How to earn an extra $500 a month: Part 1

dollars_and_centsThe concept of wealth creation at Financial Place Online is that it is a process of thrift and continuous improvement, measured over a long period of time, perhaps even over generations.  There has to be a starting point somewhere, and $500 extra income a month meets the needs of many.  The 2012 U.S. median income was just a little over $50k.  Certainly, an extra 12% is achievable, and given the U.S. median savings rate of 4%, the extra $6k per year would quadruple the median amount of disposable income if the right tax management is done to compensate.

How is $500 extra a month best earned?  Any way that it can be.  Below is a list created by FPO with investment methods to create this extra cash flow.  None of them are easy, but they are achievable.

  • If you’re 65 years old – buying the $100k annuity from our annuity example would generate $521 per month for the rest of your life.  The amount is more if you’re over 65, and less if under.
  • The Vanguard Total Bond Market Fund (VBMFX), has earned a 10-year average of 5%.  $120k invested here $500 per month.
  • It is common to see entry level houses rent for about 1% of the purchase price per month.  Paying cash for a $70,000 house would net a $500 per month extra after property management fees and repairs.  Don’t count too much on appreciation at this time.
  • Based on the 10-year return of the Vanguard Total Stock Market Fund (VTSMX), the $500 per month can be generated from an initial investment of $60,000.

This is good in theory, but the issue in the above is that there is a lot of upfront cash required.  There are two things wrong here.  One is that the cash may not be available.  The second is that each of these opportunities return less than 8%.  That’s not the smartest way to tie up cash.  Part 2 of this article will explain when it’s suitable to use the bank’s money to get a higher rate of return.

Present value of cash flows

The stock market has taken losses the last couple of days in the face of political uncertainty. It’s important to keep in mind that market moves within any given day are based on rapid changes in market sentiment. The measure of how any asset performs over time is it’s ability to generate and increase cash flow. In the case of a stock, the current price is each future cash flow discounted to the present at the required rate of return. This rate is determined by the market as a whole. The reason for discounting to the present value is that a dollar in the present is worth more than one in the future, at the very least due to the fact that money today can be put to work to earn a return on capital.

Retirement savings modeling

The retirement scenario generated by FPO (we’ll randomly post different retirement scenarios) shows the importance of the cash flow concept mentioned in the previous post.  This is also the bread and butter for FPO; growing your income, shrinking your expenditures, and maintaining/grow your quality of life.

Here’s an example of what would be a working solution based on FPOs model for figuring out how much money is needed to retire.

Year: 2012

Age: 47, Spouse: 46

Earned income before taxes: $60,000/yr

Taxes on earned income: $6000/yr

Earned income related expenses = $6000/yr

Last year of mortgage. Payment = $12,500/yr

Other expenses: $17,500/yr

Saving rate: $18000/yr

Starting in 2013: Primary residence is paid off.

Assets: $500000 rental property, $500000 high dividend and master limited partnership (think oil+gas income)

After tax income: $27500 real estate, $27500 high divident, etc. total: $55000

Note that $1000000 is assets completely replaces the earned income in transistion. These assets were building up over several decades prior to 2013. The result is cutting income by half in 2012 if there is no more earned income, but the assets still generate $55000 in income. There are only the normal expenses of $17500 year. The only unknowns would be health insurance and long term care insurance. even budgeting $12500/year for these two categories still leave $25,000 in savings rate per year. Take some of that for vacation and fun. An added plus is that someone following this example will likely figure out in some spare time to make some extra money at a high rate per hour, but that parts optional.

Cash flow is the key to getting ahead

There are many ways to get ahead financially, but they all center around one principle…freeing up cash flow.  It does no good to be sitting on a great piece of real estate if you are not renting it out or renting for a loss.  At this point the asset is a sinkhole.  The importance of cash flow can define how your business operates.  Take Apple for example.  Their cash holdings were $51B, $81B, and $121B in 2010, 2011, and 2012 respectively.  In combination with this Apple enjoyed a terrific boost in stock price.

Personal finances work the exact same.  In fact, the faster that you start thinking of your personal finances as if you were a small business, the more you’ll realize that freeing up cash in critical for success.  The topic of cash flow will come up repeatedly on FPO.  The first challenge for FPO readers is to free up $100/mo extra cash.  This can be done either through savings, investments, or picking up some extra income.  Let us know how it works for you in the comments section below.

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