Rich Dad, Poor Dad author Robert Kiyosaki utilizes the concept he calls the CashFlow Quadrant to describe the various ways in which people make income.
We’ll look at how income is generated in each of the four quadrants in this post. Yes, we all can make money from even a single quadrant, or we can choose to make money with a combination of quadrants. Today, we will discuss each quadrant individually. E, S, B, and I are the four quadrants. The letters “E,” “S,” “B,” and “I” stand for employee, self-employed, business owner, and investor, respectively.
The income generation quadrant’s left side holds quadrants E and S: Employee and Self-Employed, respectively. Your earnings are classified as earned income or active income in this case. You are paid for the number of hours you work in the quadrants on the left side. The playing field for the poor and middle classes is in the two quadrants on the left.
Business Owner “B” and Investor “I” are on the right side of the quadrant, and their wealth is regarded as passive. It means you can make money by using the efforts of others. The playing field for the rich and financially secure is in the two quadrants on the right.
Capital, education, and a new mentality are required to move from the left to the right.
The top two quadrants have your income from only one source, your job or your business. Because income diversity is minimal in the top quadrants, you face higher business and market volatility. Your income stops if the company you work for goes bankrupt.
Certainly, if you’re in the “B” business owner quadrant and you layout your business property carefully, you’ll have different clients from various business sectors, reducing the risk of a single source of income.
If the bottom two quadrants are correctly designed, your earnings will come from a variety of sources. As a result, if a single customer or investment fails, you have a diverse revenue source from which you will not lose all of your earnings.
Employee – CashFlow Quadrant
If you work as an employee, you know you’ll get paid as long as you keep working for the company, even though it’s not profitable.
However, when it comes to paying off debt, such as home or car loans, having a clear monthly wage is critical. On the other hand, full-time workers derive their income from a single source: their work, and if they lose their job, they lose their entire salary. They must rely on unemployment to fill any gaps in jobs.
Furthermore, workers pay the highest percentage of their income in income taxes. As you earn more as an employee, your tax bracket rises, and you have few options for lowering your income via deductions or credits. This quadrant is where the majority of Americans make their money.
Self-Employed – CashFlow Quadrant
You own a job when you work for yourself, or it’s called being self-employed. Non-employer corporations, in which the owner is the sole employee, are often referred to as such by the government. When you work for yourself, you trade one boss for many bosses, referred to as clients. You have the freedom to work whatever hours you want, but you only get paid when you’re on a contract. The more hours you work, the more money you earn. Self-employed people do not get paid weekends or holidays.
Some self-employed people can earn money from many different contracts simultaneously, allowing them to diversify their income. On the other hand, many self-employed individuals merely work for a previous employer or a single customer as a contractor and do not diversify their income. The truth is, many self-employed people have taken on more financial risk by working for themselves, with little or no extra compensation.
When we talk about taxes, the self-employed person must pay both the employer and employee portions of FICA, also known as self-employment or SE tax, on all taxable income. Many costs of doing business, including cell phones and travel, can be paid with pre-tax dollars, allowing self-employed people to decrease their taxable income. Smart self-employed people price their offerings to meet all of their indirect costs, such as the extra FICA share paid by the employer and any downtime between projects.
Business Owner – CashFlow Quadrant
Being an owner of the business is far from being self-employed as now you hire people to do your job for you. That is not to say that the business owner does not work in the company, but that does mean that they are compensated for both their job as an employee and their investment in the company.
Business owners can expand their operations, which is not possible for self-employed people. As the company grows, a portion of each employee bill-rate represents the owner’s return on investment for the initial money and taking on the extra risk of becoming a business owner. As the company expands, the owner gains more and more money. As with being self-employed, you have many bosses in your clients’ form, but you are also the boss of your employees.
Business owners have systems that allow them to be away from their business for extended periods while still earning money. Business owners’ income diversification and taxation are similar to those of self-employed people. However, unlike the self-employed, if the company is a corporation (S-Corp or C-Corp), not all revenue is subject to the combined 15.3 percent FICA contribution. Wages from working in the industry are subject to FICA for companies. FICA does not apply to the profit that remains after all costs and wages have been paid.
Investor – CashFlow Quadrant
The investor is the fourth cashflow quadrant. It’s all about investing your money to work for you when you’re an investor. As an investor, you should spread your money around to achieve greater income diversification while reducing overall risk by concentrating your investments less.
When it comes to taxation, there is a logical progression. Interest income derived from sources such as money markets, bonds, and T-bills, is on one end of the investment spectrum. Ordinary dividends (such as those paid to company owners) and short-term capital gains are also on this end of the spectrum. There are no special tax benefits for any of these investments.
Qualified dividends and long-term capital gains, on the other hand, benefit from special tax treatment as you progress along the continuum. These financial products are taxed at a fixed 15% rate for most investors, rather than being taxed based on how much money you make. The ultra-wealthy pay 20%, which is far less than the marginal income tax rate for most investors.
Municipal bonds, which are federal income tax-free interest income, are the next step on the continuum.
Aside from that, there’s real estate income, which can be depreciated to reduce taxable income. Additional capital gains usually taxed when a property is sold can be deferred indefinitely by using a 1031 exchange. It allows an investor to increase their assets without having to pay capital gains per transaction.
Ultimately, direct participation in oil and gas programs is also an option. Investing in oil and gas programs allows you to deduct the majority of your investment from all revenue sources, such as employment. Furthermore, thanks to a depletion allowance, only 85 percent of revenue is taxed. Most investors, however, must be accredited to participate in this game. It indicates that they have a net worth of over one million dollars or a yearly income of over $250,000.00.
How to move from left to right?
I recommend that you start changing your attitude if you want to move to the right side of Rich Dad’s CASHFLOW Quadrant. A study was conducted a while back that revealed the mentality of those who went from poverty to riches. Three factors were identified as deciding factors:
- There is a long term vision
- Delayed gratification is crucial
- Learn to use the power of compounding
They also looked at those who had been rich but had fallen into poverty. The following were the three factors that played a role:
Simply put, the path to the right side of the quadrant begins with acquiring assets that generate passive income rather than living paycheck to paycheck. Begin modestly, be patient, and watch your fortune grow over time.
- Short term vision instead of long term
- They looked for immediate gratification
- They could not use the power of compounding in their favor.
That is, the path to the right side of the quadrant begins with the acquisition of assets that generate passive income rather than living paycheck to paycheck. Begin small, be patient, and watch your income grow over time.
The Bottom Line
If you wish to achieve financial freedom you should spend time learning the ins and outs of the cashflow quadrant, and begin shifting your income and investing strategies in order to move yourself further into the business, and investor, quadrants.