Your income pays for your lifestyle spending, determines your ability to borrow, save, build wealth and gift. Given its importance, I feel it doesn’t get the attention it deserves. As a financial planner the path of least resistance is to focus on spending first but if you can increase your income as well, it can accelerate progress towards your financial goals.
Types of income
There are two types of income, active and passive. Active income is earned in the process of work, whereas passive income is generated by receiving an income from an asset. Some examples of passive income assets are a pension, an investment, an annuity, rental property, royalties, company dividends and so on. If you spend all your income, you spend time at work to earn, you will always have to work. Even if you enjoy work and can’t imagine doing anything else, will you have the same motivation, energy, health and ability in years to come? Do you do yourself out of the choice of choosing to work rather than having to work? Good money decisions today make for better options in the future. Delayed gratification is a superpower.
I believe financial freedom is the last remaining hurdle to true freedom. The need to go to work to earn a living is the last frontier restricting you from doing what you want, when you want. Financial handcuffs so to speak. It always comes back to your economic limitations. Being financially independent affords you the security and freedom to choose how you spend your time. To achieve your desired passive income, you will need to save and invest the relevant percentage of your active income consistently over time.
How to value your income?
You can value your income by valuing your time. None of us know how much time we have, the known unknown. You spend time at work to earn your income. Therefore, we can determine your income per hour by dividing the hours you spend working into your income. For example, if you earn €50,000 per year after tax, working 8 hours a day, five days a week, for 48 weeks of the year, you will have an after-tax income of €26 per hour. If your weekly food shop costs €100 you will have spent a little under four hours working to purchase your weekly groceries. When spending your money, you are spending the time it took you to earn that money too. Your time is finite, money and spending are infinite. Money can be hard earned but easily spent.
Your current income
Is your current income enough to fund your lifestyle spending, debt repayments and savings goals? Lifestyle creep is when your spending rises to meet your income. In the absence of the right structure’s, lifestyle creep is a natural default. An example of this would be a pay rise. The initial bump in income is quickly absorbed by your lifestyle spending. This invariably leads to a lack of savings for our future needs and wants. A large income does not make you wealthy, on the contrary, it is often high-income earners who don’t feel the need to manage their money due to the abundance of income they receive. An accurate budget (giving every euro a job), a sinking fund (a fund for irregular future spending), a savings rate (spending less than you earn), an emergency fund (insulating you and your family from unforeseen events), insuring debt & your income against injury, illness and death and funding your financial independence through your pension are some basic examples of the structures that are needed to keep lifestyle creep in check. It all comes down to your values and priorities. If your spending and debt repayments are high you’ll likely have little or no savings. If you spend what you earn or more than you earn, you will need to spend less &/or earn more. Create a savings rate by reducing spending, increasing income, and eliminating debt.
Start treating your personal
finances like a business. You Inc. You should adopt the same approach a
business does. A business receives income from selling a product or service. An
employee or business owner exchanges their time, energy and skills to earn an
income. A business has running costs in the form of expenses, and you have a
lifestyle in the form of spending on needs and wants. After a business has
deducted its expenses from its sales, there’s a profit, loss or it breaks even.
In general, if a business doesn’t make a profit for a sustained period of time,
it won’t be in business long. Your personal finances are no different. After
you deduct spending on your needs and wants from your income you will be left
with a profit (savings), loss (overspending &/or debt) or break even (spent
what you earned). Spending more than you earn or what you earn isn’t
How much is enough?
Wealth is relative. If you picture wealth or income as a pyramid and you live in Ireland, you are likely to be towards the top of the pyramid when compared to large parts of the rest of the world. That might be scant consolation to you, but it lends perspective not only to look ahead but to look behind too. Being grateful for what you do have as opposed to lamenting what you don’t have. Comparing ourselves to those with less as much as we compare ourselves to those with more. The pursuit of more has been and will continue to be ever present when it comes to money. Financial success is often used as a measure of life success. A lower income family will look to a middle-income family and a middle-income family will look to a high-income family and the high-income family will look to an ultra-high-income family and so on.
