Sunday, April 15, 2012


In Personal Financial Planning, the plan always starts with Income. It is always how much we earn that determines much of everything else. Of course, this factor is also one of the most difficult to change. There is not much we can do to boost or tweak it, especially if we are on fixed pay. Much of what we can do is frequently to be found in the other areas such as debt structuring, risk management and investment planning.

Here, we will try to explore the topic of ‘income’, the all-important top-line item which usually just merits half a minute in the planning/budgeting process.

For most people, income comes from work. And this work is frequently in the form of fixed-pay employment, such as being an engineer, technician, nurse, company executive, teacher, etc. Sometimes, there would be a variable component, such as commissions for a salesperson.

The advantage of this sort of arrangement is obvious. Your income is fixed and stable, thus making any budgeting or planning process simple. You always have the same top-line month after month, and as long as you handle the stuff in-between well, you will have a positive bottom line.

The disadvantages too are becoming more and more obvious in today’s world which heavily promotes entrepreneurship. A fixed pay is limiting and restrictive. The monetary value of your contributions is limited. For example, if your pay is RM5,000 a month, you will be inclined to think that your worth to society is RM5,000 a month if measured in dollar value. For some people, this might limit them from producing outstanding work which far exceeds the value of their paycheck as it would create an internal imbalance within their minds. “Why am I working so hard when the max I can make is only RM5,000? To make the best use of my time, I should only give RM5,000 worth of work in my job, and divert excess energy and creativity to other activities which may give rise to other sources of income, such as running an online business or giving tuition part time”. This type of thinking destroys the focus that would enhance the effectiveness of our work. If our top line from any single activity is limited, the only way to increase income is to add more activities. And when we have too many activities, we lose focus and all activities will likely falter.

A variable-pay job based on commissions would seem to solve the problem, but actually it only gives a short term respite and has problems of its own. Although in this case, the person can focus solely on this commission based job, the money is still too tightly tied to personal effort, and there is a lack of systematic money-gathering which produces income even when the person personally slows down or takes a breather. Once you stop, the money likely dries up too. For the short term, it offers an opportunity to amass a respectable sum of money. But what next?

This brings us from the ‘employee’ segment (as depicted in Rich Dad’s famous EBSI cash flow quadrants) to the self employed and business segments. Under the self-employed segment, you work for yourself, doing stuff such as book-keeping, plumbing, selling insurance, hawking food, freelance designing and giving tuition full time. The problems here largely resemble those of a variable-pay employee. Once you stop, the money stops. It is when self-employment grows into a business that the significant improvement takes place. From a book-keeper, you start to run a book-keeping firm, with a stable of freelance book-keepers under your care. You take the difference between what you charge your clients and what your freelancers charge you. Or as a designer, you take in jobs which you then proceed to cut up and distribute to your freelancers. Here, you can begin to earn some ‘sleep money’. It is at this point that the money you get loses its direct relationship with personal effort, and the seeds of financial freedom are planted.

The ultimate phase, is of course the Investor segment. As an investor, as opposed to a business man, you don’t even need to run the business. You just provide your money to the people running the business. It is quite like a food chain. Investors are at the top. And where do you find these businesses to invest in? The best place to look is obviously the stock market, with thousands of business ready to accept your investment monies. Sadly, most people look at the stock market as a casino rather than a market where you shop for business to invest in.

But this doesn’t mean investors don’t have to ‘work’. It just means that their work is not in actually personally producing the work with economic value such as carrying goods, cleaning kitchens, drawing blueprints, repairing machines, balancing the books, prescribing medicines and explaining insurance products. Your work now is to study businesses and choose the best ones to invest in. It involves a lot of research and judgment and leg-work too, but the rewards cease to be directly tied to the time and effort you put in. One week of focused research can reap the equivalent of a year’s ‘personally produced economically valuable work’.

All these is the result of a capitalistic system, where money goes to factors of production; and work is but one of many factors of production. The other main ones are land, machines, intellectual property and business systems. Money goes to these factors by virtue of who ‘owns’ them. Ours is a society which recognizes ‘ownership’. We get to own stuff. This is a relatively new development in society which we shouldn’t take for granted. But as it is, we get to own things, and money flows to he who owns stuff which are factors of production. In other words, you will be entitled to get money if you own stuff which produces stuff which people buy.

The best all-in-one package of factors of production is a listed company. If you buy the shares of Nestle for example, you are buying the buildings and land they own, the workers in their employ, the business systems they use, the goodwill of their brand and the trucks they drive their goods in. It is a ready-made package of money-production. That is to say, buy Nestle, and you buy the money Nestle as an institution produces. Assuming that Nestle gives a return of 8% per annum in the form of dividends and capital growth, it means that Placing RM300,000 in Nestle will net you RM 24,000 a year, or RM2,000 a month. This is money that flows to you as the OWNER of these shares, with no relation at all to how much personal work you do. The research is only done once at the start with maybe brief subsequent quarterly reviews. After that, the money flows to you even as you sleep. RM2,000 a month, the same as an entry level accountant working his ass off 12 hours a day trying to balance obscure figures from some infernal accounting system.

Therefore, in short, the price of a RM2,000 a month lifestyle is either RM300,000 or perpetual 12-hour work days.

Of course, you won’t manage to get that RM300,000 without first working your ass off somewhere 12 hours a day for some time. But the sad thing is not that people don’t manage to amass RM300,000 or 500,000 or 1,000,000. The sad thing is that they actually do after some years, but don’t know where to put it. Instead of investing it, it goes to LV bags and BMWs. There is no focused effort to move from E to S to B to I. They struggle in E, and buy BMWs to ease the pain. But of course it just creates more pain down the road.

This is not saying that the E, S and B quadrants should be ignored. You need a good foundation in the work place and in society before you can have the judgment and discernment required in the I quadrant. A doctor needs experience in seeing patients before he can run a large clinic with many doctors. An engineer with experience working on oil fields can better choose the right oil company with growth potential. Dealing with customers and colleagues brings understanding of human nature which is required by the investment strategist.

You need to go through the entire food chain of income accumulation. Just don’t get stuck at first base all your life.


1 comment:

  1. First of all, great cartoon! What you say is right though. People spend many years gathering savings, and then when they get there, they do the stupid thing. Rather then taking care to create a stream of income for themselves, they waste a lot on silly material things they do not really need.