Why should you invest [Part 2]
We spoke about how inflation erodes one’s savings in one of our previous articles. Today, we would like to share how increasing active income is eroded by tax, and how you can increase your income in Singapore without incurring additional tax. Lastly, how to continue earning well after you have stopped working.
As we all know, most of us are employees to begin with. In order to increase our income, the common understanding is to work harder and longer hours, earning the seniority and promotion. With promotion, we will obtain our pay increments. However most of the time, this eventually puts us in a higher tax bracket. As a result, our long hours and earnings are eroded by tax (we will debate about the virtues of paying higher tax another time), just like how inflation erodes our savings. This is not an optimal outcome for the time and effort we put in.
Invest to increase your Income; tax-free
The good news is, there is a way to increase your income. By allocating some time to invest in your knowledge and then into the capital market you can increase your income. Instead of seeing companies as pieces of stock certificate and electronic numbers that you trade online or through your broker, see it as a part-ownership of the company.
When the company you invest in becomes profitable consistently, it could decide to issue dividend on a periodic basis, the dividend can be treated as a source of income; passive income. You can either spend it or re-invest it to generate better returns (more on how investing will yield exponentiating returns will be covered in the coming issues).
The beauty of this method of increasing your income through dividend are not only passive, but also TAX-FREE!
Passive Income vs Active Income
We mentioned earlier passive income a few times. So what is passive income?
Robert Kiyosaki, Author of Best Seller “Rich Dad, Poor Dad” & “Cashflow Quadrant” was one of the first few who popularised the term.
First let’s define active income. Active Income is defined as income obtained from services provided. Such income includes salary from jobs, commissions, tips, etc. Majority of the people in the world earns active income.
Passive Income is income that you earned, with little to no effort to maintain it. Some examples of passive income are rental, royalties, interest income, pension. Dividends from stocks that you buy and hold for the long-term are considered passive income too. It is one of the most important thing for you to have if you were to plan to retire securely.
Why do I say passive income is important?
Active income stops when you stopped working. This could happen due to retrenchment or retirement due to health, old age, disease, illness and accidents. Such event is not an “if” but “when”. You are “dependent” on your job to provide income to allow you and your family to maintain the standards of living. To solely rely on active income and savings to retire means that you are expecting a drop in quality and standards of living the moment you retire. Would you want to be in the situation when you have to stop working when you can’t afford to?
Having to work for a job takes time away from things you really want to do, be it spending more time with your loved ones, doing things that you are passionate about, travelling, etc. What is the point of working so hard, yet you are not able to find quality time to spend it on?
Would you rather work hard, work long hours, well into old age, taxed hard and then dropped your standards of living when you retire. Or would you start to invest to achieve some form of growing passive income. Let’s look down the road and into the future, what quality of lifestyle would you choose to have?