25: Demystifying the 3 Types of Income

0:00Hey everyone, and welcome back to the Rich Habits Podcast, a Top 10 Business Business Podcast. on Spotify. My name is Austin Hankwitz and I'm joined by my co-host Robert Croak. Robert is a seasoned entrepreneur in his 50s with more than 200 million in company exits under his belt and I'm an entrepreneur in my late 20s with a background in finance and economics. Since quitting my full time job in corporate finance a few years ago, I've built a seven-figure media business and actively advise some of the most well-known fintechs around the world. As the show name might suggest every episode. We talk about rich habits as they relate to business, finance, and mindset.

0:36However, we try and bring you two unique perspectives, one from an industry veteran, which is Robert, and the other myself, someone who's still in the process of building wealth and figuring it all out. Robert, what are we going to be talking about in today's episode? In this episode of the Rich Habits Podcast, we'll be covering the three types of income, as well as why we believe it's incredibly important for everyone to understand how to build them up. We hear all the time from the fake gurus of the world, quit your nine to five and go all in on your side hustle. The problem with that is it's not only dangerous, but completely take stability of income out of your life.

1:13And trust me, you just don't want to live that way. We believe everyone should have more than just one form of income. So in this episode, we're going to walk you through the playbook as to how we've achieved these three forms of income throughout our careers. Mindset is a big part of this. Too many people get into their career, get their 401k started and feel like that's an investment strategy for financial freedom when it just isn't. You really have to plan ahead and work towards these three sources of income to achieve the financial freedom you deserve. This is going to be such a fun episode, Robert.

1:48I have been obsessed over these three forms of income since when I was in college, learning about them, trying to build them myself. So I have a little bit of experience that I can talk to her, but regardless, I'm so excited for this. So Robert, kick us off with the first type of income. The first type of income is really simple. Everyone knows it. It's earned income. This is exactly what you think. This is any income received from a job, self-employment. Think about your salary, wages, tips, bonuses, commission. Anything you receive from trading time for money is earned income and this type of income.

2:25We believe that having a proper budget and knowing your debt to income ratio is the first step towards building wealth. And 90 % of you listening right now are building wealth with your primary form of income being earned income. This is where all of us start, but definitely not where we want to end up. It's just so important to really be building on the earned income while making the strategies for the next steps. I really like to see everyone have a 50K base fully invested in the stock market index funds before they start taking steps towards the next form of income. So step number one is dialing in your earned income and getting started on your base.

3:05I think what's really important for everyone to understand is back to what you alluded to before. This is where we all start. I mean, I remember graduating college, getting a salary of about$65 ,000 and saying, okay, this is my stability of income, right? This is my earned income. I go to my nine to five, which was actually closer to seven to seven back then. But, you know, this is how I make my money. Now the question is, how can I take this stable income stream, my nine to five, and use it to begin building a base like you alluded to here, right? $50 ,000. So when I'm ready to take the leap for that next form of income, which we'll get to here in a second, I have that figured out, right?

3:44I've got that done. The budget's good. The debt to income ratio is good. I've got it all done. And that all came from, again, where we all start, the earned income. Now, the best thing about earned income is it's variable and it totally depends on how hard you want to work to get it. At the end of the day, you can go find a side hustle. You can go start doing ABCXYZ and your earned income can double or even triple depending on how hard you work. Sure, earned income is actually trading time for money, but we all have a little bit of extra time in our days, weeks, and months to trade for some extra money when we're really trying to build that base and get to a point in our lives where we're ready to take the next step toward the next income stream.

4:24I love this takeaway, Austin, and it's just really important and a big annoyance for me because I see so many of these fake gurus telling people just to quit their nine to five and go do it on your own and start your entrepreneurial journey. And I just think it's ill-fated advice because so many people really need to understand that in entrepreneurship, it's not all rainbows and unicorns. You're not going to start that business after you buy that course or you read up on it and immediately start making income. Sometimes you might go one to two years before you ever see profits or a paycheck. So I just want to make sure everyone understands that it's okay to have earned income from a W-2 job or a small business while you're building the rest of your income streams because of the fact that stability is so key in building yourself up.

