Passive income can also come from interest on savings accounts, bonds, certificates of deposit (CDs), stock dividends, patent royalties from inventions, and royalties from books, songs, and other original works.
Your job as an investor is to convert your ordinary earned income into portfolio and passive income.
It’s important to note that each of these types of income is taxed at a different rate. Ordinary income is taxed at the highest level. The government takes the biggest chunk from the money you work so hard for in your job or business. Portfolio income is taxed at a lesser rate. Passive income is taxed at the lowest rate. When you invest for passive income, your money is working for you, plus you get to keep more of that money since it will be taxed at a lower rate.
Expenses
These are the monthly expenses you pay out each month, including such things as your mortgage payment (or rent payment), car payment, student loans, food, car and gas, utilities, insurance, clothes, eating out, medical bills, and so forth.
The Balance Sheet
The Balance Sheet is made up of:
• Assets (things that put money in your pocket), and
• Liabilities (things that take money out of your pocket).
Assets
The Rich Woman definition of an asset is not the definition you’ll hear from your traditional accountant. The conventional accountant will tell you that an asset is “something of monetary value that is owned by an individual or company.” By that definition, your alarm clock and your everyday dishes could be considered assets!
Most accountants go crazy with this definition because they want to classify your shares of stock, your jewelry, your personal residence, your cars, and your mutual funds as assets. To us, none of these things has any value until the day you sell them. If you sell something and make money, it’s an asset. But if you sell something for a loss, then it most definitely is not an asset.
Using the Rich Woman definition:
An asset is something that puts money in your pocket, whether you work or not.
Why use such a definition? Because a clock and some plates and bowls will not get you closer to your financial dream, but something that is putting money in your pocket whether you work or not will.
Liabilities
Again, we go to battle with the traditional definition of a liability. Most accounting professionals will tell you that a liability is “an obligation to pay an amount you owe to creditors, be it an individual or an organization.” The Rich Woman definition begs to differ.
A liability is something that takes money out of your pocket.
You can see the dilemma. Most would list their Mercedes as an asset or something of value. We, however, would list the Mercedes as a liability because every month it takes money out of your pocket. “But it’s paid for!” you argue. The car loan may be paid for, but what about gasoline, tune-ups and repairs, and insurance?
The biggest fight we get is when we tell people your home, your personal residence, is not an asset. We received a lot of flack for that, especially when times were booming and people were taking out loans against their home, sometimes two or three times. It wasn’t until the real estate market crashed and people found out that they owed more on their house than it was worth before they started to understand this principle.
The problem with people calling their liabilities assets is that they believe they are financially better off than they really are. When the economy turned, many people were forced to face reality. They are now realizing what they have and how long they actually can survive financially.
This is why the concept of “net worth” means very little in the real world. When accountants calculate your net worth, they list everything but the kitchen sink. In most cases, to have the dollar amount your accountant attaches to your net worth, you would have to sell just about everything you own—at whatever the market will bear at the time.
This does not mean you shouldn’t buy a house or a BMW or a new Cartier watch. It just means you shouldn’t fool yourself into thinking that your liabilities, items that take money out of your pocket, are assets.
Pocket Science
Assets and liabilities are not difficult to understand. Many people have commented that “it’s not rocket science.” And it’s not. I think of it as pocket science—specifically “put-it-in-my-pocket” science. So as you pursue your financial goals, see, feel, and hear that money flowing into your pocket.
A Different Focus
Here is the revelation I had when looking at the income statement and balance sheet.
The key to financial well-being is to focus on acquiring assets.
I was always told to focus on the income column. I was taught to get a job and work hard and keep getting pay raises. Or if I worked on an hourly basis, I should put in more hours or increase my hourly rate. The focus was always on income, specifically ordinary earned income—increasing my salary, wages, or commission. As long as I put my focus and attention there, then I would be working hard for that income all my life.
The lights came on when I realized that the key to financial well-being is not to focus on acquiring income, but to focus on acquiring assets.
When I made that connection, life became easier, both in my personal financial life and in our Rich Dad Company business. I focused on acquiring assets personally and also focused on the assets we were building within our company. Yes, our books and board games are assets because every month those products generate cash flow in sales to the company and royalties to me and Robert. But the question we began asking throughout the company was: What new assets are we building today? It is simply a different way at looking at the world.
Let me tell you about our new venture, an asset-in-the-making, into digital games… and introduce Nicole Lazzaro.
Nicole is extremely smart and talented and is recognized as one of the top women in the world of digital games. She owns a consulting company and her expertise is in demand by well-known, influential companies all around the world.
She and I were having breakfast one morning, and she pulled out her iPhone to show me a new game she was developing. She was really proud of this game. She said, “In my consulting business XEODesign, my clients hire me. I love what I do, and I love my clients. They want my knowledge and experience to help them make their games more fun. However, I only earn money when I work for them. So I saved up for several years to self-finance an iPhone game called Tilt World. This is my first asset that puts money in my pocket!” she declared triumphantly. “For me, having my own assets gives me the financial freedom to pursue my own creative designs and dreams.”
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