GROSS Income), and then you have to live on the remaining after-tax income.
On the other hand, a business gets its income from its sales products and services, reports all the legitimate business expenses with receipts ( such as a new laptop, you know, newsletters and subscriptions, lunches and dinners out with clients and prospective customers), and then get taxed on what’s left.
This is exactly how someone pays less and less in taxes even when he/she makes more money than they ever made at a job. You can see how much more favorable the tax code is if you’re a business owner versus an individual.
Unfortunately, we are not taught this in school, even though investment income is way superior to earned income. Schools don’t give us the financial literacy that we would need in order to make a living on business and investment income.
Instead, we always hear the default path: get a good job, get a good salary, and make earned income for the rest of your life.
For paying a boatload of taxes, more than anybody and working for the man for the rest of your life. But don’t worry, because in a minute. I’m going to share some simple ways
Another benefit of business income is the time aspect. Earned income is the most time-consuming type of income to earn because when you work for a paycheck, you’re trading time for money. You get paid only when you show up for work, do a bunch of stuff from nine to five or even longer hours depending on what kind of job you have.
Realize that the minute you stop working, money stops coming in. The ONLY way to make more money is: either work more hours, get a second job, or take on more shifts, or increase your hourly rate.
The drawback is that you put a cap on your overall income potential like even as a neurosurgeon making $700 an hour because your income potential is still limited since everybody only has 24 hours in a day.
With business income, once you build a business, as long as you put systems in place you hire good people, then you’ll be able to serve more and more customers meaning, you have unlimited income potential.
So if you can hire good people to run the business for you. You can get out of that equation of trading time for money.
Look at Jack Ma or Bill Gates, founders of Alibaba and Microsoft who recently stepped down from the boards to focus more on his philanthropic work, yet they still own a lot of stock in the company and make billions off of that.
They are not actually doing a lot of work to run Microsoft, they leveraged other people’s time for that.
It is the number one reason why business income is so much better than earned income.
Type of Income #3: Investment Income
Now let’s talk about investment income. The investment income is when you own assets like stocks, bonds, and real estate and these assets throw off income for you in the form of dividends, interest capital gains.
Investment income can be even more passive than business income, although it takes some capital to get this income going once you buy a stock or an index fund you buy it once and for as long as you own that asset.
You’ll continue to enjoy dividends and capital gains for many years to come.
How do you decide which one to Go for?
So now let’s talk about how you can incorporate some of this advice into your own finances.
On a piece of paper, make three columns:
- one for earned income,
- one for investment income
- one for business income
Write down all of your income sources and put them in the right category.
So if you have a paycheck from a job, a second job (driving Uber on the weekends, freelancing), put that monthly amount under your earned income column.
If you own some dividend stocks, a 401k funds that also pay dividends, find out what the dividend is on a monthly basis, and put that under investment income.
So once you filled out all three columns, take a look and ask:
Where is most of my income coming from? Is it coming from all earned income?
Do I have any of business income and investment income?
Assess whether you’re earning the most leverage most efficient tax-efficient types of income.
You can be now more intentional going forward about what other types of income to focus on.
You’ll have to be clear about what you want your life to be like.
MY ADVICE: take the earned income you get from your job, and turn that into the other two types of income.
So take a portion of every paycheck, and invest some of that into index funds stocks, bonds, real estate assets that will provide investment income while you sleep.
So think about how you can convert earned income, which is a type of income we all start with, and convert that into the other two types of income.
How to Start? Which business to Launch?
If you want to create some business income wake up early or dedicate some time on the weekends to build a side business, such as:
- a YouTube channel that provides Adsense revenue,
- create an online course,
- do Amazon FBA,
- Start a blog and monetize it,
- start an Airbnb business,
- build an app if you know how to code.
There are so many ways to start your own business and basically be your own boss. There are lots of ways to monetize your skills and your interests in business income but remember it requires upfront sacrifice.
You are talented, so get creative, don’t make excuses because you have that potential in you.
As long as earned income is your only source of income and you don’t do anything to convert that to the other two types of income, you will never be free.
Earned vs Investment Income Video Tutorial
I love this video from Grant Cardone giving you all the juice about making more money.
The key takeaway here is that all things being equal, if most of your income comes from investment income versus Paycheck or income or earned income, you’ll be able to keep a lot more of what you make. Because tax treatment is so much more favorable.
Even if you love your job and it pays well. The truth is that no amount of money is worth working for and trading time for money, the rest of your life, especially paycheck income because literally your time equals your life.
And no amount of money can buy back your time. Your life, your time is really the one thing that’s more precious than money, and the only way to get off that idea of trading time for money is to understand those three types of income and be very intentional about which ones you spend your time and energy on.
Neither schools nor our parents teach us those concepts.
Yet it’s the kind of financial education you need early on in life to become free and successful, even before you take $1000s of student loans to get a degree, and then to get a job.
Here are two quotes I really like:
“The key is to work extremely hard for a short period of time (1-5 years), create abundant wealth, and then make money work hard for you through wise investments that yield a passive income for life.” — H.W. Charles
“He who makes $25,000 annually through passive income is more enviable than he who earns $100,000 annually through a salary.” — Mokokoma Mokhonoana
Please share this post to inspire others.