5:14There's nothing worse than going for a long stretch with no income and having to borrow money, run up credit cards, or worse, really ruin your credit and put yourself in harm's way. So that's why the earned income is the first step in stability and building your wealth. But lucky for all of us, it's where we all start. Robert, I love that takeaway. What's our next form of income? So passive income is number two. This is where it starts to get really fun in your wealth building journey. You've got your base built. Your budget and debt to income ratio are dialed in. Now you're going to start investing towards building your passive income.

5:52This is the funnest part. You're moving along, you're getting there, and you're just ready to start doing more things and diversify into passive income. And it's just so important to understand what that means and what it does for your wealth building journey. So, Austin, take us through the beautiful ride of passive income for our listener. And not just the beautiful ride, but how achievable it is, right? So passive income or unearned income, as the IRS calls it, is income that requires a minimal effort to obtain. This income type includes income from a rental property or even equity ownership in a business, right?

6:29Think dividends or profits. For example, let's say you invest into somebody's car wash business and your agreement states that you're owed a percentage of quarterly profits. That is a type of passive income. Chances are you're already earning passive income and you don't even know it. So don't get overwhelmed here. A good example of this is a savings account.

6:52So or a T-bill account on public.com. The interest you earn in those accounts is a form of passive income. Even the cash back and rewards you earn on your credit card spending is a form of passive income, right? So too many people hear the words passive income and immediately think, oh my gosh, I'm spending half a million dollars on a real estate deal. I can't do this. I don't know what I'm doing. I'm getting overwhelmed. And they walk away and quit or just don't even get started. We're here to tell you that it's much easier than you think. I love this takeaway, and it's just so great to cover the passive income part of this.

7:30There's no better feeling than waking up in the morning and checking my accounts and seeing thousands of dollars that were deposited from my passive income efforts that came in while I slept. Make money while you sleep or work until you die is a famous quote that's out there. And those really are the two options. That's why you have to have great strategies earlier on or accelerate your strategies later in life to make sure you're not put in a situation where you have to work until you die. And my personal favorite passive income strategy is the SPYI ETF. You guys hear from us talking about NEOS ETFs all the time.

8:07It's an ETF that tracks the performance of the S &P 500 while also paying you a 12 % annual distribution yield, right? That is so much cash, so much passive income. So if you're looking to get started, you don't really know what to do, earn your first dollar of passive income with dividends in your stock portfolio, preferably through the SPYI ETF. It is my favorite. It's what Robert and I both use to earn passive income. And it's super, super easy. Now, speaking of stock portfolios, Robert, what's our third form of passive income? Yes, portfolio income. This is where the real wealth is made. This is how the rich truly get rich.

8:45Example, you make your first investment into a multifamily apartment building, and not only do you see the passive income from your investment, but you see capital appreciation and depreciation, allowing you to not only build wealth but offset other types of income with these tax breaks. So stocks are also a form of portfolio income and the most widely known. For example, I've made$48 ,612 in portfolio income year to date in my stock portfolio alone. And remember, portfolio income is generally fully passive as the value of your investments move up over time. So Austin, this is one of my favorite things when you get to this point.

9:27We've both made it to this part of our wealth building journey where you're really expanding your investment offerings and income. And it's just truly how the rich get richer. So take us into this a little deeper so the listeners can really have a great understanding of what portfolio income is. I think the term how the rich get richer really encompasses portfolio income, right? You think about what happened in 2021 to Elon Musk when he added$100 billion to his net worth in one year because of Tesla stock. Now, sure, he has a massive position in the company because he's the CEO and he gets awarded stock because of that.

