The three legged chair theory of income
I was introduced to the idea of this theory while reading comments on another finance blog. So I can’t claim creative ownership rights. But nonetheless I found it very important so I’ve decided to expand on it. This is the three legged chair theory of income.
It’s frequently said most millionaires have an average 7 sources of income. Diversification at its finest. I’m not sure I need to reiterate, but having only one source of income – such as a job salary – is dangerous. Job security seems to be only something you read about in history books these days.
Layoffs, restructuring, cost cutting, etc can leave you jobless at any time. At moments like that, nevermind retirement saving strategies, it’s about immediate cash flow. That’s why we each need various sources of income.
Multiple income streams provides cushion during life’s little surprises and emergencies. Equally as important, they allow us to reach our financial goals much quicker the rest of the time.
Developing 7 sources of income can take years, probably decades. A more feasible goal to reach, is three. Obviously.
You need more than one income stream
A chair needs a minimum of three legs to stand. Thus, the three legged chair theory suggests we need a minimum of three sources of income at all times.
How you make the income flow is not necessarily so important. There are literally millions of ways to make money. But what is important is how liquid these streams are. There are different degrees of how fast you can turn different investments into cash, or how quickly a income stream can generate you cash.
Some investments can grow larger over time, but are a bit harder to transfer to cash in hand when you might need it. Others can be flipped to cash or make you cash in minutes. You will want to have a mix.
Don’t put all your eggs in one basket
The idea behind having multiple sources of income is diversification. Having all your eggs in one basket is just dangerous. Having a million dollars in the stock market can generate you a large amount of income via interest, but what if we experience another 2008 and that’s the only means of income you have? What if you have a few rental properties but you go a few months with renters? Multiple income streams is protection.
Diversification is the reason I like to invest in total market funds, I’m literally spreading my eggs among thousands of baskets.
Again, three legs is enough to keep a chair standing, and 3 income streams should be enough to protect you through any unexpected events.
Very liquid income streams
These are incomes from jobs, side hustles and businesses, and stock market indexes or blue chip dividend stocks. You probably want to have at least two of your three legs within this domain. Remember cash is king. At the end of the day you need to be able to generate cash quickly, especially in times of emergency.
I say at least two income streams that are liquid, because I will assume your main income stream, like a job or business income is generating you cash regularly. If your industry or market tanks, or you get fired/laid off. You will need immediate cash again. Some income streams can not be converted to cash immediately to service bills and costs of living like shelter and food.
So you want to have another secondary job, side hustle, dividend income or income stream that is paying regular cash as well.
During the good times, this second income can go directly to your investments to beef them up while your primary or first income stream is paying your living expenses. Don’t fall into the trap of lifestyle inflation too heavily if you begin making a secondary income. Be smart with your cash!
Illiquid income streams and capital appreciation
This may be real estate, business investments, or stocks and indexes you are long on. Anything that cannot or should not be converted to cash immediately. You’ll probably understand any of these investments or income streams could be converted to cash, but they usually take a little longer, or you may not wish to flip them to cash as you are waiting for them to grow long term.
You might also be in the red in a particular investment when you need the cash, you don’t want to have to sell at a loss to cover your expenses in an emergency.
These investments and income streams are necessary to growing your net worth. And they can even be generating regular income like rent from investment properties, or a business that is paying you an income. But you should not sell the real estate or the business for cash in hand.
And you may also go through periods where you don’t have a renter, or the business did not turn a profit for a month or two.
Multiple income streams create long term wealth
You’ll see it’s a mix of income streams that cover your ass when times get tough, and also allow you to really jump ahead when times are good. A chair cannot stand reliably with less than 3 legs, neither should you leave your investment portfolio and cash flow needs to chance by having less than 3 incomes streams.
Always look for ways to build income streams, that’s how the wealthy get and stay wealthy.
How many income streams do you have? What are some creative ways you use to generate money for yourself, please share below I would love to hear from you!