“Go to school, get good grades and get a good job”; a common and risky approach to life which more often than not ends up in a financial struggle.
In my early days I read a book by Robert Kiyosaki titled “Rich Dad Poor Dad” which completely changed my perspective to life. In this book, Kiyosaki highlighted the importance of “passive income” which he argues is the key to financial freedom.
Passive income is income received on a regular basis, which requires little or no effort from the beneficiary to maintain it.
On the flip side, earned income is income received on a regular basis which requires a considerable amount of effort to maintain it.
Financial freedom is attained when an individual’s passive income equals or exceeds their expenses.
In simple terms, you are financially free when you don’t need to move a muscle to survive. In the sample financial statement below, the person is 50 pounds away from financial freedom.
Let’s look at the life progression of an average person; say John.
Stage 1 – The Foundation: John grows up being told to go to school, get good grades and get a good job. In the early days of John’s career, his expenses are fairly low and easily sorted out by the earned income from his job. As time goes on, John progresses in his career; more earned income, however, only slight increases in his expense column. John becomes comfortable and decides its time to get married.
Stage 2 – Financial Growth: His wife (Jane) then moves in with him. Their combined expenses reduce as a result of shared bills such as rent, electricity and water. Their disposable income increases. Promotions at work; even better. Life is good!
Stage 3 – The Rat Race: Children pop into the picture. John and Jane decide they need to move to a bigger house (which they assume is an asset) and probably get a bigger car. Better holidays in more exotic locations? Sure! The expenses begin to climb but at this time in life its much harder to increase the earned income (the higher you go in your career the harder it is to get a significant increase in pay). John and Jane begin to struggle to keep up with the rising expenses and become ever more dependent on their jobs which at this point they cannot afford to loose. The Rat Race!
In simple terms, assets are resources that generate income; i.e. put money in your pocket. Examples include real estate, bonds, stocks and royalties. Assets are used to generate passive income.
A liability is anything that takes money out of your pocket. Examples include Loans, mortgages and cars.
John gets into this rat race because he’s not educated financially and thus does not understand how money works and how he can make it work for him. If John was taught the need to convert his earned income into an asset which will work for him in the short and long-term, probably he wouldn’t have ended up where he did. John should have been taught to slowly migrate from working for money (earned income) to having money work for him (passive income). John should have started early, in stage 1 & 2, to invest his earned income into assets which would result in cheques in the post periodically without much effort.
In summary, financial education teaches you to build your assets column using your earned income or other means to a point at which your passive income exceeds your expenses. At this point, the less financially ambitious people can go play golf all day long! Financial freedom!