Sunday, June 14, 2009

Passive income

Second post on the money theme, bearing in mind this is all based on my use of Kiyosaki and I can't take any credit for it, except in the translation. Any errors or misunderstandings are mine. I am not an accountant, just someone who has been managing my money for a few years.

In the first I talked about wealth, and concluded that it is about not having to work because you can live off your passive income. So wealth is really simple - accumulate things that give you passive income. No need to read any more! Well maybe. What is useful here is a redefinition of assets and liabilities. These are not the definitions an accountant or bank or the ATO uses, these are definitions that make it easy to think about your own finances.

Asset: Something that earns passive income. e.g. a rental
property, a book you've written, shares that pay dividends.

Liability: Something that costs you. e.g. a negatively geared
property, a boat, your home.

See? Very different to your bank, which will almost certainly count your house as an asset. But your house will not help you pay your monthly expenses. Anything negatively geared will not help you pay your expenses either, because it is making a loss.

In fact DH and I don't talk about negative or positive gearing at all - we classify our investments as in the black or in the red, assets or liabilities. If it's a liability and we can see that it's going to remain a liability, we ask ourselves exactly why we are keeping it. Most people's answer to this is that they are after the capital gain. In other words, they're gambling. They are betting that the market for whatever it is will go up. Depending on many things, that may be a good bet or a bad bet, but it is still a bet, be very clear on that. Isn't it better to have cash in hand?

But what about taxes, you say? Negative gearing decreases your tax.

True. Let's use some simple numbers to look at that.

Say I make a $100 loss on my negatively geared rental property. That means that I can reduce my taxable income by $100. Assuming I'm in a 30% tax bracket, that means my tax is reduced by $30. Woohoo! I made a loss of $70!

Say I make a $100 profit on my positively geared rental property. That means I have to increase my taxable income by $100. Assuming the same 30% tax bracket, that means my tax is increased by $30. Woohoo! I made a profit of $70!

Obviously this is much simplified, there are a lot more complicated situations where your options will be different. But this week's lesson is:

Look for things that will make you passive income right now, today. If there isn't money in your pocket at the end of the month, why are you holding on to it?

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