If there’s no such thing as enough, it will be difficult to set goals, feel content and prioritise success in other areas of your life. Is the constant pursuit of more money sustainable? Valuing more and more money without an understanding of why may result in regret later in life. Knowing how much is enough can be profoundly liberating and affords you the possibility of meeting that financial goal and being content.
Wealth affords you a good standard of living and financial security, but it is no substitute for spending time and effort on building high quality lasting relationships and experiences with your family and friends. Irrespective of the wealth people possess, we all struggle to keep juggling the many aspects of our lives. Money only serves to amplify the behaviour and characteristics you already have, good or bad. Being wealthy or poor doesn’t make you a good or bad person. The consumption and displaying of material things is not wealth, it is spent wealth.
Your ideal income
Everyone’s ideal income will vary depending on their current circumstances. If you haven’t thought about what your ideal income needs to be, the answer will always be more. Big lifestyle, big income, small lifestyle, small income. Given lifestyle creep is usually the default, your ideal income needs to cover your short-, medium- and long-term spending, plus debt repayments, plus saving for your future financial independence. Attach an annual amount to spending, debt repayments and savings and add them up to arrive at your ideal income. You can then multiply your ideal income by the number of years to your retirement. For example, if your ideal annual household income is €100,000 after tax over a 40-year career, this equates to €4,000,000 in income to fund your lifestyle spending, debt repayments and saving for financial independence, in other words your pre and post retirement lifestyle is covered.
You may already earn your
ideal income, earn more than your ideal income or earn less than your ideal
income. If your current income does not meet your ideal income you will need to
bridge this gap or lower your expectations. Your personal finances will remain
a zero-sum game unless you can your increase your income or sell an asset.
After you have created a workable budget and reduced your expenses to be as
lean as possible, the next step is growing your income. Once you know your
ideal income, how do you go about achieving it?
Increasing Your Income
Calculating your income per hour is an ideal starting point. You then need to ask yourself if you can work less for more income, work less for the same income, work the same for more income or work more for more income. This will largely depend on your line of work, seniority, and level of autonomy. Do you need to be physically present in a specific location to do your job?
Knowledge, skills, ability and experience are relatively universal in determining your level of income. How in demand is your knowledge and skills? How much time does it take you to do your job accurately? How good are you at problem solving, building, managing and leading a team or business? The better you are at all four the higher your income is likely to be. Before you can work smart you must work hard. Working hard requires time, working smart requires less time. How can you tip the exchange of time for money in your favor? Closing the gap between your current income and your ideal income will depend on how heavily you invest in your knowledge, skills, ability, and experience. An investment in your knowledge and skills is an investment in your future income.
Many of us will seek the best deal on utility bills, insurance and mortgage interest rates to save money but we can overlook getting the best deal when it comes to earning our income. Are you paid in line with industry standards? Are you being rewarded relative to the value you add? If there’s no meaningful measurement of your performance, how are you to differentiate yourself from your co-workers and justify higher compensation as a result? What can you do to improve your earning power? Below are some examples of what you can do to boost income as an employee:
Within your current job you can do extra shifts, overtime, negotiate a pay rise, secure a promotion, meet performance incentives, successfully complete further study and obtain professional designations. Non-pay related benefits such as annual leave days, employer pension contributions, life insurance, income protection, health & dental insurance, commuting tax saver scheme, gym & food subsidies.
Outside your current job you can get a new job with better pay and non-pay related benefits. You can double job, freelance, do consultancy or nixers. Start a side hustle by monetizing your knowledge, talent or hobby and potentially turn it into a business that can support you financially.
For those whom remote working is possible, it offers the opportunity for geographical arbitrage. Geographical arbitrage means earning an income from a high cost of living location while living in a low cost of living location. Employment and business are becoming increasingly borderless.
