How to Make Money

The following is my interpretation from the works of Robert Kiyosaki from the book Cashflow Quadrant

Kiyosaki sums up the 4 ways of earning money is by being a/an

1. Employee
2. Self employed
3. Business owner
4. Investor

Hence, the E-S-B-I Quadrant. I'm planing to go into detail of each quadrant in my future posts. Here's just the run through...

Being an Employee

Everyone knows this as this is the formula for steady income. We study hard to get our degrees, so we can work in a big and well known company with a respectable salary. You basically sign a contract (employment letter) to determine what you are worth on an hourly rate for your services to your employer.

The maximum income potential is: (your hourly rate) x (hours company is willing to pay you)

Your hourly rate is a fixed and the only way to increase the amount of income you have is to work more hours, but of course, there is a limit to how much you can work or how much extra time your company is willing to recognise

Being Self Employed

Being self employed is being personally involved in selling a product or a service, or simply put, being your own boss. Might sound like the best way to go, but unlike being the employee, there usually is no fixed working hours or holidays for the self employed because each blood, sweat and tear directly affect his income. the self employed person is central to the operations meaning that if he is not at work, the business would not run.

The maximum income potential is (profit margin per hour) x (hours worked)

Here, like the employee, your hours worked is limited by your own input, but of course, the limit to any human being is 24 hours a day. The only variable you can change is the profit margin per hour, so your focus is to increase it to the highest you can. Below are some examples of different self employed careers:

Doctors - High profit margin per hour compared to most service based industries. On top of that, the doctors in Malaysia sell medicine too. (In western countries, the doctors can only charge a consultant fee and the patient has to buy the medicine at a pharmacy). So selling medicine is a method that doctors use to increase the profit margin per hour.

Shop Keeper - Medium profit margin per hour. To increase the amount of sales per hour, they can source for higher margin products or find more customers

Small-time Food Seller - Low profit margin per hour. Like the above, they can increase the amount of sales per hour by improving their product mix or increasing their customer base.

Being a Business Owner

This is where things get interesting... The difference between a self employed and a business owner is that the business owner is not directly involved in the day to day operations of the business. The business owner has a self running business run by employees. His objective is to set up a business and getting the right people to run it, so his focus is to set up an effective system, or easier still, employ someone to set it up. The best way to determine if someone is a business owner or not is to ask him if he were to go on a 6 month holiday, would his business still be running by the time he gets back? If the answer is yes, then he is a business owner. If not, he is self employed. This question also shows that a business owner is not limited by time as his income is not directly affected by the amount of time worked. This is the biggest difference, and advantage, the business owner has above the self employed and employee.

His maximum income potential is: (profit margin per hour) x (business hours)

Because his income is not limited by time, he can use his time to set up more self running businesses, which in turn increases the amount of income earned per hour and number of business hours. For example:

Franchise / store branch owners - If the business has a fixed recipe or operation manual, etc, the franchise / branch can be duplicated. A 2nd store opening will double BOTH the profit margin per hour AND Business hours. Both variables in the equation above can be increased - unlike the employee or self employed where time is a limitation

Multi Level Marketing (MLM) - MLMs can actually make you into a business owner. After setting up an effective sales downline, you will notice that for every successful downline, you've just increased your profit margin per hour and business hours because your downline is using their time and effort to make you more money. Once again, no limit to profit margin per hour and hours worked.

The most important concept in this type of segment is that time is no longer a limitation of your income. The business owners build up cash cranking machines, which are the self running businesses, then continue to build more. This is where the good life is.

Being an Investor

An investor is a person who buys an entity and rents it out, and over time, the entity should increase in value from the time it was first bought to make it a positive investment. A person who buys shares from the stock market and sells it for a profit is NOT an investor. This is a common misconception that any person who makes money buying and selling shares to make a living is a "good investor". He is merely a trader making a profitable transaction. I'm planning to write an article on the difference between a trader and an investor. So from the definition above, here are some examples of investors:

Property Rental - The owner buys the property for an amount of money. Usually rents it out at the amount slightly higher than the monthly installment, and over time, the property increases in value. Because the rent covers the monthly installment, this means that the renters are actually helping the property owner pay off the mortgage. And when the mortgage is fully paid, the investor has just acquired a property of full value by paying just the down payment. If he put down $20k for a $100k property,

his return on investment is (100k - 20k) / 20k * 100% = 400% at the end of the loan period

but if over the time the rent is paid, the property value increases to say, 120k,

his return on investment is (120k - 20k) / 20k * 100% = 500% 

Running a Foodcourt - Similar to property purchase, you only need a downpayment, not the full amount if you can plan that the rent you are charging and monthly sales profit covers the bank loan. Over time, you are using just your downpayment amount to aquire a property in full value.

The concept of investing is not about creating massive amounts of cashflow, rather, using the smallest amount of money to acquire an asset at full value. Many people do not think of it this way. This concept of leveraging money is covered in more detail in Kiyosaki's book, OPM.

Dividends on Stock - The investor buys shares in a company that he believes will continue making money in the future, therefore profitable and pays out a dividend annually. He reinvests the dividends into buying more shares of the same or another company, and year after year, accumulates more dividend-paying shares. These dividends should give a better rate than the fixed deposit (FD) rates from the bank and on top of that (as a bonus), increase the value of the underlying share. Because selling the share for a profit is not the focus of the investor, the daily fluctuations of market price do not make him nervous. His focus is to acquire more profitable company shares that pay a dividend to increase the number of income producing assets. So another way to look at this is that an investor buys the company shares, rents it out to the company, receives rent in the form of dividends, and if he has done his homework right, bought the shares at below its market value, and the share price increases over time. When's a good time to buy shares at below its market value? During a stock market dip / crash / correction, when everyone's selling shares...