What is the Cash Flow Quadrant?
Rich Dad Poor Dad was one of the first books I read when I started learning more about personal finance and while it had a number of great topics in it, there was one that really stood out to me, the Cash Flow Quadrant. The Cash Flow Quadrant explains the 4 different types of people in the working world. You have Employees, Self-Employed, Big Business Owner, and Investor. If you're familiar with the Rich Dad narrative, he had two dads a Rich Dad and a Poor Dad. His Poor Dad wanted him to be an employee and get a job working for someone else, become a doctor or lawyer or have a small business for himself and be self-employed. His Rich Dad advised him to either have a big business or be an investor. While you can get rich at all 4 parts of the quadrant, I will go over what makes each quadrant unique and let you decide which one you would like to pursue.
This section of the quadrant is where the majority of people are. You trade your time for money and if you want to make more money you have to put in more time. You work for someone who has a business and they pay you a certain amount. A lot of times even if you provide a lot more value, your income is capped to a certain extent. You can still be a well-paid employee but if you don't work, you don't make any money. As a professional basketball player, I am technically an employee. My team pays me a certain amount a month and even if I score 50 points a game over the season, my salary is capped at a certain amount till the next year's contract. If I decided not to play, then I wouldn't get paid.
Employees are often taxed the hardest too. To illustrate this, I will give an example from Warren Buffett who is currently worth 86.3 Billion Dollars. As noted by the Oracle of Omaha himself in an op-ed column in The New York Times in 2011, Buffett claimed to be paying only a 17.4% effective tax rate (that year) compared to 20 workers in his office who were paying an average tax rate of 36%. Buffett's op-ed says his tax rate is lower than his employees' because money made off investments is taxed at a lower rate than wage income. "If you make money with money, as some of my super-rich friends do, your percentage may be a bit lower than mine. But if you earn money from a job, your percentage will surely exceed mine — most likely by a lot," Buffett said.
One day you might say that you're tired working for someone else and you want to go in business for yourself. Great! While you are still trading your time for money, you now OWN your job. If you don't work at your own business, then you don't make any money. You are now able to enjoy more freedom than if you were just an employee as well as the opportunity to earn much more income, but you are also usually putting in more hours and taking on a lot more responsibilities and risk. It is an eat what you kill mentality. An example of being a self-employed person could be doctors, real estate agents, or people who are in trades like electrician, carpenter, or plumber.
Big Business Owner
The biggest shift from when moving from employee or self-employed to a business is that you now have a system in place, and you have people that are working for you as employees. You are no longer selling your time for money and you are still able to make money without you directly being involved in the business every day. For example, as a realtor, you could create a real estate business where you hire real estate agents, secretaries, and an overseer to manage and run your real estate business
Also, one of the biggest advantages of being a large business is the tax advantages that come with it. Recently it came out that Amazon was able to avoid paying federal taxes for the 2nd year in a row. You may say how is that possible and fair when in 2018 Amazon is only the 2nd company to reach a value of 1 Trillion Dollars. That is because big business is incentivized by the current tax laws. "Amazon avoids paying federal taxes using a variety of tax credits and tax exemptions that are legal and built into the U.S. federal tax code. Some of these can include the research and development tax credit which allows them to deduct some of the costs of new investments and also a big one for this past year was the ability to deduct stock-based compensation of executives.
You've probably heard of HQ2, the new campus that it's trying to build somewhere in the United States, and cities are tripping over themselves to come up with new incentives to get Amazon to come into their town. New Jersey, for example, is offering $7 billion in tax breaks if Amazon builds its new campus somewhere around Newark, New Jersey." Business Insider
One of the things that Donald Trump, a businessman himself, did when he became the President is he lowered the corporate tax rate from 35% to 21%. That gives businesses another advantage. In order to play the game and win the game, you have to know what the rules are. Big businesses are taking legal advantage of the rules that are in place and when you understand that you can see why it is very advantageous to have a big business.
This is the part of the quadrant where your money works for you and you create a passive income stream. This usually includes investments like stocks, bonds, real estate, royalties, licensing fees. This is the ultimate cash flow because now you are making money whether you work or not. In order to get to this point, you are usually taking the money you've made as an employee, self-employed person, or business owner and putting it into something that will grow and increase your money.
As you can see from this breakdown, the most opportunity is on the right side of the quadrant with being a big business owner and investor. If you learn the rules of the game and how to operate within the rules, you can become very successful. It may be hard at first to create those systems and build up your investments, but the reward can be worth it. I hope you enjoyed this post and leave a comment below about what you found interesting about the Cash Flow Quadrant breakdown!