Wise Money Decisions

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)

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Last time I discussed my goal to be in a position to retire after a 20 year career.  To reach my goal I need to accumulate a large amount of money.  There are many ways to make money: jobs, savings accounts, stocks, mutual funds, real estate, start a business, receive an inheritance, etc.   I find it useful to categorize the different ways that money is made as follows:

• Labor
• Capital
• Gifts & Inheritance

Each of us makes money from all three categories.  For most people, the vast majority of their money comes from labor and a much smaller amount comes from the other two categories.  Over the next couple days I’m going to discuss the pros and cons of each category.  I will start with labor because it is the most familiar for most people.  For now let me arrange the categories into a table with some defining characteristics:

What is Labor

When I was 10 years old I did a paper route.  I got paid six cents a paper.  That’s labor.  A few years later a math professor hired me as a math guinea pig.  He wanted me to do all of the math problems in a textbook he was writing.  That’s labor.  Not to mention the most boring summer job ever. 

These days I provide legal services.  That’s labor.  I help people invest their money.  Also labor.

What’s Good with Labor

Most people earn most of their money from labor.  Labor is the only way to make money when you start out in the world.  There’s a low barrier to entry.  Even if your only skill is digging holes in the ground, you can find someone willing to pay for it.  As you develop skills your labor becomes more valuable.  A doctor makes more than a ditch digger, for example. 

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This is the first post of the Wise Money Decisions blog.  I want to lay out the purpose for this blog and set the stage for what’s to come. 

My Big Goal

When I started my career, I set the goal to be in a position to retire within 20 years.  Not that I will retire.  But that I will have the choice.  And I don’t mean retirement in the geriatric-Florida-Medicare Plan B kind of way.  For me, retirement means freedom from the need to work.  If and when I achieve my goal, I would thereafter work only if I enjoy it and not because I need the money.  I would spend more time doing things I choose to do, and less time doing things I have to do.  I would spend more time with my family, reading, traveling, writing music, and helping others.  I would spend less time working.  And I would never have to tolerate a job just because I need the money! 

In order to retire in 20 years, I need to have enough saved up that I can generate a lot of passive income from things like interest and dividends.  When most financial planners calculate how much you need to save for retirement, they assume you will draw down a portion of your savings each year. 

I make my retirement projections a little differently.  I don’t intend to draw down my savings in retirement.  When I kick the proverbial bucket I intend to leave to my kids about the same amount that I retired with.  If they’re lucky.

What are the pros and cons of calculating my retirement this way? 

Advantage:  I can live until 100 and never run out of money.  I can invest more aggressively during retirement because I have a large cushion.

Disadvantage:  I need to save more for retirement than most people.   

And there’s one more upside.  I’ll have something to leave to the world when I die.  I’d like to leave enough to my wife and kids that they’ll always think kindly of me, but not so much that they’ll pull the plug early. 

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