If you are a business owner or self-employed, you can expand or contract your product or service offering depending on demand and profitability. Increasing costs means you can choose to absorb them by reducing profits or passing on price increases to customers, depending on market share and price sensitivity. How does your price compare to competitors? Costs plus profits should equal price. Are all new and existing products and services profitable across new and existing customers? Do you have the financial resources and growth prospects to build a team, scale while not compromising quality and service? Can key functions of your business be reliably outsourced cost effectively? What are the growth strategies and business models within your industry? Cost and sales data is information from which to gain market insights. Stick to what you know and do it well.
Ways to boost passive income. If you are a homeowner, rent a room relief means you can earn up to €14,000 per year tax-free. For a high-rate taxpayer, it is the equivalent of earning roughly €23,000 in pretax income.
Creating intellectual property or content is another passive income opportunity. Creating one piece of material that can be shared with thousand if not millions. For example, the song Let It Be written and produced by The Beatles is one piece of music that has been listened to by over 435 million people on Spotify alone. If the Beatles got a cent for each listen, they’d receive a royalty cheque of €4,350,000 from Spotify. The one-to-many business model at scale can create a profitable business and therefore a lucrative passive income. Content can be opinion, knowledge or entertainment. You just have to look at the some of the top earners across audio, video and social platforms. Whether its subscriptions on Patreon, sponsorship from businesses, advertising or selling your own products & services, attention & interactions are the new currency.
It is important to position your career or business in industries that are growing and will continue to grow versus those that are in decline or will be in decline. Most jobs that can be automated or systematized, will be, as it will be more efficient and cheaper. This is especially true given the exponential acceleration of technological change into the future.
Understanding what you are good at, enjoy doing and marrying that with a career that will last into the future is very important. The employment landscape is one of increasingly rapid change. Future proofing your career and therefore your income will depend on your ability to adapt and position yourself in growing industries, and jobs that will be in demand into the future. If you don’t evolve & adapt to the changing business landscape, you run the risk of becoming surplus to requirements. The need for upskilling, retooling, and pivoting will only become stronger as the pace of change continues to accelerate. Focus on what you can control.
Timing and luck, good or bad, plays a huge part in our lives whether we realise it or not. Luck is when preparedness meets opportunity. If you are not fishing in the right place, your future career and therefore income is less and less within your control.
Risks To Your Income
Injury, Ill Health & Death
Economic cycles such as recessions
Technology, automation & systemization
Your ability to earn an income is your most valuable wealth building asset. Therefore, you are your biggest asset. Some time ago, I came across a clip of Warren Buffet talking to high school students in Omaha Nebraska. I thought much of what he was saying was applicable to anyone regardless of their age. Here is what he said:
Seventy years ago, I was in high school. And when I was in high school, I really only had two things on my mind, girls and cars. I wasn’t doing very well with girls, so we’ll talk about cars. Let’s just imagine that when we finish here today, I’m gonna let each one of you pick out the car of your choice. Sounds good, doesn’t it? Pick it out, any color, you name it, it will be tied up with a bow and be at your house tomorrow. You say, well what’s the catch? The catch is, it’s the only car you are going to get in your lifetime. Now, what are you going to do knowing that it is the only car you’re ever going to have, and you love that car. You’re going to take care of it like you cannot believe. Now what I’d like to suggest is that you’re not only going to get one car in your lifetime but you’re only going to get one body and one mind. And that’s all you’re going to get. That body and mind feels terrific now, but it has to last you a lifetime.
In summary, we need to prioritise taking care of our bodies and minds to be at our best. An investment in yourself pays the best interest.
Link to Spotify podcast episode: https://open.spotify.com/episode/0Og4ldMg7rG00BXZoi37Wh?si=b023c23bb079466b
Link to Apple podcast episode: https://podcasts.apple.com/ie/podcast/s2-e11-your-income/id1539630506?i=1000552764144
For personal financial planning advice email firstname.lastname@example.org or call (01) 539 2670.