Income

Definition of Income

noun

money received, especially on a regular basis, for work or through investments.

Why am I teaching you about income?

Learning about income might seem like a trivial topic, but it is the foundation of all financial goals.
Sure, everyone knows what they make (right?)
But the real question is, do you know how much you have remaining at the end of the month after you pay for all of your expenses?
We won’t dive into a budget just yet, but we will cover ways to understand your income, its components, and a variety of ways to increase your income (instead of trying to eliminate those $5 coffees that social media gurus hate so much).
Here’s another piece of advice:
- Sometimes it is better to focus on improving what you have then trying to expand to other avenues.
- I’m not saying don’t try something new.
- I’m saying maybe it would be more beneficial to save some money from your day job before you start opening LLCs or buying real estate.
- Sure, everything is a risk and you aren’t always going to make it real far playing it safe.
- I’m just saying that focusing on one thing at a time can be a good thing.
- Here’s an example: If you have credit card debt that keeps you up at night, I wouldn’t suggest investing in the stock market or buying a rental property. Pay off that debt immediately and then strategize for your next investment. Imagine the stress of having a mortgage and credit card debt payments? No thanks.
Here’s another reason why income is important: Live Your Life
- Sure, reducing expenses is a very effective way to increase money in your pocket
- But at the same time, live your life – go golfing, go out to eat, spend money on vacations.
- Being frugal shouldn’t make you miserable
- I know the counterargument here is to say that you shouldn’t spend your money care-free
- Yes, there are repercussions and I don’t advise having a spending habit that pushes you to credit card debt
- But going golfing isn’t going to be the sole reason you cannot save a million dollars for retirement
- So what do we suggest? Do your best to either budget extremely well or find ways to increase your income. Yes we know, easier said than done, but we wouldn’t be doing our jobs if we didn’t mention it.
- How do you increase your income?
  - Get a new job that pays more
  - Ask for that raise or promotion (or ideally, both)
  - Or do what every social media guru is pushing nowadays: get a side hustle
    - Bartending or being a server is the oldest form of a side hustle
    - Look for a part-time job fits into your schedule
    - Start an online business (prime example: Polymath Finance)
  - These aren’t easy tasks, but it can help facilitate additional income that can help you reach your goals

Now, let’s dive into the details.

There are two types of income (generally speaking of course): Earned Income and Passive Income.

Earned Income is revenue generated from a paycheck or business activity and involves direct effort (shout out to those who didn’t quiet quit. Yet.) We can break down Earned Income into two additional sub-topics (again, generally speaking): Those who receive a paycheck from an employer (W2) and those who receive payment directly from the business or customer (1099).
1. W2 employees work directly for a business and receive income after taxes are paid. Their paycheck is also reduced by items like health insurance, retirement contributions, and the beloved Social Security payment. A couple key highlights of a paycheck:
  1. There are two types of taxes -> Federal (standard tax table for everyone) & State (dependent on the state the person lives in).
  2. Social Security -> These are retirement benefits that we hope don’t run dry when it’s our turn to cash in.
  3. Retirement Contributions -> Build up that retirement account as best you can and take free money from your employer if a match is offered.
  4. Health benefit deductions -> Make sure you and your dependents are covered. It sometimes sucks to pay into health insurance, especially if you tend to be healthy. But I guarantee it’ll be much worse than not having health insurance at all.
  5. Year-End Taxes ->
    1. Without going into immense detail, the filing of a tax return is the correction of all the taxes you paid during the year.
    2. Technically, the less money you receive back, the more accurate your taxes were. Of course, it is typically better (or at least feels better) to receive money at the end of the than to get $0 (or worse, owe money)
  6. Bonuses ->
    1. Additional (and usually discretionary) money received from an employer on top of salary earned.
    2. I generally suggest to not include this in the budget so it is always gravy on top of whatever you already received.
    3. Sometimes it is a lumpsum way of bolstering your savings, other times it is how people fund their retirement accounts, and other times it is a necessary item that people rely on for their expenses (credit card payoff).
    4. No matter how you utilize your bonus, there isn’t a wrong answer, but it is optimal to not include it in everyday spending so it can be used for retirement/investments/etc.
2. 1099 recipients are self-employed individuals who receive income earned as independent contractors. A couple highlights are as follows:
  1. These payments are made in the gross amounts, so taxes are NOT taken out like a W2.
  2. Save some of that money for taxes!!
  3. Rule of thumb, put away 30-35% of the amount until you can get comfortable with home much you will owe.
  4. If you have substantial income earned from being a 1099 worker, it might make sense to speak with a tax professional to ensure all of your income is properly recorded and you are utilizing the proper tax deductions to limit what you have to pay.
  5. It might also make sense to form a business (think LLC) so legitimize your business and to maximize your profits and minimize your taxes.
  6. Oh, and I almost forgot, SAVE SOME OF YOUR DAMN MONEY FOR TAXES.

