The 'Three Pillars of Income' Strategy for Employees Aiming for Financial Freedom: How to Combine Salary, Index Investing, and Real Estate Investing
When aiming for financial freedom while working as an employee, designing a diversified income stream is very important. This time, I will introduce a strategy that combines three pillars: ‘salary income from the company,’ ‘capital gains from stock investments,’ and ‘rental income from real estate investments’ to simultaneously achieve monthly cash flow and future asset growth.
For dual-income employee households working full-time, building these three pillars of income should make stable cash flow and future asset formation more certain.
Why is income diversification necessary?
A situation where there is only one source of income supporting a family’s finances is, so to speak, a ‘one-legged batting style.’ While salaries are relatively stable, they are always side-by-side with risks such as a decline in the employer’s business performance or the inability to work due to illness or injury. Bonuses, in particular, can drop sharply if the company’s overall performance is poor, even if individual performance is good, making them a form of income that is difficult to control on one’s own.
By combining stable monthly salaries with the different natures of ‘stock investing’ and ‘real estate investing,’ you can increase your income pillars to three.
Stock Investing (Index Investing)
Many index funds do not pay dividends; instead, they have a mechanism where dividends received from the included stocks are automatically reinvested within the fund. Instead of receiving dividends in cash, they go toward asset growth, and by selling off a portion of the assets when needed, you can achieve an effect similar to receiving dividends.
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Feature: Aiming for long-term compound growth
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Period: Requires operation over units of 20 or 30 years
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Effect: Utilizing compound interest to grow assets like a snowball
Real Estate Investing
This is a ‘business’ combined with ‘asset management’ aimed at income gains, obtaining cash flow through monthly rental income.
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Feature: A ‘second source of income’ generated independently of your own labor
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Method: Using leverage on your own capital (e.g., 10 million yen) to purchase a large property (e.g., 120 million yen)
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Effect: Building cash flow of around 2 million yen per year
The big point of having these three pillars is that risks are diversified because the nature of the cash flow and the time horizons for each are different.
・Short-term: Covering monthly expenses with salary from the company
・Medium-term: Building cash flow separate from salary through rental income from real estate investing
・Long-term: Maximizing the compound interest effect of stock investing to eventually build large assets
By diversifying across time horizons in this way, you become able to flexibly respond to changes in life events.
First Pillar: Maximizing Salary Income
The most important and foundational of the three pillars is, after all, salary income.
Salary is a stable monthly income and also the capital for creating asset-based income. It is precisely because you have a salary that you can manage your monthly income to save money, and use those assets as capital to build a foundation for asset-based income such as real estate and stock investments.
Salary serves as the backing for ‘social credit’ (creditworthiness)
Salary also serves as the backing for social credit (creditworthiness).
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Mortgage: Essential for taking out a loan when purchasing a home
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Car loan: Also necessary for borrowing when purchasing a car
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Real estate investment loan: Unless you have a sufficient background, such as having assets of 100 million yen or more, for a typical employee, even if you have assets of 30 to 50 million yen, the hurdle for receiving a loan from a bank becomes extremely high without salary income
Salary income is indispensable for enriching your current life and connecting it to future investments. In particular, full-time dual-income households have a higher total household income than single-income households, so the speed at which assets accumulate is significantly faster. As a result, your creditworthiness will increase further, you will gain greater trust from financial institutions, and the range of investment options available to you will expand.
The two wheels of ‘effort to increase salary itself’ and ‘ingenuity to increase take-home pay’
To maximize salary income, both ‘effort to increase the salary itself’ and ‘ingenuity to increase take-home pay’ are necessary.
Effort to increase the salary itself
There are options such as salary increases through skill improvement or acquiring certifications, or changing jobs, but isn’t the most certain way to give your all to your current main job? If you produce overwhelming output and achieve results that everyone recognizes, you can sit at the salary negotiation table, and your income will naturally rise.
Ingenuity to increase take-home pay
We will wisely utilize systems to reduce the tax burden while increasing the money remaining on hand.
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iDeCo (Individual Defined Contribution Pension): The full amount of contributions is eligible for income deduction, reducing income tax and resident tax
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Furusato Nozei (Hometown Tax Donation): As long as it is within the deduction limit, you can receive return gifts with a self-burden of effectively 2,000 yen, reducing household expenditures
Since iDeCo assets cannot be withdrawn until age 60 in principle, it is important to start with contributions that do not strain your household budget.
From the salary secured in this way, we make maximum use of the concept of ‘advance savings and advance investment’ and set aside money for index investing and real estate investing in advance. By doing so, the seed money for the second and third pillars of ‘asset-based income’ will naturally increase.advance savings and advance investment of the concept of ‘advance savings and advance investment’ and set aside money for index investing and real estate investing in advance. By doing so, the seed money for the second and third pillars of ‘asset-based income’ will naturally increase.
