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Sunday, November 14, 2010

Streams of Income

It’s bad enough to initially depend on just one source of income, but it’s even worse to not invest it or diversify it such that you protect it over time. In other words, there is more than one way to diversify your income.

(1) You can diversify your sources of income so that you have, say, two or three jobs
(2) You can diversify the ways in which you earn income

It’s better to go with the second option, even though, strictly speaking, it can be considered a version of the first.

You can work three jobs if you want. That will definitely give you three different sources of income. If you get laid off at one place, you’ll still have the other two jobs. It’s great to keep your options open, after all. Maybe you’re moving up at one place and you want to give it some time.

But working three jobs is really no different than just working more hours at the same job. You’re still a rat running on the wheel – just a bigger wheel, and you’re running faster, or for a longer period of time, and you get a bigger piece of cheese to take home.

What you really need to do is slowly outsource your own income stream.

Progressively safer streams of income

1. Invest in high yielding dividend stocks that grow their dividends yearly.
2. Reinvest a portion of the dividends into more high-yield stocks.
3. Use the other portion to pay current bills (and debt servicing if you have it)
4. Repeat by reinvesting proceeds into a different asset class: real estate with cashflow.
5. Repeat by reinvesting remainder of RE cashflow into another class: a business of your own, for example.

You may want to change the exact order and the benchmarks at which you would buy an investment property, for example, but the idea is generally the same. Protect your investment income by diverting it into different asset classes with (ideally) less risk.

Your day job is the most risky form of income. Not only do you have just one, but you have to pay with your time and energy just to get a return. You need to take that most highest level of risky income and lock it in to less risky streams, like dividends. I think these are actually less risky than starting a business on the side, because that’s just going to take up more of your precious energy in the beginning. Some can do it – for various reasons. I think starting a business is an excellent idea, but I think you can get more leverage in the beginning with juicy dividend growers.

On this model, the more that your day job kills you, the more you should try to save as much of that money as possible and convert it into another, less taxing, source of income. Do the same with your high-yield stocks. Precisely because they are high-yield (especially if the payout ratio is high, or they’re high yielding because of a recent price drop), you’ll want to redirect those dividends into forms of money with less velocity, like the money market or a bond fund. Then I’d get out of the corporate sphere altogether and create my own source of cashflow by buying an investment property and renting it out.

If you have enough income right now, perhaps you can skip these steps and just purchase your rental property right away. But the idea is the same. Recycle that money into a system that can be set on automatic, but wherein your money cycles through progressively lower levels of risk (you can do the work to determine the order of risk for each opportunity). Once that’s done you can focus on how to increase it the velocity of these cycles of money

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