A topic that pops up consistently. If you solely rely on one source of income, there is a very low chance you will be able to reach financial freedom. Caveats of this being unless you have a very well-paid job, or you have hit retirement age and have received a lump sum. Warren Buffet was quoted saying “If you don’t find a way to make money while you sleep, you will work until you die.” Or as Marshall Sylver also said “Either make your money work for you, or you will always work for your money.”
Assuming you currently sit on only one source of income; which is typically ‘Earned Income’ from an activity in which you exchange your time for money, you can do some basic sums to work out just how long it will take you to become financially free.
Salary* – Needs Expenditure** = Savings and Investments*** + Wants**** (i.e. the Fun Fund)
Total Debt / Savings and Investment = Number of Months to reach Financial Freedom
* Salary is your monthly take home pay after tax and other automatic deductions (i.e. pension, student loan etc.)
**Needs expenditure are the things you have to buy in order to fulfil your basic biological needs for human survival. Likely to be around 50% of your salary.
***Savings and Investments is the budget set aside to pay off your debts or invest. Likely to be around 20% of your salary.
****Wants are the things you would like to buy but could live without (or at least a reduction of). Likely to be around 30% of your salary.
The percentages used in this equation were discussed in the book ‘All Your Worth: The Ultimate Lifetime Money Plan’ by US author and Senator Elizabeth Warren.
Your goal is to reduce the number of months to reach financial freedom. Ideally you want to do this as quick as possible to reduce the impact of interest from debt and also begin increasing savings and investments. To achieve this, you may need the help of some additional sources of income.
I should express at this point that I am in no way a Financial Adviser, nor am I qualified in Finance what so ever. I highly recommend you do your own research and make your own conclusions.
Income Source 1 – Earned
I know I’ve mentioned this source already, but that’s because typically, most of you can already put a tick in this box. If you can’t tick this off; and you’re looking to get financially free, this is a pretty good place to start. Unless you are incredibly lucky, money will not just get given to you for free. It really doesn’t grow on trees. The simplest thing that you can legally provide in exchange for cold hard cash is your time and effort which is rewarded in £s Per Annum (a salary).
Until you are in a position to invest in additional sources of income, there are some things you can do to make your ‘Earned Income’ more valuable
- Request a pay rise/promotion
- Look for a higher paying job (or same pay, less hours etc.)
- Increase your skill set so your time and effort become more valuable to a company
- Work overtime if its paid.
- Get a second job
- Offer to take on work that is unappealing such as unsociable hours if its paid extra.
The options that require more time or effort should only be temporary to give you a boost. It is incredibly important to maintain a good work life balance otherwise you could burn out or simply miss out on making memories.
The ultimate goal is to reduce your time and effort yet maintain or increase your salary per annum.
To do this effectively, you will need the help of additional sources of income.
Income Source 2 – Profit
The definition of profit is ‘A Financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something.’ Businesses make a profit by selling their goods or services for a higher price than it costs them to provide it. For example, if you buy 5 products for £100 each and sell them on for £120 each, you make £100 profit. This is the simplest way to view it.
However, you will need to be careful when you have to start factoring in other costs that you may have accrued during this process.
If you buy in 5 £100 products and store them in a facility that charges £100 per month and you sell all 5 for £120 each, you will have made £100 in profit but lost £100 in expenses, equating to £0 profit.
If you also spend £15pm on running a website, £10pm on advertising and £25pm on packing and shipping you will actually be making a £50pm loss.
To make a profit you will need to ensure that your income is greater than your expenditure.
To do this, you could:
- Increase the price of the item you are selling. Be sure to consider just how much you are selling the product for. Are there cheaper alternatives that people will opt for? If so, why should someone buy it from you at a greater price?
- Push for a reduced cost of the supply. A lot of suppliers offer a multi buy discount i.e. buy 10+ for a 10% discount, 25+ for a 15% discount etc. Assuming you are able to sell all the stock this is a good way to increase your profit margins. You could also look for a cheaper supplier or haggle with your current supplier.
- Reduce your expenditure. Find a way to save money on your everyday running costs. Can you store the goods in your spare room or garage? Do you have trustworthy friends who have a spare room? If you pay them £50pm to use their spare room you’ve just saved yourself £50 per month.
Social media can be used for cheaper advertising. Facebook for example charges nothing for you to set up and run a business page in which you can post links, adverts, pictures and videos, and ideas etc. This has the potential to reach customers all over the world. Utilise all social media platforms like Pinterest, Twitter, Instagram, and YouTube. Who wouldn’t want a product or service that goes “Viral”?
To make profit into an ideal income source you need to be increasing your profit margin and reducing your involvement. Drop shipping is a popular method used by businesses. This is when you sell a product on behalf of someone else who fulfils the order. For example, if someone wanted a pizza, you could offer a pizza to them for £20 and then order the pizza yourself from Dominos for £17 and have Dominos deliver it directly to the buyer. Neither party is any the wiser, both got what they want and you make a £3 profit. Now imagine if you could automate this process. Take Just Eat for example, they never see the goods, they don’t provide the goods, they don’t store or process the goods. What they provide is a way of connecting buyers and sellers of food and take a cut of each transaction. Yes, you could order your food directly from the supplier and it will no doubt be cheaper. Probably not a lot cheaper and so the buyer would weigh up their options in terms of cost verses convenience.
Income Source 3 – Interest
Interest is what you earn from lending out your own money for a fee. Typically, this ‘fee’ is depicted by banks as an interest rate. When you deposit your money into a savings account, you are agreeing to let the bank use your money, on your behalf, to invest or loan to others, in return for a profit. The more money you can deposit, the bigger your return. UK savers, using authorised banks, are protected by the Financial Services Compensation Scheme (FSCS) who will protect up to £85,000 of their money (per bank) should the bank fail. So, if you are lucky enough to have more than this available, you should consider spreading it out to other authorised banks.
