How Money Works

There is a good bit of confusion concerning how money works. Let's talk about the income part now, and the expense part at another time.

There are three types of income; earned, passive or portfolio, and system. Just about everyone is familiar with earned income. It comes from a job, or professional fees, or some environment that involves us trading time for money. One way to say it is time equals money. When you hear that, the person speaking is familiar primarily with earned income.

Passive or portfolio income is income derived from money at work. Some people save money from earned income, or receive it from other sources, and choose to invest it. Depending on what they know about money, or are told by others who may hold themselves out as professionals, it's possible that this invested money could create income in the form of interest, dividends, or capital gains. When someone says it takes money to make money, you will know they live in this world.

The third type of income is unfamiliar to all but about 2% of the population. System income is derived from the development of a business system, and such income is not dependent necessarily on a 40 to 50 hour week for 40 years, nor does it need to require very large amounts of capital. When you think of system income, think of Michael Dell, Bill Gates, Rich DeVos, Sam Walton, and Howard Schultz. Each of them have built businesses that generate income for them personally. While each of these businesses require some oversight, the amount of time required of each of them is nominal, compared to the very substantial cash flow these businesses generate for the owners. The Walton and DeVos families most likely invest the least time relative to income, based primarily on time, and the business structure that is in place. System income is ideas and business structure at work.

Very few people understand system income or how it works, which is why most people struggle financially. Too many investors either fear loss of capital, and therefore shortchange opportunities, or are driven by the desire to find shortcuts to wealth, and constantly trade, looking for the next Microsoft.

Those who are prepared to learn, to work with people, and to understand how to conduct proper due diligence can become as wealthy as they choose to be, both in time and money. This group I call the fellowship of the 2%.

One question I'm asked from time to time is "What sector, industry, or stock should I invest in today?". My question is, why do you want to invest in that sector or stock, and what will it do for you in terms of helping you reach your goals?

What most people haven't stopped to consider is why they save and invest to start with. I've yet to meet anyone who can take their 401k statement, or the deed to their home, or title to their car, and scan it in the card reader at Publix to buy groceries. The point? What people need is not assets, but cash flow. The reason people save and invest is to develop assets that will generate income when they reach a point that they would rather roll over instead of roll out. Their hope is that these assets will generate the income, instead of them having to get up everyday and sit in traffic.

So...if the point is income, or cash flow, then perhaps the question becomes, "What is the best way to build cash flow?". Now we can have a meaningful conversation. There are individuals, whom most of us will never know, who have mastered the understanding of how to create cash flow. Some of them live very extravegant lives, others live lives of service. In all their circumstances, they have achieved personal control of both time and money.

So how? Here is the key. If you invest time, then invest time to develop people and infrastructure, so the combination of the two generate income. If you invest money, invest money in business enterprises that allow you to receive ongoing cash flow from a one time investment. There will likely be some type of ongoing oversight, even after the cashflow is fairly secure. This oversight however, is a completely different exercise than having earned income, or owning a job, which is what 95% of franchisees do.

Until next time...

Randy