The key to financial freedom is making money work for you instead of working for money. Financial freedom means you are not dependent on anyone financially. You are in a position of complete self-sufficiency. You do not rely on a boss/master/institution to pay you a monthly check. It also means that you do not need to work. You could spend the next year, five years, ten years, or twenty years fishing, playing golf, smoking pot, surfing, hiking through the Himalayas, or traveling around the world on a motorcycle – and you would have a sufficient flow of passive income to fund your activities.
That is the goal, but how do you get there? There are two kinds of income – active and passive. Active income is the fruit of your labor. It is the remuneration you receive after putting in a hard day of work. When you start off your journey, 100% of your income is going to be active. The first step is to draw up a budget and understand how much you earn and how much you spend – and move into the territory where you earn more than you spend. That excess income needs to be invested religiously. You eventually want to reach the point where you have invested enough that the returns of these investments (passive income) are sufficient to sustain your lifestyle.
The question that now needs to be asked is where do you invest this surplus income. The first term you need to learn in the wonderful world of investing is “asset class”. Investments are divided into asset classes. Asset Class 1: Stocks/Equities (commonly referred to as the stock market) The stock market is one of the greatest generators of wealth on the face of the earth and the more you know about it, the better. Having said this, you do not need to be an expert in stocks to become financially free – a basic understanding will suffice. This is what you need to know. The stock market is a place where you can invest in thousands of public companies.
What does it mean to “invest in a company”. All companies need funding. They need cash and access to funds to operate. The way in which a company is funded is known as the company’s “capital structure”. Companies have access to two broad sources of funding – debt and equity. Debt is money lent to the company (most commonly by banks) and equity is the capital provided by the owners of the company. This allows us to create this simple formula: Total Capital = Debt + Equity
When you buy 1 share of Amazon on the stock market, you become an equity holder in Amazon. You become an owner of a very small slice of that company. How small? Amazon has issued approximately 500 million shares. When you buy 1 share of Amazon, you are the proud owner of 1/500,000,000 of the company. What does it mean to be an equity holder or owner of a public company?
Lets start off by explaining what you are not.
1) You are Not the Boss
Your single Amazon share does not entitle you to walk into Amazon offices, boss people around and demand a corner office. Those responsibilities rest with the companies management. Jeff Bezos happens to the largest shareholder in Amazon (with approximately 11 percent of the outstanding shares as of 2020) and is also in the management committee. However being the largest shareholder does not necessarily entitle you to run the company. Steve Jobs was fired from Apple, nothwithstanding holding a considerable equity stake in the company. The same happened with Travis Kalanick of Uber. 2) You do not own the assets of the company
As an investor in a company, you own a portion of the company (no matter how small that portion is); however, this doesn't necessarily mean that you own property of the company. You will recall that the capital structure is made up of debt and equity. Debt is the money that the company borrows from banks and other lenders. The debt holders have the first claim on the assets of the company.
As a common shareholder….
You possess the right to share in the company's profitability and gains from its stock price appreciation. If you had invested $1,000 in Amazon when it was listed on the stock market in 1997, it would be worth almost $1.6 million today (Oct 2020). Shareholders may also share in a company's profits by receiving cash or stock payments from the company—called dividends. Common shareholders can also influence a company's management by voting to elect the board of directors, who appoint the CEO. If a company issues new shares to the public, current shareholders have the right to buy shares before they're offered to new shareholders.
Owning equities is an exceptional source of passive income. There is nothing more passive than investing in great companies run by great people, and sitting back as the gains come rolling in. Few would disagree that 2020 was not a complicated year for financial markets. The coronavirus wrecked havoc through capital markets with numerous companies, such as Hertz. Some companies have turned the challenges of COVID 19 into opportunities and have added huge value to shareholders. Tesla is one that stand out. The stock was trading at close to $100 at the beginning of 2020 and by the end of the third quarter (end September 2020), the stock price had increased more than four-fold to $420.
For more on stock investing:
Asset Class 2: Bonds You will recall that the capital structure of a company is made up of equity and debt. We have already dealt with the equity portion – now is the time to deal with the debt portion. When companies are created, they need cash. They need to be funded. If you start a business today, it is likely that you will invest money in the company. In addition, you may invite friends and family to invest in the company. These initial investments are equity or ownership interests. As your company grows, you may tap out the resources of your friends and family, and you may decide to take your company public on the stock market. You will invite strangers to invest in your company. They will do so via the stock market and you will be accountable to them to maximize the return on the investment. These shareholders can at times be demanding, pushy and a general pain in the rear end.
It is therefore nice to know that shareholders are not the only source of funding available to you. Another common option was your local bank. You would draw up your business plan, extract urine, blood and DNA samples, put your pride in your pocket and walk into the branch. After hours of humiliation and relentless begging, the bank manager’s secretary would let you go into his office and pitch your business. If the bank manager agrees to lend you the money, you are able to plough that money into your business safe in the knowledge that the bank is not an owner of your business. The loan does not entitle the bank manager to have any say in the day to day running of your business.
In the same way that large companies list on the stock market, so too can they borrow money in the bond market. Instead of asking for more money from the bank, they issue bonds in the public market where anyone can buy them. When you buy a bond, you are effectively lending money to the company. You are acting as a banker.
For more on bond investing:
Asset Class 3: Real Estate There is no shame in being turned on by bricks and mortar. It appeals to all the senses – you can see it, touch it, smell it, taste it and even hear it, especially when filled with tenants. Real estate is an almost perfect form of passive income. It offers many money-making opportunities: flipping condos, renting multifamily homes, crowdfunding rentals and real estate investment trusts. The list goes on. Residential real estate investments are the most common forms of real estate investing. These include single-family homes, condos, and townhouses that can be re-sold or rented out for a profit. Rebel Finance focuses on passive income. Therefore, we are not going to focus on real estate flipping. Flipping is not passive. We are going to focus on rentals.
Airbnb and the sharing economy has added a new dimension to real estate investing. You can buy a condo in Tulum, Mexico, slap some paint on it, install an indoor swing, loft the bed and put a rug on it and create a meditation space, and bingo – you will find hippie Americans willing to shell out $100 per night. Property rentals are beautiful. John Keats, in his poem 'A Thing of Beauty' proclaims that a thing of beauty is a joy forever. Beauty never passes into nothingness. Our earth is replete with innumerable natural objects full of beauty. Keats wrote this poem while sitting outside a beautiful block of council houses in Bethnal Green. He was inspired by the flow of rents he could extract from these assets.
Twelve Cardinal Rules of Property investing:
Asset Class 4: Start Your Own Business A small business is an amazing way to serve and leave an impact on the world you live in. Small businesses are the backbone of any economy, but starting your own business is risky. You need to abandon the secure environment of monthly paychecks, employee health care plans, and paid vacations, and lunge into an environment where you are the boss and you become the provider of this security to your employees.
Seven Steps to Start Your Own Business English: https://www.rebel-finance.com/post/7-steps-to-starting-a-business
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