In order for interest earned to become a reasonable income source you will need a large sum of money of which you don’t need to have access to. If you withdraw your money from a savings account, you are likely to incur some form of penalty, especially if it was a fixed term savings account. The more flexible you need your money to be, the smaller the gain you will receive.
Income Source 4 – Dividend
Dividends are payments from a company, to its shareholders, using its profits. To earn dividends, you must have shares in a company that actually pays dividends. The more shares you have in a company, the more dividends you will receive when it does pay out. The number of dividends a company pays out depends on factors such as the amount of profit earned and what they intend on doing with it. Some companies would choose to reinvest their profits into the business to help it grow. This is especially true for companies that are still growing and need to buy more assets. Whereas more mature companies that have a more predictable profit margin often like to reward their investors for their support. Paying out dividends can make a company more appealing to investors.
On a smaller scale, if you own your own Limited Company you can pay yourself using dividends (assuming you make a profit). A lot of freelancers use dividends as a way of topping up their salaries in a tax efficient manner. For FY19/20 you have a £2000 tax-free dividend income allowance above the current £12,500 Personal Allowance. You also only get taxed 7.5% on dividends income between £2000 and £37,500 which is far better than the 20% basic rate income tax which is what you would pay if you had a salary between £12,501 and £50,000.
So, for example, throughout FY19/20, if you paid yourself a salary of £8,632; which is the National Insurance Primary Threshold, and then paid yourself £41,368 in Dividends (totalling £50,000 and assuming you have no other income sources at this point) you would only pay £2,662.50 in Income Tax.
£50,000 – £12,500 (Personal Allowance) – £2000 (Dividend Allowance) = £35,500 (Taxable Dividends)
£35,500 x 7.5% (Basic Rate Dividends Tax) = £2,662.50
If you had a £50,000 salary you would have to pay £7,498 income tax and £4,964 National Insurance.
Income Source 5 – Rental
Rental Income is money earned from renting out property or equipment. If you have a spare room or a second house, you can rent these out to other people in exchange for money. This also applies to renting out your garage, loft, driveway, garden, or if you can afford to buy it up front, industrial space. If you live in a big city or near a train station, you could let other people park on your driveway. You can use any available space you have within your property to rent out as storage. First check the rules of your mortgage if you have one.
With companies like Airbnb or Booking.com you can advertise your available accommodation for others to rent for a holiday. The income earned from this depends on what you have to offer. If you have a spare room in a fancy house in London you will be able to offer this out at a much higher cost than a flat in a small remote town.
If you have high quality equipment from reputable brands, you can rent this out to people for their projects. How many times have you wanted to do some one-off DIY like installing a decking and have been put off because decent equipment would be so expensive, and you have no room to store it when you’ve finished? I mean, why cut the wood with a handsaw if you could use a high performing circular saw? How about if I lend you my circular saw for a week for £20? Seems a lot more appealing then settling for a cheaper alternative or grafting with a handsaw. Equipment can include almost any other items you own like fancy jewellery, cars, caravans, gaming platforms, computers and various other technologies. Whatever you choose to rent out, just know that there is always a potential of damage or loss.
Income Source 6 – Capital Gains
Capital Gains are realised when assets you own increase in value, and you sell them for more than you purchased them for. If you buy a house for £150,000, live in it for 5 years and then sell it for £180,000 you will have made a Capital Gain of £30,000. Capital Gains can be earned on a lot of things you probably already own like jewellery, paintings, artefacts, cars, property, and shares etc.
Having this as an income would be a slower game plan as you have to rely on the item in question increasing in value which often takes time. There are windows of opportunity to buy low and sell high quite quickly but you have to be ready and waiting, and know what you are doing. Stocks and shares in particular can be very volatile with large peaks and troths. Day traders make a handsome living off of buying low and selling high.
Before you run off and buy a load of things to put in storage for a few years there are some downsides to this you need to understand. Capital Gains Tax, if not understood correctly, can help themselves to between 10 and 28% of your profit earned. Also, remember that Capital Gains are only realised once the item is sold, meaning that just because you think the value has gone up, doesn’t mean someone else is willing to pay it.
As of FY19/20, you only pay Capital Gains Tax on:
- Most personal possessions worth more than £6,000, apart from your car (unless it was used for business)
- Property that is not your main home
- Property that is your main home IF you’ve let it out, used it for business or it is larger than 5,000 square meters in total
- Shares that are not in an ISA or PEP
- Pretty much anything bought as a business asset.
The takeaway from this though is that it is only a percentage of the gains, so at the end of they day you are still making money.
Income Source 7 – Royalties
Royalties are payments made to the original owner or producer of particular property, by a third party who wishes to use that property to make a revenue stream of their own. Income earned from this source can be very lucrative if successful. According to The Independent, Mariah Carey continuously rakes in over £400,000 each year in royalties earned from her single ‘All I want for Christmas is you’, despite the fact is was released in November 1994 and only reach number 2 in the UK Singles Chart.
J. K. Rowling, Author of the Harry Potter book series, will forever earn royalties (as long as she holds the rights) from anyone who wishes to use anything relating to Harry Potter. This includes theme parks, attractions, fashion, books, music, plays, and films.
If you wish to earn an income from Royalties you are going to have to come up with an original idea that others can use to make money. This could be in the form of a product, song, catchphrase, sound, franchise, book, performance, design, technique, photography or various other things you can protect the rights to, using Intellectual Property Rights such as Copyrights, Trademarks, and Patents.