Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.
The average American grosses $60,000 in wages. At a standard 4% annual increase, it would take someone 18 years to double their income from $60,000 to $120,000. In this episode, Travis explains how to get a double-digit pay increase every year via passive income.
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Travis Watts: Welcome back, Best Ever listeners. You're listening to Passive Investor Tips right here on Best Ever. My name is Travis Watts, I'm the host of the show. Disclaimers as always, never financial advice, not telling you or anyone what to do; educational and informational purposes only.
Today's episode is going to be fun. I'm really excited to share this with you. We're talking about how to effectively get double-digit pay increases every single year. So let's go ahead, without further ado; I'm just gonna dive right into the content. I was on ssa.gov, which is the Social Security Administration .gov website, and I found out that the average American in terms of gross income wages in 2022 was nearing about $60,000. So I'm going to use that as our basis and example for this episode. And using the same source, same website, you can actually dig through all the way back to 1984 through 2022, and you can look at average annual pay increases, what people are getting as far as a pay raise. And I'm going to have to estimate this one, because they don't make it as simple as just saying "The average is this throughout all the years", but I'm going to call it 4% a year is what the average American more or less is getting in a pay increase. So two factors that we're going to use for our assumptions in this episode - a person making $60,000 a year and getting a 4% pay raise throughout their working career.
Now, using a salary increase calculator, which you can find for free all over the internet, or just using your simple calculator, and using the rule of 72, which is something that we talked about on episode six here of Passive Investor Tips, it's effectively how long does it take to double your money. So we could plug in 72 divided by 4% annual pay increase equals 18. That means 18 years to have double a salary from $60,000 a year to $120,000. This can be applied obviously to investments as well. So keeping all of that data top of mind, let's dive into how to actually get a double-digit pay increase every year by using passive income.
We'll say that the person who's making $60,000 per year at any point in their career decides "I'm going to become an investor. I'm going to make a passive income investment, and I'm going to invest one time throughout my entire working career, just once, and I'm going to put $60,000 into an investment", and for example purposes, we'll say it's going to pay an 8% annualized cash flow return, or dividend, or interest, or whatever it may be. So effectively, what that generates is $400 extra per month, or $4,800 per year.
So in this example, what this person really just did is provided an 8% annualized pay increase to themselves without having to rely on their employer. But let's just say that their employer does give them the 4% that they anticipate every year, so they're getting 8% additional income from their investment, and getting 4% from an employer. So effectively, they're getting a 12% annualized pay raise. But it gets even better than that.
If this particular person decided "I'm going to use that passive income to reinvest for the next year", they're now going to have $64,800 invested at 8%, for example, instead of $60,000 invested at 8%. So that gives them an 8.6% annualized pay increase, and it bumps up the passive income to $432 per month, or a little over $5,000 per year. And the simple takeaway here is if you just add in being a passive income investor, in conjunction with an active income, you can effectively double the results that most Americans are getting.
But it gets even better. See, active income is taxed at the highest tax brackets, so as high as 37% at the federal level in 2023, and any applicable state tax, depending on where the person lives. So if we look at California, for example, and a very high income earner, they're paying 37% at the federal level, they're paying up to 13.3% at the state level, plus they're paying 6.2% towards social security, they're paying another 1.45% towards Medicare, and that's if they're employed by someone, they're actually splitting the bill on Social Security and Medicare. If you're self-employed, you're paying the entire social security and Medicare. So what does that look like in total? It will be 57.95% if you're employed, it would be 65.6% in tax, if you are self-employed. So that's pretty nasty just in itself to think about, but that's not even including some cities have a city income tax. Manhattan, or New York City's got about a 3% additional tax on top of the state tax. Sometimes you have local taxes, you have sales taxes, gasoline tax, property tax, and the list goes on and on. We are just taxed to death here in this country. But I digress.
So when you're an investor, you have the option to consider different asset types, and each have different tax structures to them. So in some cases, if we take real estate, for example, you can pay as little as 0% tax each year on your passive income, or your cash flow, if depreciation is factored in. And long-term capital gains, if you're holding the real estate more than 12 months, can be taxed at favorable rates, 15% to 20%, depending on your income level. And there's other assets that you can look at; municipal bonds are tax-free at the federal level, and if you're investing in your own state, in its municipalities, sometimes it's tax-free in the state as well. So that can be a totally tax-free investment for you.
So not tax advice, just pointing out that you can look at assets that are much more tax-favored compared to active income, where there's not a whole lot you can do to reduce that tax. But I've gotta tell you, I'll take zero to 20% any day over 60% plus when it comes to paying tax... And this really starts to matter a lot as your income increases over time. Someone who makes $60,000 per year and that's their only source of income may not care a whole lot whether they're in a 10% tax bracket or a 20% or even a 30% for that matter, because we're just talking about a few thousand dollars of difference. But imagine a person who's making a million dollars per year and they're paying 60% of that income to taxes. That $600,000 every single year. Just imagine what they could otherwise do with that income if they didn't have the tax obligation.
Travis Watts: So bringing this concept full cycle, I want to leave you with three quick things. Number one is becoming a passive income investor gives you a secondary way to increase your overall income year to year without having to rely on just an employer. Number two is, depending on the tax structure of your investments, they can be much more tax-favored compared to active income. And you can think about it this way. If an employer gave you a 4% pay raise, but you're paying 50% out in tax, that's only a 2% annualized pay raise. If you had an investment that gave you 6% per year, and it was only taxed at 20%, you're still netting more than a 4% pay increase for that year.
And number three is, over time, if compounded, your investments can actually create a livable salary for yourself to replace a job or a career, or at least allow you to retire. And in fact, I want to show you this, because this is really powerful, so I'm going to put this here up on the screen. So an investor who makes $60,000 per year and makes one investment in their entire lifetime of $60,000 invested at 8%, annualized, paid out on a monthly basis, pro rata, if you times that by 40 years, assuming that's the working career timeframe, they're left with about a million and a half dollars. And at this point, you might be thinking one or two things. Well, first of all - yeah, we're not factoring in taxes, we're not factoring in inflation and other variables. But if you take 1.5 million invested at 8%, you're getting $120,000 per year in passive income. That's income you don't have to work for. That effectively doubled the starting salary of that individual. So imagine if that individual had taken a little more action and made multiple investments throughout their career instead of just the one, and what that might look like. I encourage you to play around with some of these calculators online if you're a geek like me, and you like to look at this kind of stuff.
So something to think about here for the week. I hope you guys found some value in this episode of Passive Investor Tips. I'm Travis Watts. If we haven't connected on LinkedIn, Facebook, Instagram, Bigger Pockets, let's do it. Always happy to be a resource for you or anybody that you think could find value in these episodes. Feel free to like, share, subscribe, leave a comment. I love the engagement you guys have been giving back from the show, so I thank you so much for that. Have a Best Ever week, everyone, and we'll see you in the next episode.
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