Income 101: A Blueprint to Maximizing How Much You Make (Finish)

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The “80-20 Rule” And How It Applies to Making More Money

Hundreds of years ago, an ancient Italian economist had an idea. Throughout his life he had observed that 80% of the land in Italy was owned by 20% of the people. One day, as he was gardening, he noticed something else: 80% of the peas came from 20% of the pea pods in his garden. He realized quickly that this “80-20 rule” didn’t just apply to land and peas, but in fact to most things in life – including careers and relationships.

In the “Four Hour Work Week,” entrepreneur Tim Ferriss talks extensively about the Pareto Principle and how you can use it to be more efficient in your day to day life. His advice is simple: figure out the 20% of businesses, clients, and relationships that matter most. This focused approach will save you valuable time, energy, and money.

While I agree with Tim, I don’t think he tells the whole story. Yes, it’s important to find 20% of clients, businesses, and personal relationships that are going to make you all the money. But finding the 20% that matters is only the first step. You actually have to convert these opportunities into cash flow!

A personal example: when I worked in finance, we pitched hundreds of deals to clients. Most of these sales pitches would fall apart quickly, allowing us to focus on the 20% that actually had potential.

But converting them into successes was a whole different ballgame. Just because we eliminated 80% of the riffraff didn’t mean we were automatically going to achieve that home run of a lucrative, long-lasting business relationship.

The Difference Between Absolute and Relative Income

This is another concept from the Four Hour Workweek. A simple scenario: John is an investment banking analyst making $10,000 per month for 500 hours of work. Paul is an internet entrepreneur making $5,000 per month for 100 hours of work.

Who earns more?

In terms of absolute income – the total amount earned, John obviously earns more. But in relative terms – which measures your hourly earning power, Paul actually comes out ahead. John makes an average of $20 per hour ($10,000/500 hours), while Paul makes $50 per hour ($5,000/100).

In our competitive, adrenaline-fueled world, many people focus exclusively on absolute income. They will work 60, 80, 100 hours a week to earn as much as they can – often at the expense of their families, health, and social lives. Absolute income can be a black hole – sure, you’ll make a little extra money, but at what cost? It can quickly become a high-effort, low-reward situation, where you’re slaving away to maximize the financial gains of others.

Instead, Tim emphasizes the importance of relative income. A high relative income gives you flexibility; if you are making hundreds of dollars an hour, you have more discretion over how much you have to work. It also allows you (if you choose) to make more money on an absolute level – all you have to do is work more.

Achieving a high relative income requires a few things:

-  Hard Work: The whole point of passive income is that you’ve put in the work to build a brand that other people can’t easily clone. You’ve invested the time and effort into building relationships and/or awareness upfront. But this isn’t easy! It takes a huge amount of energy early on (usually for very little monetary reward). Simply put, patience and hard work are the name of the game. Otherwise, everyone would do it.

Ownership: The best way to maximize your earnings is to own a valuable asset. This can include anything from real estate to a small business to a highly-trafficked website – anything that will earn you money. It isn’t easy to own something of value; it requires time and often some money as well. But it is well worth it in the end.

-  Distribution: You don’t want to be the one doing all the selling. Take a look at the most valuable brands in the world – Coca Cola, Microsoft, Louis Vuitton. They all have one thing in common: amazing distribution. Around the world, thousands of retailers are selling these products on behalf of these brands. The same principles work on a small scale as well. When Tim Ferriss started his online food supplements company, he found dozens of online retailers to sell the product for him. He’d pay them a commission and pocket the rest. Within a few years he was making hundreds of thousands of dollars each year for just a few hours of work each week.

The Difference Between Active and Passive Income

Active income is money that you have to work for. Most day jobs fall under this category…as does this blog. Also included here are investments that need to be actively managed (such as real estate or a small business).

On the other hand, passive income is money that requires little to no work on your part. Having significant sources of passive income is the key to increasing your hourly wage. Examples of this include search engine optimized websites, automated businesses, and (in certain cases) long-term investments such as stocks and bonds.

Here’s a table illustrating the differences between active and passive income:

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