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Once upon a time there were 3 sisters—Sally, Susan, and Sarah—who lived in a suburb far far away. They had normal lives, a normal upbringing, and kind, supportive parents.
But they made very different choices.
Sally is a freelance writer and makes $20,000/year, working 25 hours per week.
Susan is a software developer and makes $70,000/year, working 50 hours per week.
Sarah makes $57,000/year, working 0 hours/week. She’s a retired lawyer with a $950,000 portfolio generating 6% return a year.
Who makes the most money?
Well, at first glance, Susan does, at $70,000/year. But what happens when we take taxes into account?
Assuming that all 3 sisters live in Ontario, here’s what happens to their salaries after taxes:
- Sally makes $18,359.03/year. At a 8.2% tax.
- Susan makes $54,770.61/year. At a 22% tax rate.
- Sarah makes $55,399.05/year. At a 2.8% tax rate.
As it turns out, Sarah, the retiree, actually makes the MOST money because she pays the LEAST tax.
Why? Because investment income is more favourably taxed than employee income.
That’s why, as an employee, Susan pays a WHOPPING 22% in taxes whereas Sarah pays only 2.8%. YEESH! No wonder Warren Buffet says his secretary pays more tax than he does.
As a retiree and investor, Sarah not only has the most freedom, she pays the least taxes. And unlike Sally and Susan, who are trading hours for dollars, her investments continue paying her even in her sleep.
If you’ve ever read Robert Kiyosaki’s “Cash Flow Quadrant” you’ll know what I mean. (Full disclosure: this is an affiliate link. But if you’d rather get it from the library, I won’t judge)
Now, you might be wondering, why the HELL are you promoting Robert Kiyosaki? Isn’t he the “Rich Dad Poor Dad” con man who sells bogus “get rich quick” courses?
And yes, you are right. His courses are complete bullshit and most of his books are crap (borrow them from the library, don’t buy them), but this book is the exception. I’m not a fan of Robert, but I LOVED this particular book. And the part that struck me the most and stayed with me was:
The Cash Flow Quadrant
To give you a bit of background, the Cash Flow Quadrant is the idea that we all fall into 1 of 4 categories:
- Employee (E)
- Self-Employed (S)
- Business Owner (B)
- Investor (I)
The people on the LEFT side (E and S) work the longest. This is because they trade hours for dollars. If they decided to NOT show up for work, the money STOPS coming in. 95% of people are in these quadrants, generating 5% of the income. I was one of them.
The people on the RIGHT side (B and I) work the least for the most gain. This is because these people have invested in assets that continue working even when they don’t.
The business owners (B) have invested in staff, machines, etc, that make money for them. The investors (I) have invested in assets (stocks, real-estate, etc) that pay them to own them. This is why B’s and I’s say they make money in their sleep, because they really do! 5% of people are in these quadrants, generating 95% of the income. I am now one of the 5%.
When you are in the LEFT side, as an employee or self-employed person, you are either poor or middle class, because your hours are limited, and you can’t scale your time to get rich.
BUT, if you were to become Financially Independent, and move from the E or S quadrant to the I quadrant, you’ve moved from being a poor/middle-class employee—who works the longest and pays the most taxes—to a rich investor, working the least and paying the least taxes.
Which brings me to my favorite Robert Kiyosaki quote:
“Poor people buy things, middle-class buy houses, and rich people buy assets.”
People who buy things are poor because all their net worth is in depreciating assets such as clothes, gadgets, and cars. Sometimes this is out of necessity and totally not their fault.
People who buy houses are middle class because all their net worth is locked in 1 asset and they can only cash out if they sell. While they own the house, they must continue working because they can’t just sell a brick or a window to pay their bills.
People who buy assets are rich, because they pay the least taxes while enjoying the most freedom.
And I know because I have been in all 3 at various points in my life. Growing up, I was poor. My parents could only afford a tiny 1-bedroom rental apartment for all three of us, so I lived in the closet (but I did have all the moth balls my little heart desired, so there’s that.). Back then, my parents had so little money that when I got a present from a friend, they took it and re-gifted it to other kids because they couldn’t afford to buy presents themselves. Those were good times.
And then when I started working, I became middle-class. Only I refused to buy into the housing mania out of sheer stubbornness.
And now, somehow by stumbling into Financial Independence, I became rich. I pay almost no taxes and make money in my sleep.
Going from poor to middle class is REALLY hard. But going from middle class to rich is surprisingly easy. Just copy our moves and you can do it too.
And this is why I know what Robert is saying is true. The rich don’t buy things or own houses. The buy assets and as a result, pay the least taxes and enjoy the most freedom.
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