Let’s imagine you want to generate an extra $10,000 a year in income so you can improve your standard of living; take more vacations, buy better clothes, or treat yourself to a nice restaurant and night on the town once a week. If you owned $125,000 in blue chip stocks, this would be a non-event. You’d park you money in the shares, and begin collecting quarterly dividend checks. Of course, the problem is that it’s nearly impossible for man or woman who is trying to juggle their other responsibilities to build up that kind of nest egg.
That leaves you with the choice of working more hours or creating your own source of income. If you were to start a home-based business with, say, 50% profit margins, you would need to generate $20,000 in sales to have the $10,000 in hand. Depending on your income level, between Federal and State income taxes, including payroll, you’re going to be lucky to end up with $6,800. If, however, you had made the $10,000 through real estate investment income, you’d have at least $1,500 more in your pocket because you wouldn’t be subject to the payroll tax. Next year, that extra $1,500 could generate roughly $100 on its own in dividend income. Over time, the power of compounding kicks in and suddenly you find yourself thirty years older collecting $100,000+ a year as you sit by the fireplace.
This concept was explored in depth in the article All Income Is Not Created Equally where you learned that how you make your money could determine your ultimate net worth due to various tax laws in the United States. It’s actually possible for a blue-collar worker who focuses on special investment income to end up many, many times wealthier than a successful doctor or lawyer earning much more. This is especially true if the worker shelters as much of his or her income as possible in tax-advantaged accounts such as a self-directed IRA.
