Utilize Income Buckets To Build Wealth
Nov 21, 2023
One of the most undervalued aspects of wealth building is the understanding income "buckets". There are three primary income types you should be using on your journey to Millionaire in Medicine: active income, passive income, and portfolio income.
Active Income: The Starting Point
Active income is the money you earn through direct and immediate effort. This includes your salary, wages, and any income generated from your active participation in a business or job. For most healthcare professionals, this is your W2 salary or money earned from a 1099 gig. While active income is often the most reliable and consistent source of funds (especially in the initial years of any financial journey), it has its limitations - namely you have to work for it.
Thus, you're trading time for money.
To optimize active income, do the following:
a. Skill Development: Enhance your skills and expertise to become more valuable at your job. Whatever it is you do - be the best at it. This could lead to promotions, salary increases, additional leadership opportunities, or even entrepreneurial opportunities.
b. Negotiation: Don't be afraid to negotiate your salary. You should renegotiate your contract annually in your first 5 years of practice to ensure maximal income growth. Don't be afraid to change jobs.
c. Diversification: Explore additional income streams within your active endeavors! This could include freelancing, consulting, or starting a side business to supplement your primary source of income. Although these things aren't passive, they can provide a fun way for you to pursue additional passions while earning more money. As a PA, I've spoken for a pharmaceutical company and done expert witness work. Both served this purpose well.
Passive Income: Building Wealth While You Sleep
Passive income is NOT money earned with minimal effort on your part. It's money the IRS deems as "passive income". This can include rental income, royalties, dividends from investments, and income generated from automated business ventures. Building a solid foundation of passive income is essential for achieving financial independence, as it allows your money to work for you.
Strategies to optimize passive income include:
a. Real Estate Investments: Consider investing in real estate properties to generate rental income. This can provide a steady stream of money while also allowing for potential property appreciation. There are ways to reclassify this type of income as active (which is actually very favorable for strategic tax planning), but that's beyond the scope of this article.
b. Dividend Stocks: Invest in dividend-paying stocks to receive a regular income stream from your investment portfolio. Reinvesting these dividends will accelerate wealth accumulation over time and is a "must do" for anyone still in the wealth building phase.
c. Automated Online Businesses: Explore online ventures such as e-commerce stores, affiliate marketing, or creating digital products. These businesses can run on autopilot, requiring minimal ongoing effort once set up. Officially determining if this type of activity is passive or active should be left up to a seasoned CPA.
Portfolio Income: Growing Your Wealth Through Investments
Portfolio income, also known as capital gains, is generated through the buying and selling of assets such as stocks, bonds, and real estate. This income is derived from the appreciation of your investment portfolio over time. This one is the easiest for a medical professional to achieve, but also has one major requirement - in order to see substantial portfolio income you have to start investing consistently now.
To optimize portfolio income:
a. Create consistency: Dollar cost averaging a set amount of money each month into investments, which you can subsequently automate, is a keystone habit for wealth building.
b. Reallocate 20% of active income into investments: You won't see substantial portfolio income if you're not investing a substantial amount. 4% into a 401(k) may be a starting point, but it's not enough to sustain even a traditional retirement - let alone build real wealth.
c. Long-Term Perspective: Adopt a long-term investment mindset. Avoid succumbing to short-term market fluctuations and focus on the overall growth potential of your portfolio. Half of investing success is learning to overcome your own psychological tendencies and control your emotions!
The big goal?
Convert active income into the other two categories. Although no income is truly passive, the latter two categories don't require you to trade time for money - which is key.
Remember, all of these categories are essentially IRS designations. Why does it matter? The more you learn, the more you can learn how to tax hack your way into paying the least amount of tax legally. Taxes are all of our largest expense, and ignoring them means leaving a big chunk of your potential wealth on the table.
As always, invest early & travel often.
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