Passive Income -> Revenue generated from an investment that does not involve direct effort. I will go into more detail in future threads.
1. Rental Income -> revenue earned from owning a rental property
  1. Pros: Good cash flow and great way to build equity
  2. Cons: Very capital intensive and not very liquid
2. Dividend Income -> revenue earned from owning stocks that pay dividends
  1. Pros: Good cash flow and great way to build a portfolio
  2. Cons: Stocks aren’t typically high growth and companies do not always pay dividends
3. Interest Income -> revenue earned on money from banks (savings, money market, CDs, treasuries)
  1. Pros: Very safe and reliable
  2. Cons: Money doesn’t grow as well as compared to other investments; money can be locked up for a certain amount of time (i.e., CDs)
4. Business Venture Income ->
  1. revenue earned from an investment in a business (private equity)
    1. Pros: High earning potential and great way to diversify cash flow
    2. Cons: Highly risky investment and not typically offered to retail investors
  2. revenue earned from a side business that needs little or no direct involvement (SaaS)
    1. Pros: Truly passive income, high scalability, and high earning potential
    2. Cons: Extremely difficult to build and maintain

Important Calculations

Monthly Net Income ->
1. It’s important to understand what you take home on a monthly basis. Key words: Take Home.
2. Sure, it’s nice to tell you people you make $100k, but…
  1. What is that number in terms of a net monthly amount?
  2. How does your net income compare to your expenses?
  3. Are you able to support yourself on that number?
  4. If not, is it more efficient to reduce expenses, or should you think about increasing income? (i.e., side gig)
3. To calculate this, we first must understand the frequency of your paycheck.
  1. Monthly and bi-monthly are the easiest – just take the paycheck you receive and do the monthly math
  2. Every week or two weeks is a bit more challenging – take your paycheck, multiply by 26 or 52, and then divide by 12
  3. Hourly is the most challenging (unless you work the same hours every week) – there are a couple options here
    1. Most accurate = take a year’s worth of paycheck and divide by 12
    2. Next best = aggregate as many paychecks as possible and find the average weekly amount, multiply by 52, and then divide by 12. Let’s go into a bit more detail here: If you figure out that you typically make between $1,000 and $1,300 per week, then take $1,000 + $1,300 = $2,300. To get the average of these numbers, divide $2,300 by 2 which equals $1,150. Now, the $1,150 is the average paycheck you get on a weekly basis, so multiply this amount by 52 to get the yearly amount, and then divide by 12.
    3. Easiest = Take last week’s paycheck, multiply by 52, and divide by 12.

*For #2 and #3, if you get paid bi-weekly, then multiply by 26 and then divide by 12.

Gross Income to Net Income Ratio ->
1. This is a tricky one and not always the best calculation, but it is good to know what the percentage of your gross salary is. It will help with budgeting and help with forecasting for future pay raises/decreases.
2. I’d suggest using the Monthly Net Income calculations first to find the net amount
3. Divide your Gross Annual Salary by 12
4. Divide the Net Monthly Income by the Gross Amount
5. Example:
  1. Gross Salary = $100,000; Monthly Gross Salary = $8,333.33
  2. Net Monthly Income = $5,833.33
  3. Percentage of Gross Salary Kept = 70%
6. Real Life Use -> Now let’s say your $100k salary is going to increase to $125k, and you want to know how to budget or if you can afford that more expensive house/car. The simplest way to do this is to take the $125k, multiply it by 70%, and then divide by 12. This equals $7,291.67, which means you have additional $1,458.33 to work with. Now obviously these won’t be exact numbers and things will change in your paycheck (increase to taxes, different deductions, etc.) but at least it will give you a ballpark of the new salary number.

So, we’ve discussed income. Again, this might seem trivial, but having extra knowledge is always beneficial.

Monthly Net Income

Gross to Net Ratio