10:04But at the end of the day, he made$100 billion in portfolio income by having that stock in his portfolio. So that's exactly what we're talking about here, right? Portfolio income is my favorite form because it can also mean so many different things. For Elon Musk, that was the Tesla stock. For you, that might mean capital appreciation for your own stocks. It might mean price appreciation in real estate or even price appreciation in a farmland investment. I'm talking about you, acre trader. So there's a lot of different fun ways that people can build up their portfolio income. Now, the best thing about portfolio income is the fact that it compounds on itself over time.

10:40We all know the eighth wonder of the world, compound interest, right? That's portfolio income. And as the stock market moves higher and valuations rise over time, so does that annual income generated for you by your portfolio. For example, Robert just made nearly$50 ,000 year to date with his stock portfolio. I'm around the $12 ,000 to$13 ,000 range, but as compound interest does its thing for myself, my portfolio income year to date, I'm sure we'll eventually get to that$40 ,000,$50 ,000,$60 ,000 range just like Robert's. This is how the rich get richer. You get a little bit and it compounds on itself over time.

11:15Now, we've talked about all the great parts of portfolio income, but my favorite part is the tax treatment. This is very different from earned income and passive income. Portfolio income is taxed at a much lower rate, usually 10 to 20 percent compared to 20 or 40 percent for your earned income and passive income where that might be taxed at. Again, this is how the rich get richer. We have all heard the term long-term capital gains, right? This is what Robert is alluding to versus short-term capital gains and even like rental income, right? Rental income is a form of ordinary income, I believe, depending on the different types of real estate projects you might have going on and how active or passive you are in that.

11:54But I know dividends certainly can be a form of ordinary income. So Robert, you took the words out of my mouth. Portfolio income is the pinnacle. It's where we want to go. Better tax treatments, larger gains, all the fun stuff. Yes, so now we get to the fun part of the show. We've got to read off a quick announcement for you guys and an advertisement for our sponsor. This episode of the Rich Habits podcast is brought to you by Neos Investments. Neos offers ETFs that aim to offer monthly income while providing core portfolio exposure across equities, fixed income, and cash alternatives like T-bills.

12:27Their ETFs may be particularly interesting for folks looking to generate passive income. You know what I mean. We just talked about that. Inside of their investment portfolio, they even offer an ETF that provides exposure to the S &P 500 index while aiming to offer high monthly income beyond what investors would receive from plain exposure to the index. Their funds may serve as a compelling income-focused alternative or complement to many of the investments already inside investor portfolios. If you're looking to add passive income-focused ETFs to your portfolio, consider learning more about NEOS's ETFs at neosfunds.com.

13:05And as with all investments, investors should carefully consider their investment objectives, risks, charges, and expenses of NEOS exchange-traded funds before investing. To obtain a prospectus containing this and other important information, please visit neosfunds.com and please read the prospectus carefully before you invest. NEOS ETFs are distributed by Foresight Fund Services, LLC. An investment in NEOS ETFs involves risk, including possible loss of principal. The equity securities purchased by the funds may involve large price swings and potential for loss. A fund's income may decline when yields fall.

13:40Fixed income securities will decline in value because of an increase in interest rates. Time for everyone's favorite part of our episodes, the question and answer segment. Our first question comes from Austin M. Austin asks, I'm ready to buy my first house. I've saved up a 20 % down payment and the price of the house is$250 ,000. However, the best fixed interest rate I can get right now is 7.8%, which is much higher than what I budgeted for. I'm trying to keep my after split monthly mortgage around$1 ,200 per month, but this is trending toward $1 ,800. Should I wait for interest rates to come down before buying?

14:19Austin, do not wait. You'll be waiting for years and years and years. We've heard from all the big economists talking heads that interest rates are going to continue to climb for the coming months, call it maybe even 12 to 18 months before getting cut and coming back down. If you can't afford the$1 ,800 per month, either save up a bigger down payment, right, which is going to bring that borrowing cost down, or buy a cheaper house. But if your monthly mortgage, right after your split with your girlfriend here that you alluded to, is less than 25 % of your take-home pay, you should be in decently good shape.

