Never depend on single income. Make investment to create a second source. – Warren Buffett
Buffett quotes are usually more eloquent. My grammar checker hated this one.
But it’s one of my favorites because he sounds like a caveman. And it’s one way I like to think about investing, as a secondary source of income.
It might as well be a quote from a caveman because the concept is so simple and obvious.
We’re programmed to focus on our careers as our only income source. Study hard, get a job, rely on the job for a salary, healthcare, retirement savings, and social life.
Maybe this way of thinking is leftover from our parent’s generation and their employer loyalty, pensions, and gold watches.
We do our best to stay employed. But lose a job, and suddenly the government is expected to step in and save the day.
Americans often borrow too much money to buy the nicest house and car they can mathematically afford. Everything is fine as long as they stay employed and the economy remains on sound footing.
But crossing fingers and hoping things stay good is a bad plan.
The way to avoid financial troubles, even in a depressed economic environment, is to borrow far below your means (or not at all), build a significant emergency fund, and create secondary income streams to supplement your primary income and grow wealth.
Or marry someone with an income.
Doing these things gives you options if your employment situation changes. It might.
Caveman-Buffett’s quote suggests you take some of the money you earn and put it toward investments.
That way, if your primary income is lost or pauses due to a government shutdown, unemployment, or whatever life throws at you, you still have money coming in to help pay the bills. Hopefully, on top of a healthy emergency fund.
When Buffett says investment, we assume he means stocks. He’s a bit old-fashioned.
Stocks are great for long-term growth and income, and it’s easy to get started nowadays. But there are endless ways to invest to earn additional income streams. Not all are financial investments.
In January this year, I wrote a post about the five best investments for long-term growth. The first recommendation was to invest in starting a low-cost side business.
Starting a business may have associated costs to get started and operate, but there are hundreds of legitimate business ideas that cost very little to ramp up. Returns on a successful side business can be very high, and there’s no pressure to make it a full-time gig.
Real estate, alternative investments, and investment in education are other ways to invest in helping to never depend on a single income again.
However, all of these investments require the most important asset of all, your time. Though some of these income streams may eventually be passive, each requires an upfront time investment. If you invest enough time in exploring ways to build additional income streams, you’ll find something that eventually works for you.
Can You Max it Out?
We all know we should be saving for retirement, whether we are or not. Getting started investing for retirement is one thing, maxing out is another.
Only 13% of workers of 401(k) participate maxed out their contributions in 2017.
I recommend maxing out your employer-sponsored plan if you have one, or maxing out a traditional IRA if you don’t. For most people, that’s a challenge. But start small, then try to increase your contributions each year until you reach the max.
Set a realistic goal to get there, like five years.
After maxing out my 403(b), our family is also contributing the max to Mrs. RBD’s spousal IRA, my Roth IRA, and we’re executing our college savings strategy. I do all of this before investing after-tax money into dividend stocks and real estate crowdfunding.
Do not save what is left after spending, but spend what is left after saving.
Being able to make all of these pre-tax and after-tax investments is a result of smart money habits over the past decade.
We also bought less home than we could afford, owe nothing on our cars, and refinanced our home and rental mortgages several times to lower monthly payments.
Most importantly, when my income grows, our lifestyle stays the same. This enables us to use salary increases and business income to invest in our future and increase our income even more.
Is Retirement Savings Enough?
But as you know, money invested in retirement accounts is meant to grow untouched until at least age 59 1/2 to avoid penalties and allow for compounding growth.
Retirement investing doesn’t really provide a secondary income stream. The money grows tax-deferred until it can be easily accessed. Distributions and earnings must stay in the tax-advantaged accounts before then.
This is where after-tax investments come into play. Still, contribute to tax-advantaged accounts first. Then at the end of each month, aim to have excess cash flow available to invest by creating a budget and sticking to it.
Use excess cash flow to create additional income streams.
Explore side business ideas. Can you invest $100 in a business idea and return a profit and scale into something worthwhile?
Buy individual stocks or index funds. Keep investing in stocks after your tax-advantaged accounts are maxed out.
I’m OK if you don’t completely max out your tax-advantaged accounts and squeeze some after-tax money out of your budget to invest. I’d rather you invest excess cash flow than spend it.
Reality sets in… income earned from secondary sources is taxed. But real estate, long-term investment income, and even business income now are more tax efficient than salaried income. Avoid the taxman when you can, but don’t let him scare you from the pursuit of prosperity.
The quote above isn’t something Buffett repeats every earnings quarter on Squawk Box. He uses his influence to comment on the economy and politics, talk about great businesses, and recommend that most ordinary investors buy an S&P 500 index ETF and leave it at that.
But my interpretation of his quote is broader. Buffett is an entrepreneur, and he’s interacted with great business leaders throughout his career. He’s a firm believer in capitalism and the power of investing.
Investing is not just about buying stocks. Companies invest in themselves to remain competitive. They invest in their people and in growth. They diversify business lines to manage cyclical risks.
It’s said in personal finance, that we should all think of our financial lives as if we are a business. Money comes in, expenses go out. We invest in education for ourselves and our family so that we can prosper. And we can diversify our income streams and investments to help deal with the unexpected.
Do you agree with Caveman-Buffett’s quote? Is one income enough, or should we never depend on a single income?
Photo via DepositPhotos used under license.