The second pillar: Aiming for long-term asset growth through stock investment
The core of the stock investment pillar is investing in long-term, diversified, low-cost index funds such as the S&P 500 or All Country World Index (Orkan). If you fully utilize the ‘Tsumitate Investment Quota’ and ‘Growth Investment Quota’ of the new NISA, you can capture the growth of the global economy while receiving the benefits of tax exemption.
There are three points to keep in mind when managing your investments.
Do not let market fluctuations affect your mood
The market moves every day, but if you get distracted by those movements, you won’t be able to focus on your work, and it will be difficult to build the significant assets needed for the future.
Maintain a long-term perspective
The time horizon for stock investing spans a long period of 20 to 30 years. Even if stock prices fluctuate by 10-20% in the short term, that is merely a fragment of a process that lasts 20 to 30 years. If prices drop in a single year, there is no need to worry unless it is time to start withdrawing your funds.
Utilize tax-free allowances across the entire household
The tax-free holding limit for the new NISA is 18 million yen per person. For dual-income households, by having each spouse hold a NISA account, you can utilize a total tax-free allowance of up to 36 million yen for the household.
Secure ’emergency funds’ before investing
Before you start investing, what you must prepare is ’emergency funds’. We recommend that you secure six months to a year’s worth of living expenses in cash and savings, and only invest surplus funds.
With emergency funds, you won’t have to sell regardless of the market condition
By holding onto your investments without selling, your principal continues to be managed in the market, allowing you to maximize the power of compound interest over time.
The Third Pillar: Generating stable cash flow through real estate investing
The appeal of real estate investing lies in the ability to generate income in the form of monthly rent from properties. While stock investing is responsible for long-term asset growth, real estate investing plays the role of creating ‘current cash flow’ in addition to the role of ‘growing future assets’.
Specifically, the remainder after deducting expenses and loan repayments to financial institutions from rental income becomes your cash flow, which serves as your monthly ‘second income’.
‘Potential cash flow’ that nurtures future assets
Regarding future asset growth, there is a concept called ‘potential cash flow’.
The mechanism of potential cash flow
Loan repayments are divided into ‘principal repayment’ and ‘interest repayment’. Of these, the principal repayment portion reduces the outstanding loan balance and accumulates as net assets on the balance sheet.
For example, if the annual loan repayment is 4 million yen, and 2 million yen of that is principal repayment, it means your net assets are increasing by 2 million yen each year.
This potential cash flow can be realized when you sell the property. If the speed of loan repayment is faster than the speed at which the property price declines, the difference between the sale price and the remaining loan balance remains in your hands.
Expand your scale by combining with surplus salary funds
When you save monthly cash flow to use as your own capital for the next property, you can further accelerate asset formation by combining it with surplus funds from your salary income.
Asset Expansion Simulation
・Surplus funds from salary: 2 million yen per year
・Real estate investment cash flow: 2 million yen per year
・Time to save the next 10 million yen in equity using only real estate cash flow: 5 years
・Time to save when combined with surplus salary funds: 2.5 years
By combining surplus salary funds, you can save the necessary equity in about half the time, allowing you to move more quickly toward purchasing a second property.
Using the 10 million yen in equity saved this way as a down payment, you can secure a loan of approximately 110 million yen from a bank to purchase a 120 million yen property, creating a virtuous cycle that generates even greater cash flow. In reality, there are also purchase costs of about 7-8% of the property price, so it is safer to incorporate these into your financial plan in advance.
Property Selection and Property Management Selection Determine Success or Failure
Since real estate investment has an aspect of a ‘business,’ it is essential to carefully evaluate the following points.
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Scrutinize location, yield, repair risks, and vacancy risks
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If borrowing with a variable interest rate, factor in the risk of interest rate hikes
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Select a partner (property management company) that is strong at securing tenants
In particular, monthly cash flow changes significantly depending on whether you can maintain full occupancy. Finding a reliable property management company is the key to the success or failure of your investment.
While covering repayments and expenses from rental income, you accumulate both ‘cash flow remaining on hand’ and ‘potential cash flow revealed upon sale.’ This is the royal road of real estate investment.
Maximizing the Credit Limit of Employees
Employees have the strength of a stable monthly salary. For dual-income households, utilizing the ‘double income’ household annual salary as an attribute (credit) makes it easier to receive loans from financial institutions under favorable conditions. It is possible to leverage your position to purchase real estate and generate cash flow efficiently.
Considering the Establishment of an Asset Management Corporation
For dual-income households that have decided to aim for a scale of three or more properties from the start, the option of establishing an asset management corporation and owning properties under the corporate name will also come into view. When establishing a corporation, it is safer to check your employer’s work regulations (side job regulations) and consult with a tax accountant.
Household Budget Design to Realize Three Income Streams
What is important in creating these three pillars of income is the design of your overall household budget.
Three Steps to Asset Formation
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Secure living expenses and seed money from your salary
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Increase investment principal (seed money) through stock investment
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Enter real estate investment after growing your financial assets
To start real estate investing, you need a substantial amount of your own capital. For example, if you need to provide 10 million yen in personal capital for a real estate investment, and you only have 15 million yen in financial assets, you would only have 5 million yen left, and it is highly likely that you would not be able to receive a loan from a bank.
