In part 2, before I go on to describe some of the ways that I can generate passive income - the first step towards achieving the dream lifestyle - I'm going to expand some more on the general concept of going from where I am now (which I'm going to call the Lifestyle 1.0 model) to where I want to be (which I'm going to call the Lifestyle 2.0 model).
I've been using what I've learnt recently to generate my own strategy for achieving my goals. I believe it's important to develop the strategy first, as this will:
- Reduce the likelihood of failing at the first attempt;
- Give me something to refer back to and provide motivation when things don't got as planned; and
- Give me clear milestones that I can use to track progress towards my goals.
The strategy that I've started to develop is called my Lifestyle 2.0 model. I can't profess that the model is particularly revolutionary; it is something I've developed based on inspiration from 'The Four-Hour Work Week', as well as other books I've read such as 'Rich Dad, Poor Dad' by Robert Kiosaki. My model takes the best concepts from these books, tunes them slightly to leverage the 'web 2.0' revolution that is happening right now, and also takes into account my experience and knowledge of risk management gained from my career to date in Information Security.
The purpose of my Lifestyle 2.0 model is to show how I'm going to use a few basic business and financial principles, as well as a commitment to taking advantage of the web 2.0 opportunities, to help me achieve my goals of gaining financial freedom and escaping the 9-5 so I can pursue my dreams full-time.
To understand my Lifestyle 2.0 model you first need to understand the Lifestyle 1.0 model. You will easily recognise the Lifestyle 1.0 model because it is what most of us live today. I've split the model into separate sub-models, including a 'cashflow' model and a 'living' model.
Lifestyle 1.0 Cashflow Model
This is a basic diagram that I've created of the Lifestyle 1.0 cashflow model that most of us can relate to:
The Lifestyle 1.0 Cashflow Model is a process flow that determines our financial wealth. The Lifestyle 1.0 Cashflow Model is the model that most of us follow, but also the reason why most of us will never be rich, or at the least will never achieve financial freedom.
Here's how it works:
- Our sole income is from a salary. The salary comes from being an employee. The salary is dependant upon us providing x amount of effort and x amount of hours per week. The income we receive from our salary is paid after tax has been taken off.
- Most of our income is spent on expenses. Our expenses is made up things such as living costs - bills, groceries, general expenses, etc, - but also payments to discharge our liabilities (debts such as a mortgage, credit cards, loans, etc).
- If we have anything left over after expenses we may put this into a savings account. We can count a savings account as an asset because it is working for us - it is generating interest.
Knowing the difference between an asset and a liability
Here's a quick explanation of these terms, which is fundamental to understanding the model:
Asset: An asset is something that puts money into our pockets. Most of us wrongly consider our house as an asset. In most cases, an house is a liability not an asset because it takes money out of our pockets (mortgage payments, insurance, upkeep, etc). An house is only really an asset if you rent it out to provide an income, or you cash in on any equity that may be in the house, i.e. you sell the house and there's money left over after paying off the mortgage, or you re-mortgage the house to release some equity and you use the released equity to generate income that is greater than the proportion of the expenses inccured from the increase in liability payments (increase in mortgage).
Liability: Conversely, a liability is anything that takes money out of our pockets. One of the biggest liabilities that most of us buy is a car. A car loses value as soon as we get into it and continues to take money out of our pockets for as long as we keep it. A common misconception is that a car, like a house, is an asset. It's not because it's not making us any money. Also, unlike an house, a car will never become a real asset because it won't increase in value. A key principle in the 'Rich Dad, Poor Dad' book is that rich people put their money into assets, wheras the middle class put their money into liabilities which they think are assets.
Lifestyle 2.0 Cashflow Model
This is a basic diagram of the Lifestyle 2.0 Cashflow Model, which I explain in more detail below:
Here's how it works:
- Our income is derived not a from a salaried job, but from 'income generating assets'.
- As a business owner, we pay tax after we pay ourselves, and after expenses. The beauty of being a business owner, rather than an employee, is that we can claim a proportion of our expenses as a business incurred expense. As an Internet business owner, we work from home, which means we can claim a proportion of our household bills as a business expense. Because we're a business owner, we pay ourselves the minimum wage so as to only pay the minimum amount of income tax. The rest of our income from our business is derived from dividend payments. Of course, we also have to pay corporation tax, but corporation tax is at a lower rate than income tax, and corporation tax only gets paid on profit made after expenses. Although we pay both income tax and corporation tax, our overall tax burden is actually less than a salaried employee in the Lifestyle 1.0 model.
- Most of our income goes back into our assets column. As our assets grow, so does our income, which in turn grows our assets. This cycle continually increases our overall wealth.
- We buy assets and avoid liabilities. If we want a luxury such as an holiday, nice car, etc, we make sure it is paid for by our assets. We must not incur liabilities due to luxuries.
- If we do incur liabilities, it is to buy assets. However, we use risk mitigation strategies to ensure that the income generated from assets financed by liabilities will always be greater than the expense of the liability that paid for the asset.
- Although we do buy traditional assets such as property and shares, most of our money goes into creating new Internet business opportunities - we understand that we have the potential to make more money in the short-term by capitalising on this thing that is being called 'web 2.0', than on traditional assets.
A real asset makes money while I sleep
In my model, an asset is only really an asset if it makes money for me while I sleep. A day job is not an asset because it is dependant upon my contribution, both in time and effort, and once I stop contributing, so does the income. Whereas if done properly, a Lifestyle 2.0 asset will make me money, and then continue to make make me money without requiring any further effort or time on my part - it should be self-generating.
How do you measure wealth?
Am I wealthy if my net worth is $1 million. What about $2 million? In my model, the measure of my wealth is not how much I am worth in the traditional sense. In part 1 I suggested that a man earning $250,000 a year but working 80-hour weeks is actually worse off than a man only earning $50,000 but working a ¼ of the time.
In my Lifestyle 2.0 model my wealth is simply determined by the following calculation:
- If I was to stop working today, how long could I continue with the same standard of living before I would have to work again?
At the moment, because I'm living the Lifestyle 1.0 model and have only just begun the Lifestyle 2.0 model, the answer to my wealth question is only a few weeks. So the success of my Lifestyle 2.0 model will be measured by calculating my wealth in days, weeks, and years, not in dollars.
That's it for part 2, in part 3 I will describe how my Lifestyle 2.0 Cashflow Model will be used to achieve my Lifestyle 2.0 Living Model.