Income

 

I suppose this subject won't need any introduction. I’m sure everybody knows what an income is.

 

Even kids know when it is time to get allowance from their parents. So we are going to skip any formal definitions.

 

In my book, income means actual money coming in.

 

For this book's purposes, gross income is irrelevant.

 

What we are interested in is net income also known as take-home-pay. Here in Malaysia, the Malays fondly call it as "mashyuuukkk!" which means money going into your pocket or bank account.

 

Please note that tax planning can make a difference to your take-home-pay but it is too complicated to be covered in this book. So if you have a huge gross income, please hire a proper tax consultant to maximise your return.

 

There are two types of income, active and passive.

 

In simple terms, active income is when you have to work for the money.

 

Passive income on the other hand is when the money work for you.

 

Salary, overtime, bonus are active income. Home business and freelance work are also active income. No Work No Pay.

 

Here are some examples of passive income that I got from Wikipedia:

 

• Earnings from a business that does not require direct involvement from the owner or merchant
• Rent from property
• Royalties from publishing a book or from licensing a patent or other form of intellectual property, such as computer software product
• Earnings from internet advertisements on websites
• Dividend and interest income from owning securities such as unit trusts, stocks and bonds
• Pensions

 

Even if you play with penguins all year round, passive income will still be credited to your account. No Work Still Got Paid. How awesome is that!
 

Passive Income - Expenses > 0 = Financial Freedom
Passive Income - Expenses < 0 = You Will Work Till You Die

(Active + Passive) Income - Expenses = 0 = You Are In Trouble
(Active + Passive) Income - Expenses < 0 = You Are In Double Trouble

(Active + Passive) Income - Expenses > 0 = There Is Hope That You May Not Work Till You Die

How so?

(Active + Passive) Income - Expenses > 0 = Surplus Cash = Investment = Passive Income

Over the years if you diligently invest your surplus cash, your passive income will grow and eventually surpass your active income.

 

When your passive income exceeds your expenses, treat yourself to a nice holiday. You can now say sayounara to your job!

Homework: List down your income. Refer to your asset list if need be. Identify whether they are active or passive. This is going to be part of your Cash Flow Planning which will be covered in Chapter 7.

As a general rule, when you started working active income will dominate your portfolio. Over the years if you manage your cash flow well, your passive income should take over.

 

How fast it should take over, depends on how fast you wish to retire.

Expenditure

No lengthy formal introduction required. In simple words, expenditure or expense is money going out.

 

For our purpose, there are three types: fixed, variable and emergency.

 

Fixed expenses are those that mostly resulted from you signing on the dotted line.

 

Housing loan, car loan and any contract that has a locked-in period like maybe your internet plan or credit card's 0% instalment payment.

 

Most of these contracts are quite tricky to disengage yourself from without incurring extra costs and acute headache.

 

Let me give you an example, the housing loan. Let's say you lost your job. For you to discharge your housing loan, you need to sell the house.

 

What if during that time the economy is also in recession? You can choose to let the bank foreclose your house but that would tarnish your financial rating. You will have problem later to get new loans.

 

The point I’m trying to make is, think carefully before you commit yourself to a fixed expenditure. In the case of a house, maybe instead of buying you could rent. Even though rental is also a fixed expenditure but it is an easier contract to terminate.

 

Please don’t get me wrong. I am not saying that you should not buy a house. What I am saying is you should not buy a house just because your BFF bought a house.

 

Always answer these questions before you sign on the dotted line:

 

• Are there any other alternatives?
• Is this the best option?
• What is the exit strategy if I can't afford to pay?

 

Variable expenses are your day to day expenditure.

 

Buying clothes, handbags, shoes, food are under this category. You need to pay close attention to this area because this is where impromptu and normally illogical spending happened.

 

"But it was on sale!!" Sounds familiar?

 

Emergency expense is self explanatory.

 

If you don't manage this well, it could lead you to financial ruins. Be warned!

 

I've watched enough Korean drama series to know that a lot of people were forced to turn to loan sharks during emergency. A loan shark is a person or body that offers loans at extremely high interest rates.

 

Once you get in, it is quite difficult to get out. Since their businesses are flourishing all around the world, I believe the threat is very real. The scriptwriters are not making it up!

 

So keep this in mind when you wish to buy another pair of shoes, handbags, or latest gadgets that you can live without:

 

• Do I have enough in my Emergency Fund?
• Should I set aside the money for emergency instead?

