Yesterday I provided an overview of the three ways to make money: labor, capital and gift. I discussed the first way, labor. Today I will discuss the remaining two ways: capital, and gifts.
What is Capital
Once you’ve made some money from your labor, you can invest and make money from capital. The most common way is opening a savings account at a bank. Other ways: invest in stocks or funds, real estate, collectibles (art, stamps, baseball cards), or start a business. Starting a business requires a combination of labor and capital. Some businesses require high amounts of both, while other businesses may require more labor and less capital.
What’s Good with Capital
Generally, making money from capital requires less effort than labor. It usually takes less time to manage your capital. Your capital works even while you’re not. For example, I own stocks of Japanese companies. It’s nice to think they’re on the other side of the world making money for me while I’m asleep at night.
Capital is taxed less than labor. Not only is the tax rate lower, but there are also more tax planning opportunities to reduce your tax bill. As mentioned above, I’ll post soon on the taxation of labor vs. capital.
How To Make More Money on Capital
Capital is scalable. If you want twice the return, you can invest twice as much capital. Or you can find ways to invest your money at a higher return.
Downsides of Capital
With all the advantages of capital, what downside could there be? Just one. It takes a lot of capital to make significant amounts of money. Let’s take the stock market as an example. Even if you find ways to achieve an average annual after-tax return of 15% per year in the stock market (not an easy feat), you need to invest about $600,000 bucks to generate enough return to live a middle class life in Silicon Valley! (based on 2006 median income of $85,446)
What are Gifts
Here I include gifts from the living as well as inheritances from the deceased. I’ve never received an inheritance. I hope it is a long, long time until I receive one. I have received gifts. None have been unusually large. My grandparents used to send me birthday cards. Some years there’d be a $20 bill, and other years just a couple of $1’s. I’m not sure how that got decided each year.
In my line of work I know a lot of people with wealthy parents and relatives. They tend to receive large amounts in the form of gifts and inheritances. Even larger than my birthday money. But for most people, the money received in the form of gifts and inheritances is minor compared to labor and capital.
What’s Good with Gifts
Making money through gifts takes little or no work. While the federal government imposes gift tax on large gifts, there are ways to plan around it. It’s harder to plan around the estate tax completely, but few people have sufficient net worth to pay the estate tax. It’s one of those problems you wouldn’t mind having.
How To Make More Money on Gifts
People have done weird things to get in good graces with rich friends or relatives. When it happens, it’s usually on TV. But there are plenty of real life situations too. Anna Nicole Smith comes to mind. Seriously, don’t try to make more money on gifts. Just be nice to everyone and treat everyone the same. It’s its own reward.
Downsides of Gifts
Can’t think of one, other than that you don’t have any control over whether you receive gifts.
Why Does All of This Matter?
Most of us start out life making the vast majority of our money through our own labor. As we progress through life financially, we have the opportunity to make money through investing our capital. The key is to increase the proportion of what you make through capital. Why? Making money through capital is easier than labor. It takes less time and effort. And it’s more fun.
If you’re like me, you look forward to the day when you are able to generate enough income from capital that you no longer need labor. When that day arrives you may choose to continue working, perhaps because you enjoy what you do. The point is that you will have the choice. Your time will belong to you.
For that day to arrive, you must invest your capital. If you’re a good investor, that day will arrive sooner. If you’re a great investor, you can accelerate it by years or decades. In future posts I will show how anyone, no matter how much money they make, can accelerate that day by 10-15 years by investing wisely. It doesn’t require risky investing or get rich quick schemes. It does require a little know-how. Not a lot, just a little. And it requires a commitment to wise, long term investing.
The reward is worth the price.