While making money as an employee is a good option for many people, most of us (including myself) never made a conscious decision to make money from employment. We just fell into it by default. And that’s the problem. If you’ve never evaluated the benefits and risks of being an employee and compared them to the risks and benefits of other ways to make money, then you may have set yourself up for some avoidable displeasure.

In this post, we’ll begin to step back and take a fair look at employment. First we’ll discuss the basics of the system and then we’ll look at some pros and cons of employment. We’re also going to introduce some criteria that we’ll use to evaluate any income system, whether it’s being an employee, making money online, or investing your money. The criteria we use to evaluate income systems are as follows: The Asset – what exactly it is that is making money in this system; The Cash Inflows – specifically how income is received from this system; The Taxes – how the system and the income it generates are taxed; The Cash Outflows – the expenses and debts created by the system; and lastly, System Control – who exactly controls and runs the system.

Looking at these criteria allow us to systematically examine any method of making money and determine what the pros and cons of that system are. Let’s now take a look at employment as a system for making money.

The Asset:

All systems of making money fall into one of two categories:

1)trading the use of an asset for money, or
2)creating or adding value to an asset that you then sell.

Employment falls into the former category since you are the asset that is being traded for money.

Think about that for a minute. Does that seem a bit Orwellian to you? “You are the asset that is being traded for money.” If you strip away all of the emotional and human aspects of your job and just look at it from a financial standpoint, that’s exactly what is happening. Or, if we want to be more specific, your time is the asset being traded for money. You go to work, give eight hours of your life to your boss, and he or she pays you a salary. If you stop giving him your time, he stops giving you his money.

The Cash Inflows:

Typically an employee agrees to perform specified tasks or meet certain goals in exchange for cash pay and non-cash benefits. Wages are generally received on a weekly, biweekly or semi-monthly schedule. Benefits may include paid vacation, paid sick-days, subsidized health and life insurance, and training.

The Taxes:

Wages from employment are generally subject to federal, state, and local income taxes as well as payroll taxes (FICA and Medicare). These taxes are withheld from each paycheck so there is minimal opportunity for tax planning or tax deferral. This is important to note since taxes on wages are generally higher than on other forms of income.

For example, if I were making $400,000 a year (I’m not yet) then I would pay tax at the following rates:

Federal: 35% of taxable income
State: 5% of taxable income
County: 1% of gross wages
City: 0.5% of gross wages
Payroll: 7.65 of gross wages

That’s a total of 49.15%. So for every additional dollar earned I only get to keep 51 cents. However, if that additional dollar of income came from a rental property then I could keep 60 cents. And if the additional dollar came from a capital investment in a business then I could keep 80 cents.

Cash Outflows

Working as an employee also causes you to incur expenses. You will probably have automobile expenses due to a commute, and could possibly even need to purchase an additional vehicle. On top of that, additional costs for clothing, medical treatments, food, and insurance should be expected.

System Control

When you work as an employee, the system that is generating your money (the business that you work for) is going to be owned and controlled by one of several people – it might be your boss, it might be a group of partners (such as a law firm) or, in a large company, it might be the shareholders. The important thing to note here is that in all of these situations, the system is not controlled by you. You will generally have little to no say in the operation of the business, the clients it takes, or how much money it makes.

This is part one of our look at employment as a system to make money. Hopefully this has helped you think about having a typical job in a new light. In our next post, we’ll examine employment further and see when it’s a good idea to have a job and when it’s not such a good idea.

What is an asset?

I started writing this post several days ago and came up with a great definition of an asset. Then I tried to explain my definition to John he completely shot it down – not because it was inaccurate but because it was too complicated. So I’m going to use John’s definition: an asset is something that puts cash into your pocket.

For example, if I own a website that generates $1,000 of advertising revenue a month, that website is an asset. If I own a stock that pays me dividends every quarter, that is an asset.

A business can also be an asset. If the entire business entity has more cash inflows than outflows it is an asset. In fact, a common measure of a business’ value is  its positive cashflow times some industry-specific multiple. If the business is not generating a positive cash flow, it’s not an asset and it’s not worth anything.

What is not an asset?

Things that takes cash out of your pocket are not assets. Most of the things that you buy for yourself are not assets – your car, your house, your dog. While all of these things have the potential to make your life happier, they aren’t assets.

A lot of people think of their house as assets. I recently heard a coworker say that she and her husband wanted to invest in a house while prices and interest rates are low.  What she really meant is that she and her husband were about to pay several thousand dollars to commit themselves to a large monthly payment that they couldn’t afford.

The idea of a personal residence as an investment is one of the greatest fallacies of our times.  The house that you live in has one primary purpose: to shelter you. You can choose to pay for that shelter by paying a monthly rent or by paying one lump sum upfront (purchase price of home).  The home that you buy might appreciate, but that appreciation is completely worthless to you until you sell the house. At which time, you will more than likely use the money to buy another house. The appreciation is stuck in the house – which means that it’s not putting cash in your pocket – which means that your house is not an asset.

Why is this important?

The definition of an asset is important only in that it helps you start thinking about assets. In order to change your financial situation you need to internalize the following two rules:

1. Every stream of cash that flows into your pocket is created by an asset.

Where do you get most of your cash?  Think back through the last month and identify the source of all of the deposits to your checking account.  Rule #1 states that each of these cash flows was created by an asset.

Here’s an example from our lives.  During the past month, we deposited 2 payroll checks and one bonus check. We also had direct deposits for interest income and a commission payment from Amazon. Given this you should be able to deduce that we have the following assets: cash, internet properties, and ourselves.

The average American gets an semi-monthly infusion of cash from there employer. If every stream of cash is created by an asset, then what is the asset that creates your salary? That’s right. It’s you.

Think about this for just a second. The main asset (and maybe the only asset) in your life is you – your body, your mind, your talents. YOU! Hold that thought and let’s move on to the second rule for a second.

2. Every stream of cash that flows out of your pocket has to be paid for with cash created by an asset.

If you buy a piece of land and do nothing with it, you’ve just purchased something that is going to cause cash to flow out of your pocket in the form of property taxes.  If you took out a loan to purchase the land, more money will flow out of your pocket to pay for interest and to pay back the principal of the loan. The land that you thought was an asset is not really an asset. In fact, it’s making your poorer every single month.

And where does the cash come from to pay for this land that’s making you poorer and poorer and poorer. Oh yeah, back to rule one now. It has to come from one of your other assets. And if you don’t have asset other than yourself to produce the cash, you’re having to work harder and harder to pay for this supposed asset that is actually draining money from your wallet.

What do I do now?

For now, just mull these things over. Figure out what assets you have in your life. Make a conscious decision that you are happy with the assets that you have, or make a conscious decision that you would like to change the assets in your life.

If you only have one or two assets that are creating all of the cash in your pocket, consider what would happen if one of those assets disappeared. Could you do without the cash from that asset?  Do you have insurance that would help make up the difference?

Consider whether your life viewed as a whole is an asset? Does the cash that you earn from working exceed the expenses that you incur to sustain your life?  If you life as a whole is an asset, then you will have cash leftover each month.

And finally, imagine what your life like you want it to be. Then imagine opening up your mailbox and pulling out your monthly bank statement. Open it as you walk back to your house (the house that you want to be living in) and look at the deposit section. Where are the deposits coming from? How big are they? How have you chosen to make money?