14:53I know in the DM you talked about being frugal. Figure this stuff out, you're a smart guy. Now, the longer you wait, the higher prices will rise in real estate. We know one thing is for certain, rents always go up, real estate always goes up, right? There's not more of it, right? God's not making more land. So if you can afford to buy the house, buy it now and then just refinance it later down the road, right? Interest rates aren't going to be 7, 8, 10, 12 % forever, assuming that they continue to go up, right? They will trend down eventually as inflation subsides. We'll learn more about that at the Jackson Hole meeting from the Fed here late August, so stay tuned.

15:27But at the end of the day, refinancing is always an option. But if you can afford to buy the house, buy the house. Don't wait on outward variables like interest rates impact that decision for you. The world moves fast. Your workday, even faster. Pitching products, drafting reports, analyzing data. Microsoft 365 Copilot is your AI assistant for work. Built into Word, Excel, PowerPoint, and other Microsoft 365 apps you use. Helping you quickly write, analyze, create, and summarize. So you can cut through clutter and clear a path to your best work. Learn more at Microsoft.com slash N365 Copilot.

16:33Spotify. That's stitchfix.com slash Spotify. Great question, Austin, and even better takeaway, Austin. That was incredible. And just keep in mind, Austin M. Prices are going to continue to rise. Interest rates, we don't know what's going to happen. More than likely, they're going to continue to rise for a while, and we will likely never see rates of 2 % to 3 % again, or at least not in the coming years. So why wait on the home, hoping, sitting on the sidelines, that you're going to be able to get a better deal down the road and you may never be able to do it, I think there's two real good options here.

17:07Buy it now if you find what you can afford and you love and refinance later, or you can also ask the seller to credit you and partake in buying down the interest rate. This is a great strategy during times of rising rates, which is right now. Really good question, Austin. Now our next question comes from Big Daunch, which I don't know if that's a real name or a meme or whatever, but we thought it was a good question. So we included it, but congrats, big donch. You got your name on the podcast here. So they asked, I'm excited to try new side hustles and earn extra income, but I'm worried about taxes.

17:43I don't know how they work at all. Do I have to register a new business for every side hustle I do? What's the blueprint here? Robert, you know so much about taxes, side hustle, business structure, all of that. Kick us off. Yeah, big D great question. And it's really up to you. You have to look at it from this perspective. If you're bouncing around trying 10 different side hustles right now, then no, you don't need to memorialize it with an LLC and an operating agreement and everything else. But if you have a side hustle or a small business that you're growing and you're working on religiously, then yes, you should put it in an LLC.

18:16You should have an operating agreement. You should have an EIN and you should have a business bank account to give yourself the liability protection that you deserve and the reason we have LLCs in the first place. So I think it's just very important to understand if you're just playing around and learning a bunch of different things, then no, I don't think it's necessary right out of the gate. But as soon as you stabilize and you get this going and you've proven the concept, then yes, I always believe you should have an LLC, do it right, and make sure to protect yourself. I also want to add that if you're at the point where money, like hundreds and thousands of dollars, are being deposited to a bank account, if it is your personal bank account or any bank account, actual money is being transacted and depositing, you need to be incorporated.

19:03I think that's the big stepping stone that I learned. I was over here, I remember, in middle school and high school shoveling snow out of driveways and I was getting paid$20,$40 a driveway in cash. I'm not going to report that. It's my money. I'm going to go buy a t-shirt with it or something or a skateboard. But now that I have a real business and I've got thousands of dollars moving on a weekly basis, it's like, wait, okay, hold on. I need to be incorporated. I need to report taxes. This is a real thing. So I think that's kind of a little checkpoint to keep in your brain here as you do that.