Therefore, it is necessary to first increase your financial assets to around 50 million yen through methods like stock investing. By providing 10 million yen, which is one-fifth of that amount, as your own capital, you can finally start your real estate investment strategy.
Of course, it is entirely possible to aim for 100 million yen in assets or financial freedom through stock investing alone. However, combining it with real estate investing is effective for building assets more efficiently and accumulating monthly cash flow. There are actual cases where, compared to using only index investing, incorporating real estate investing shortened the time it took to be able to live solely on asset income by about 10 years.
Division of Roles and Cooperation Between Spouses
In the case of dual-income households, one could consider a division of roles where one person handles stocks and the other handles real estate, but fundamentally, it is desirable to have the mindset of growing assets while cooperating as a couple.
When receiving a loan for real estate investment, not only individual assets but the entire family’s financial assets are examined. It is ideal to be in a state where you are working on asset management together, such as sharing information as a couple and going to view properties together. Aim for a virtuous cycle where you cooperate toward a common goal (a life without money worries) and income from assets increases as the principal grows.
Managing Household Finances
There may also be a division of roles between spouses in managing household finances. Even if there are minor differences in who pays for fixed or variable costs, it is important to discuss how much the family spends in total, how much is spent on each item, and what the limits of acceptable spending are.
In our case, we conduct a ‘household budget review’ once a year for about an hour. The time spent on asset management itself is very minimal.
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Stock Investing: I don’t even check the valuation of index funds once a year, so I spend almost no time on it.
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Real Estate Investing: Aside from monthly bookkeeping, I only ask the management company to handle tasks like requesting new tenants when someone moves out or dealing with issues like branches growing from neighboring properties.
In this way, we conduct daily management while cooperating with the management company.
The important thing is to set up a time for discussion as a couple and align your understanding. Even if you are not in complete agreement, I think it is sufficient if you both understand what the other is doing.
The ‘Order’ of Asset Formation is Important
The purpose of saving money is to increase income through asset management. To achieve financial freedom, expand assets with index funds, stay in the market to maximize the power of compound interest, and continue investing. Then, perform real estate investing to obtain monthly cash flow. This order is important.
The Strengths of Stock Investing and Real Estate Investing
Salary Income Supports the Peace of Mind of ‘Not Having to Sell’
The risk of stock investing is a market downturn, but if you have monthly cash flow from salary income, you do not need to liquidate assets to cover living expenses. If you can manage within the scope of your income as an employee, you do not need to sell even if stock prices drop temporarily.
Even if there is an unrealized loss, stock prices have recovered over several years in past market crashes. For example, after the Lehman Shock, the S&P 500 took about 4 to 5 years to return to pre-crash levels, including dividends. According to past US stock data, there has been no period where holding for the long term of 20 years or more resulted in a loss. While the future may not be the same, with the peace of mind of ‘not having to sell’ and emergency funds, you can continue to manage your principal.
Real Estate Investing Wins in Asset Efficiency
In terms of asset efficiency, real estate investing has the edge.
In the case of stock investing, the profits generated are limited to the scope of your own capital. For example, if you invest 10 million yen and earn a hypothetical annual yield of 5% (through dividends or selling off portions), your annual profit would only be 500,000 yen. Incidentally, the dividend yield for the S&P 500 or All Country World Index is around 1-2% per year.
The major difference with real estate investing is the ability to utilize leverage.
・Purchase a property worth 120 million yen with 10 million yen in capital
・Generate 2 million yen in annual cash flow
・The profit relative to the 10 million yen of personal capital (CCR: Cash-on-Cash Return) reaches 20%
While you can increase assets very efficiently in this way, leverage also increases the impact of vacancies and interest rate hikes. Additionally, entering the market requires a significant amount of personal capital. That is precisely why the order of first building up assets through index investing is important.
Summary
Salary income from a company, stock investing, and real estate investing. I believe that building these three pillars of income is an approach that allows employees and dual-income households to steadily approach financial freedom.
Solidify your base with your salary, capture long-term growth through stock investing, and generate monthly cash flow through real estate investing. By continuing this combination, the goal of 100 million yen in assets in your 40s or 50s becomes well within reach.
What is important is the order of asset formation.
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Maximizing salary income and controlling expenses Start by maximizing your primary income and controlling expenses to create surplus funds.
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Stock investing in index funds Invest the surplus funds you have created into index funds to grow your financial assets.
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Expansion into real estate investing Once your financial assets have grown to around 50 million yen, allocate a portion of them to real estate investing. By utilizing leverage, you aim to achieve both current cash flow and future asset growth.
By following this order, you can build assets efficiently.
Of course, the situation varies for each household. I believe it is important to discuss things according to each family’s circumstances, such as the speed at which surplus funds accumulate and what kind of goals you want to achieve and in how many years.