What is the Cashflow Quadrant?
In this post, I’m answering the question “What is the Cashflow Quadrant?”.
Popularized by Robert Kiyosaki in his book “Rich Dad, Poor Dad”, this quadrant has given many, including myself, an insight on how to build wealth the right way, while disconnecting the income they make from the time they put in.
PS: we’re going to be talking about financial wealth. I know there are many other ways to be wealthy, but you’re on a money blog, so… 🙂
A note on building wealth
Before I dive in, I wanted to make a note about the concept of building wealth.
Again, this is one of the many insights I’ve gotten from the book and I hope it’ll change the way you think about (building) wealth.
When it comes to wealth, it’s very binary. And, although a lot of people make it seem complicated, can actually be explained simply.
Wealth = Net worth
Net worth = Your liabilities - Your assets
There. That’s wealth.
The cashflow quadrant can give you insights into how to build (more) wealth, so let’s get right into it.
The Cashflow Quadrant
The cashflow quadrant (and I’ll be referring to it as Quadrant from now on) is divided into 4 pieces. There’s a left-side and a right-side.
As you’ll see, where you land on those sides can mean a very big difference in your net worth.
This is the one all of us are most familiar with and have the most experience with.
As a traditional employee, you agree to being paid a certain amount per hour, capped by a certain amount of hours per week.
The concept of ‘getting paid by the hour’ is an important one when it comes to building wealth.
If you make $10/hour, and you work 40-hour weeks, your income ceiling is $400/week.
You can up that ceiling by negotiating a higher wage and/or more hours.
But there will always be a ceiling.
In a very unrealistic scenario, let’s say that you work 24 hours/day and 7 days a week, at $10/hour.
$240/day x 7 days/week = $1680.
And there it is again. The ceiling.
Keep in mind that you can only get paid when you put these hours in.
What happens when you take a longer vacation? Or become ill for a long period of time?
The amount of money you can make, the wealth you’re able to build, is directly correlated to your time.
If you stop working, there’s no income.
Staying on the left side of the Quadrant, someone who is self-employed has their own business.
Unlike the employee, whose wage is dictated by the company, a self-employed person can set their own wage.
This means that potentially more wealth can be made vs being traditionally employed.
Let’s use a starting massage parlor as an example here.
Lisa just got the green light to officially open her massage parlor and she’s getting a steady stream of bookings.
She’s priced her services a little more expensive than usual for the area, but she makes up for it by overdelivering every time and providing an exceptional experience.
Lisa is absolutely loving it! Go Lisa!
Fast-forward a few months, and Lisa wants to take a little vacation.
She’s not traditionally employed, so she doesn’t have traditional paid vacation days.
Now, she’s running into an issue.
If she takes a week off, that’s a week she can’t book appointments. A week of no income.
Because, just like the traditional employee, her income is still directly correlated to her time.
She may be making multiples/hour more than an employee, when she doesn’t work, she doesn’t make any money.
Back to an unrealistic scenario:
Let’s say Lisa makes $75/hour, works 24 hours/day for 7 days a week.
$1800 x 7 days/week = $12,600.
And here it is again. The ceiling.
There will always be 24 hours a day. So for a traditionally employed or a self-employed person, there’s only so much money that can be made.
And this is the issue with the left side of the Quadrant.
How much money you can make is directly correlated to the time that you put in.
Sick, vacation, sabbatical = no income
The Business Owner
Moving over to the right side of the Quadrant now, we start with the business owner.
Out of all the components of this Quadrant, it may be the most riskiest.
But, as the adage goes, high risk can mean high reward.
Let’s continue to use Lisa as an example.
Lisa’s massage parlor has been doing great.
So great that she can now move to a bigger place with multiple massage rooms and hire other massage therapists to also service clients.
Do her costs go up? Yes.
Does her income go up? Yes.
But the key difference with the left side of the Quadrant is that now Lisa can take a vacation, and her other hired massage therapists can still keep the doors open for customers to be booked.
Lisa’s income is now detached from the hours that she puts in.
She can take a vacation, a sabbatical or even, god forbid for this imaginary person (no offense, real-life Lisas!), be sick for a longer period of time and still make income and build her wealth.
Going back to the Net Worth equation, now that she’s growing her business, she’s also growing an asset.
An asset that isn’t taxed as highly as employee-income. An asset that she is virtually in complete control of. An asset that she can potentially sell.
Just like The Business Owner, The Investor’s income isn’t correlated with the time they put in investing.
I think this side of the Quadrant needs the least amount of explanation.
When you invest your money you’re actually letting your money do the work for you.
Using powerful concepts and financial instruments like compounding, target-date funds, index funds, ETFs, stocks and literally so much more, the $50 you invest can be $100 in 5 years.
I know that this is very much an oversimplification on the process, so please read I Will Teach You to Be Rich on the nitty gritty of all of it, but the concept is simple.
Where should you be on the Cashflow Quadrant?
I will never bash somebody for loving the kind of security that traditional employment can bring.
But traditional employment alone isn’t the way to grow your wealth.
There’s no 1 part of the Quadrant you need to be on for that.
Somebody who’s traditionally employed can also become an Investor.
Becoming an Investor is one of the biggest recommendations that I can make to anybody who is looking to build their wealth.
You need to have at least one foot somewhere on the right side of the Quadrant.
As I’m writing this post, I’m on all four.
I’m traditionally employed, but through having feet on the other 3 parts, I’ve been able to go from full-time to part-time.
I’m a freelance Project Operations Manager.
I have this blog, which I’m treating like a business and thus an asset.
And I’m an Investor.
Where are you on the Cashflow Quadrant, where do you want to be and what action will you take in the next 24 hours to get closer to that goal?