19:31And to the tax question specifically, I think a general rule of thumb is about 30%. 30 cents of every dollar that you earn in profit, set that to the side when it's time for tax time so you have the money ready when Uncle Sam comes knocking. Now, a really good thing that I like to do is I like to park that money into T-bills or a high-yield savings account that I've opened with my business. So my business is earning interest income, right back to that passive income thing we just talked about, on that money while I'm waiting for that quarterly payment. So it's not too much, maybe a couple hundred bucks, but that's a couple hundred dollars in interest income I didn't have before.

20:08So taxes, they're not scary. Everything's fine. And again, if you're making that money and it's actually moving the needle for you, incorporate, do all that fun stuff. But if you're doing some couple hundred dollars here in car washing or doing this, this, that, and the other, and it's all cash, you're good, man. Just don't spend it all in one place. Yeah. I love this takeaway on the taxes, Austin, because so many people don't have with their businesses, their small businesses and their side hustles, they don't have a separate tax account. And then what happens is at the end of the year, they do their taxes and their accountant or their lawyer says, okay, by the way, you owe$6 ,800 this year.

20:45They don't have that set aside. And that's why I like the fact that you touched on setting that tax money aside early on and frequently, because that way you're not getting hit with this big lump sum later and you don't have it. Last question comes from Chris C. Chris asks, I have the opportunity to invest toward my Roth 401k at work. Do I choose this over my Roth IRA? What's the difference? So I wanted to include this question because one, we get it all the time, but two, there's a big misconception between the Roth 401k and the Roth IRA. The Roth IRA, right? The IRA part of that stands for individual retirement account, keyword individual.

21:25It's all about you. You have full responsibility over the account. You deposit the funds and you invest them accordingly, right? You are the individual that oversees that account. Now the Roth 401k, that 401k part is different because it's sponsored by an employer. Now that employer usually matches your contributions up to a limit, but you need to be employed to be offered this type of retirement account. There are higher contribution limits, which are really exciting, but less investment flexibility. Robert and I talk about this all the time, how he actually alluded to this at the beginning of the episode.

21:57Having a 401k is not a strategy for financial freedom. You need to do much more than that. So what's the difference here? Well, you can actually do both. I have a Roth IRA, an individual retirement account, and a Roth solo 401k, solo because I'm self-employed. But I'm double dipping, and I think everyone should also be double dipping if they can afford it. You want to pile up as much money into these long-term retirement accounts as possible, so when you're ready to retire, you have the funds to enjoy your retirement and retire with dignity. IRA is individual. You can do this throughout your entire life.

22:30It doesn't matter if you're employed or not. And the 401k is normally employer sponsored. You have to be employed to receive this type of retirement account. And the best part is this retirement account rolls over from employer to employer, which means that if you have a$25 ,000 sum of your 401k at one employer, and maybe you get laid off or you switch to different companies, you can roll that into a different retirement account and start contributing again toward your retirement at that new employer, right? It's not stuck at this one place. So really good question, Chris. I love this one because a lot of people don't understand the difference between the IRA and the 401k and that they can do both at the same time.

23:07That was amazing. What a great episode. So excited for the public to get to hear this episode and follow along with us. So remember, if you enjoy the Rich Habits podcast, please give us a warm, warm review. Five stars would be lovely. And we just appreciate you guys so much each and every week following along on this journey with us and the Rich Habits podcast. We are super grateful that 33 ,000 of you every Monday morning come back and listen to what we have to say. We're working very hard on two major projects. We're going to tease to you here right now. The first one is a discord group, right?

23:45A ton of you said, Hey, how do I connect with other listeners? I want to network. I want to learn. I want to ask questions. I want to talk to you guys individually. What's the plan here? So we're working on a Discord group that should be live here in the next couple weeks. Everyone's invited, by the way. So if you're listening, you will be invited. And the next here is a little bit of a video course. So not to give away too much, but it's going to be an incredible video course. It's about an hour long. It's very digestible, very straight to the point. And our favorite part about it, it's very reasonably priced, very reasonably priced.

24:18So we are super, super excited about that. Stay tuned and be sure to come back next Monday to the Rich Habits Podcast and we'll see you then.