Moving from Labor to Capitalist

The vast majority of people are labor.  Labor - People who are paid money for the wealth they create, usually not paid in proportion to the wealth they create - the surplus value between what they are paid and total wealth created is what is given to the Capitalists.  Capitalists are the recipients of the wealth created by labor, that surplus value created by labor gives them an income.

We live in a capitalist system, but we are not taught how to be capitalists.  We are taught to be labor.  All of your our education prepares us to make a living by working for someone else.  We seldom, if ever, encounter a class or a teacher who teaches us how to become a capitalist, or how to create an income from capital (or from other people's labor, for that matter).  Neither Steve nor I ever encountered 'Capitalism 101' in our educational path.  We don't remember any teacher who taught us how to become capitalists, there were plenty who taught us how to be labor.

How do you amass enough capital to produce an income, how do you become a capitalist?  You've got two choices, you can amass enough of your own capital to generate an income or you can use other people's capital (leverage capital) to create your income (think of taking out a mortgage to buy a rental property).  To leverage capital you have to create a better return than what you are paying.  Now that is some of what's gone with today's economy, people have leveraged too much.  That doesn't make the approach bad, the application of the approach has been done incorrectly.

In working out how much capital do you need, there are a number of variables.  The two fundamentals are what income do you require, and what return on capital do you need?  There are a couple of complications - tax and inflation.  From a tax perspective, the relation between gross income and net income is not linear.  The greater the income, the greater the proportion of that income is taken in taxation.  The other complication is inflation, if the income is to be self-sustaining the capital must not only deliver the income, but it must also deliver the growth in capital so that the income grows in proportion to inflation.  Some investments do this better than others, e.g. property, over time the value of property and property rental income would increase with inflation.  Cash investments, less so.

We need to also recognise the way the tax system is currently set up.  Between 0 and £6000, every pound you earn is not taxed - every pound is worth a pound.  From £6000 to £36,000 (roughly), by the time you've paid NI, you've paid 31 pence in tax for every pound that you earn so £1 = .69.  From £36,000 upwards, you are effectively paying .45 pence for every pound that you earn so £1 = .55.  So if you wanted £20,000, you'd need to earn £6000 (£1 = £1) and then you need to earn another £21,000 (£1 = .69 therefore £21,000 = £14,000 approx). 

(Although I have shown this example using the UK tax system and £'s, the concept is the same for the US tax system and $'s - as the tax goes up, you must earn proportionally much more capital for a small increase in income.)

Back to the fundamentals and the first question, what income do you require? 

- To get a gross income of £18,000 a year, at 10% you'd need £180,000.

- To get a gross income of £40,000 a year, at 10% you'd need £400,000.  That is, you need to amass an additional £220,000 in capital to earn an additional £12,000 a year

- To get a gross income £100,000 a year, at 10% you would need £1,000,000.  Or you would need to amass an additional £820,000 in capital.

(We use 10% because it is easy, what we are trying to show is the radical difference in proportions of capital needed to generate small differences in income.)

Now remember the tax implications here, to have £6000 net, you need to earn £6000 gross.  To have £12,000 net, you need to earn £15,000 gross.  The amount you need to generate an income of £6000 a year is £60,000 and the amount you to generate an income of £12,000 is £150,000 so while you doubled the income, you have to amass two and a half times the capital to generate that income.  At higher rates of tax, it is even worse than that.  You have to work significantly longer and harder to generate a relatively small improvement in annual income.  So the most effective thing you can do is reduce your income requirement.  

There are a huge number of things that you can do to reduce your requirement for income, which we will be talking about in an upcoming post.  We'll also be talking about ways to amass the capital quicker and exploring how to live well on £18,000 a year.

And quite frankly, the time to amass £180,000 is far shorter and far more doable for most folks than the time it would take to amass £1,000,000.  So the more modest the income you need, the shorter the time to get it (and not more than you need) - which means you'll move more quickly from being labor to living your dream lifestyle!