 

Homework: Go through your Liability List. Identify whether the expenses resulted from the list are fixed or variable. Start to think of ways to reduce your expenditure (both fixed and variable).

 

Do you have enough savings to cater for any emergency expenses? If not, do you have family support in the event of emergency? If not, what are you going to do about it?

Surplus - Deficit

 

Remember these formulas?

 

Income - Expenses > 0 = Surplus Cash
Income - Expenses = 0 = You Are In Trouble
Income - Expenses < 0 = You Are In Double Trouble

The secret to achieve Financial Freedom is you must always have surplus cash. That is all there is to it. Nothing complicated. Everybody can do it.

So the first step in this journey is to make sure that you have surplus cash at the end of every month. There are two ways to go about it. Either you increase your income or reduce your expense.

 

You will reach your target faster if you can increase your income and reduce your expense.

How to increase your income?

 

Ask your boss for a raise? It would be fabulous if you can do that! Some of you may be able to do that but most of you most probably can’t.

A few other ways are:

 

• Quit your present job and change to a better paying job
• Do part-time job
• Start a part-time home business
• Improve your skills so that you can be promoted faster

 

I am sure that if your surf the internet you can find more ideas. Just bear in mind that there is no such thing as easy money. Be mindful of scams. If it seems too good to be true then chances are it is.

 

So be very careful. You want to make money not lose money.

Perhaps now is a good time for me to introduce two new concepts.

 

First one is patience. Nobody could and should be rich overnight. It is against the order of the universe. If you don't believe me, ask Bill Gates or Warren Buffett. I am sure they will say the same.

 

People who won lottery, not all of them stayed rich. Some ended-up broke or dead!

Check these stories:
http://newsfeed.time.com/2012/11/28/500-million-powerball-jackpot-the-tragic-stories-of-the-lotterys-unluckiest-winners/
http://www.money.co.uk/article/1002156-how-the-lives-of-10-lottery-millionaires-went-disasterously-wrong.htm

There is a perfectly good reason why people should not turn rich overnight. They won't have the experience to handle their wealth.

 

If you start small and slowly build up from there then by the time you reach your financial target you will be so comfortable in handling your wealth that it is like your second nature.

So be patient and persevere. Nothing is sweeter than the taste of deserved success.

“Patience can be bitter but her fruit is always sweet.”

 - Habeeb Akande

“Success is sweet, but the secret is sweat.”

 - Norman Schwarzkopf

The second concept is delayed gratification.

 

This will enable you to control your expenditure. Instead of buying everything that you want now, attach target to it. For instance, you will only buy the new iPhone if you can increase your savings by 30% in 3 months. The more expensive the reward, the more stretch the target should be.

 

This way all the expensive stuff that you buy will not merely be a vain exercise but each and every one of them will represent your success. Try it. It is gratifying!

How to reduce your expense?

 

From my experience, to reduce your expense is not easy. Most especially when most of your expenses are under fixed category.

 

The easy target is of course your variable expenses. Instead of buying books may be you can borrow them. Instead of buying newspaper maybe you can just read their free online version.

 

There are many sites in the internet that can teach you how to save costs. Do check them out.

Even though it is not going to be easy, you must always try to find opportunities to restructure your fixed expenses.

 

When it comes to your financial well being, it pays to be well informed. Always keep track of the latest development in your big ticket items like housing and car loans. Go to Finance websites and forums once in awhile. They have a lot of good tips.

 

I made a big mistake once and still paying for it now. I didn’t check the forum on time because I was busy with work. By the time I checked, it was too late. That mistake costs me 0.35% p.a. extra in interest expense every year.

 

In percentage term it may not look much but in absolute term, year after year, it is a lot. What to do? You win some you lose some. To stay in the game, just make sure that over the years you win more than you lose!

Whenever you are with your friends besides the juicy gossip stuff, try to talk about finance occasionally.

 

After listening to my friend's story about her loan refinancing escapades, I called my bank. Within a month, my interest rate was reduced. My housing loan restructuring saved me close to $6k a year in interest costs!

Another way to manage your expense is to not let it grow faster than your income growth.

 

If your net income increases by 10%, make sure your expenses maximum expansion is 5%. If you can keep the expansion to 0%, then half the battle has already been won.

By the end of Chapter 3, you should be able to know how much is your monthly cash surplus or (God forbids) deficit.

 

Homework: Devise ways (legally!) to increase your cash surplus and take immediate action. Start with the low-hanging-fruits like stop buying newspapers or reduce your cigarettes intake.

 

Always bear in mind that “procrastination and time are your greatest enemy”.