Get a hair cut and get a real job! That’s what most young people are told. Nothing is hammered home harder and more often than the importance of getting good a job and a good income.
When you are starting out and have nothing, getting an income is paramount and most incomes come from jobs. As explained in About Me, a good job and income is what I focused on. Yet, I will argue that investing can be just as important, if not more important than salary income.
As explained in About Me, I lost a lot of money due to bad investments. When you lose money, you stay in places like the place I stayed at in the above photo.
As it turned out, I wasn’t alone in the losing money camp. Two friends of mine also had good jobs and above average income for over 15-20 years. They bought two investment properties each during the U.S. housing bubble. When the housing bubble burst, both friends lost most of their life savings. One friend now lives in his smallest house. It’s worth less than what he paid for it. He feels like he’s starting from scratch again.
You may think that my friends are isolated examples. According to Forbes in May 2014, 18.8% of American households are still underwater. According to the Federal Reserve Bank of New York:
“At the peak of the boom in 2006, over a third of all U.S. home purchase lending was made to people who already owned at least one house.”
This implies that over a third of homes purchased in 2006 were investment properties. This is just one example of how a bad investment decision can result in devastation. I can guarantee you that the majority of these homeowners had jobs and salary income, but that did little to protect their wealth from the ravages of bad investing. People can see the effects of hurricanes and earthquake. The devastation from bad investing is less visible, but it affects millions of more people.
The flip side are successful investors, such as Warren Buffett and hedge fund managers. They make the bulk of their money from investing, not from salary. According to CNN Money, the top 10 hedge fund managers made $600 million to $3.5 billion. Nobody makes this kind of money from salary. CEOs make the bulk of their money from stocks and stock options as well, not from salary.
In fact, one can argue that the richest people in the world are rich because of stocks. Bill Gates has a net worth of approximately $81 billion. This is not from collecting his share of Microsoft’s profits.
Salary income is a false sense of security. You can lose your salary in an instant if you’re fired. Banks are notorious for poor risk management. They rely on a borrower’s salary as the indicator of their ability to repay loans. As shown during the great recession, millions of people lost their jobs and defaulted on their loans. So many millions of people defaulted that the banks would have gone bankrupt if the government didn’t bail them out with billions of dollars.
You can view “investing” as another side-job, or a self-employed job. You can never lose this income stream because nobody can fire you. Ideally, you should have multiple streams of income. This way, if any stream stops, you have other streams to rely on.
Governments are prolific spenders and experts at wasting other people’s money. This is why they have huge debts. When any business spends or wastes too much, it dies and disappears. Governments never die. They keep spending and wasting. This is why they try to grab as much of your money as possible through taxes. No matter how much money you make, it is equally important to know how much you’re taking home.
Let’s suppose that Jane is an investor and Joe is employed with a job. Let’s suppose that they make the same amount of before-tax money. Jane’s take-home pay will likely be greater. According to Wikipedia, taxes in the U.S. are lower on dividend income than on salary income. According to the Globe and Mail, taxes in Canada are lower on dividend income as well and can actually be zero.
According to Wikipedia, taxes in the U.S. on capital gains are equal to or lower than on salary income.
Taxes on capital gains are lower in Canada as well. According to EY, if you have a salary of $50,000 in Ontario, you will pay $8,694 in taxes and take home $41,306. If you make $50,000 in capital gains in Canada and this is the only money you made, you will have a taxable income of $25,000. According to EY, you will pay $2,854 of taxes on a taxable income of $25,000 in Ontario. This means that you would take home $47,146 ($50,000 less $2,854).
(Note: Please read my disclaimer below. I am not a tax expert. Your situation may be different and therefore you should consult a tax expert.)
This is why the rich pay so little tax. There has been a lot of news about the top 1% getting so much richer than the average working person. This is because the rich know how to invest and because stocks have been rising and they pay little tax.
There is more than just income-inequality. There is take-home inequality as well.
Warren Buffett has claimed that he pays a lower tax rate than his secretary. This is because most of the money that he makes is from capital gains and dividends. Most of the money that his secretary makes is from salary. According to Salary.com, Warren Buffett received $485,606 in total compensation, of which $100,00 was received in salary. According to Forbes, Warren Buffett makes $37 million a day.
As explained in How to Beat Most Hedge Funds and Warren Buffett, I did extremely well with my investments since 2008. In fact, in 2009, I made more take-home money than I’ve ever made in my life and more than 99% of the population. This is how much of an impact investing can have. Yet, most schools spend 0% of their time teaching investing and 100% of their time teaching science, business, arts, literature, sociology and psychology.
Another benefit of good investing is that you can, not only have financial freedom, but you can have location freedom. You can invest from almost anywhere in the world that has internet. Investing is location-independent.
Even if you have never bothered to learn how to invest, many of you will rely on your investments for the rest of your life when you retire. Now that people are living to 85-90, you will be relying on your investments for 20-25 years or longer if you retire early. Some may rely on their investment advisors to manage the investments, but I’ll explain in Using Investment Advisors why clients under-perform the market (and it is largely because of clients, not necessarily because of Investment Advisors) and why you can make more money by investing properly.