Income, Taxes, Expenses, Investment
As I am writing this post, I am thinking in my mind ‘wait, what’s the big difference between taxes and expenses’ – they seem to be both subtractions to Income to arrive at ‘investment’. There are several distinctions – first being the other in which they occur. For employed people, it’s income -> taxes -> expenses -> investment. For self-employed people, it’s income -> expenses -> taxes -> investment.
Let us examine each of the 4 blocks:
1. Income – it is a no-brainer that the more income you earn the richer you can get. This block I think is fairly well understood. Though there are advanced level concepts like having multiple income streams, but overall the concept is fairly well understood.
2. Taxes – this is the money that goes out of your salary before you get it. So if your income in block-1 above was $100, and you pay 10% in taxes, you get $90 ‘take home’. But if the taxes are 20%, then the take home (after-tax) is only $80. Now there are fully legitimate ways to reduce taxes, we will explore those through out this blog.
3. Expenses – now that you have taken home $80 after paying taxes, you will spend something, on food or clothes or vacations or anything else. Let us say you spend $55. Now you have $25 left.
4. Investment – what do you do with the remaining $25? You should keep a certain portion of it in your checking account for a rainy day, but you should invest the rest. Why? Because investing makes the money grow. How much? I always use 8% as my benchmark, a well diversified stock market portfolio returns somewhere in that range over long periods of time.
Now that we have defined the 4 building blocks – the formula for getting rich is simple: maximize your income, minimize your taxes, minimize your expense, and invest wisely.
P.S. Another problem in just letting all the $25 in your checking account is inflation. Money loses value every year. The same thing will cost a little more tomorrow, and noticeably next year, and significantly more 10 years from now.
OneMoreDime Trivia: Inflation in Russia during 1994 was 840%. A good joke those days was – you should ask for your check when you go in the restaurant and not when you have finished eating; because if it takes you two hours to eat, then the check will be 0.2% higher. (840% per year is about 0.1% per hours).
OneMoreDime Trivia: The highest level of inflation I remember reading is: In Germany(1923), prices rose 2,500% in one month. So a car that costed $10,000 a month back costs $260,000 now (If I had the car, I would sell it now, lol).