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This article was originally posted on Two Cup House as a part of the Alternative Living Arrangement Series

Housing is typically the largest monthly expense in any budget. But what if it wasn’t? What if we could eliminate the cost of housing? Or better yet, What if we flipped this concept upside down and actually GOT PAID TO LIVE?!? This is exactly what I did.

Following conventional wisdom or traditional ways of thinking does not resonate with me; maybe I am crazy. Rather, I have always challenged ‘the norm’ or the ‘its always been done this way’ mentality. The same holds true when I heard housing is generally the largest monthly expense in a budget. Being fairly frugal most of my life, I wanted to keep my housing options as affordable as possible.

A general rule of thumb is to keep rent/mortgage payments less than or equal to 1/3rd of your income. However, many individuals are paying 50% or more of their income for housing. This is common for younger adults, who are early in their careers, and live in expensive cities.

I currently live in a 52 square foot (9′ 6″ x 5′ 6″) room in a home that I renovated last year (more on the tiny room in a bit). Prior to the renovation, I had no idea which room I would be living in. The goal was to live in one room and rent the other rooms for a profit (Yes, I said PROFIT!). And that is exactly what I did.

Realistically, I could live any of the rooms and still earn a profit. However, around the time of moving into my home, I stumbled upon several blog posts about the minimalist lifestyle (I also wanted to maximize my cashflow from the property).

The minimalist lifestyle intrigued me and resonated with some of my life experiences. I spent a summer during college working with Habitat for Humanity in El Salvador. The locals we were building homes for had few material possessions. Most of the people owned maybe two or three pairs of clothes and many lacked shoes.

I was perplexed at how happy these people were with ‘so little’. I came to realize, these people who I thought to be ‘poor’ were actually very ‘rich’. They were rich in the sense of their friendships, appreciation of nature and the joy from a simplistic lifestyle. They were not burdened with debt or worrying about keeping up with the Joneses (whoever the heck they are).

From these wonderful people, I learned that happiness in life does not come from designer clothes, fancy cars or other material (and trivial) objects. Rather, meaningful relationships, basic necessities such as food and shelter, enjoying a scenic view from the top of a mountain (or volcano in El Salvador) and the other simple things in life bring happiness.

NOW! The thing you are all wondering about, the 52 square foot room. Yes, I opted to live in the smallest room and maximize my cash flow and passive income. While moving in, I spent a lot of time sifting through my possessions in an effort to downsize my life into such a small space; the results were astonishing.

I donated four (4) large bags of clothes to a local non-profit. The clothes were in great shape but either did not fit or were never worn anymore. Over the previous several years, I accumulated a bunch of junk that served no purpose other than taking up space. I began to randomly give away nicknacks to friends and throw away the other junk.

Living in such a small space, I knew organization would be paramount. As a result, I bought a loft bed off of Craigslist. The bed has a desk with several shelves and drawers. This instantly allowed me to double the amount of space I could utilize in the room. I also bought additional storage to stack on top of my dresser.

Lastly, I modified my closet to double the amount of hanger space and bought a shoe rack that hangs from the inside of my closet door. Suddenly, 52sf of room seemed a whole lot bigger (see pictures below).

Now, living in such a small space and with 4 other people is not always the most enjoyable situation. I share a bathroom with two other people, which is not the end of the world. Generally, I opt to shower at work to avoid the morning traffic jam in the bathroom. Things get untidy in common areas relatively quickly with so many people. Everyone keeps different hours and sometimes I am woken up by my roommates stumbling in from the bar. Meshing interest, political views, lifestyles and needs of 5 people under one roof can also present challenges. Thankfully, I have a girlfriend who does not mind if I crash at her house on occasion.

The minimalist lifestyle and renting out extra rooms in a house provides many benefits. Downsizing to a small space forced me to declutter my life. In fact, a minimalist lifestyle has made my life simply more enjoyable. Eliminating the cost of housing has done wonders to my ability to save, pay down debt and invest. I am on my second home and intend to add a few more over the upcoming years. At some point, I believe that I will take a more reasonable sized room. All the headaches of living with so many people and in a small room seem worth the short term pain. The long term gain is almost priceless as I will be retiring in my early 30s (or at age 30 if things go really well).

Life in 52 sq ft  = loft!

Plenty of space at this desk!

A place for everything…

Think you can live small for a few years to live big for the rest of your life?

What if you could collect a steady and predictable income without having to lift a finger? Better yet, what if that income were to increase every year at a rate greater than inflation (meaning you earn more over time)? Sounds pretty good, right? Well, this idea is not hard to obtain. Dividend-paying stocks provide an excellent source of passive income and there are several reasons to own dividend-paying stocks. In fact, I plan on having dividends provide somewhere between 25% and 33% of my monthly retirement income.

First, you may be wondering what the heck is a dividend? Individuals may buy stock in publicly traded companies. Many publicly traded companies share their profits with stock owners (shareholders) in the form of dividends. Dividends are cash payments by a company to the shareholders. Cash dividends accounted for 71% of the market’s overall returns over the last 40 years. These payments typically occur quarterly but can also be monthly, semi-annually or annually.

Dividends allow investors to capture returns without selling the underlying asset. A dividend provides you with cash while allowing you to still own the business. The business’ value can appreciate over time while continuing to provide more dividends.  As an investor, you should never have to sell your asset in order to earn a return. Additionally, I would never own a stock that does not pay a dividend. Why would you own an asset that does not provide a return?

Dividends have preferential tax treatment. What does this mean? Dividend income is subject to capital gains tax and not income tax. Most people will pay a 15% tax rate on dividend income… Unless you are a complete baller and fall into the highest income tax bracket, then you will pay a 20% tax rate on dividend income.

Most companies generally increase their dividend payments annually. Some years the dividend increase may be north of 10% while other years shareholders enjoy a modest 4-5% increase. Typically, dividend increases out-pace inflation; this serves as a great hedge against inflation and way to preserve purchasing power. Companies that have a strong track record of continually growing their dividends are known as Dividend Aristocrats.

Now that we have established what a dividend is, the next logical question is what to do with a dividend? There are two schools of thought on utilizing dividends.

The first practice is known as a dividend reinvestment plan or a DRIP.  A DRIP allows an investor to take the cash from the dividend payment and reinvest it back into the company that paid the dividend. Numerous companies offer DRIPs and there are several advantages to dripping. By participating in DRIPs, investors can purchase fractional shares,  avoid costly transaction fees and even receive a discount on their purchase (discount only offered by some companies and typically ranges between 1% and 10%). Jim Cramer is a big believer in DRIPs.

Alternatively, investors can elect to receive their dividend in the form of a cash payment. There are limitless options once the investor has received the cash. The investor could elect to buy another company with their funds from dividend payment. This would provide an additional dividend income stream and increase diversification. This would also add to the power of compounding interest.

Additionally, the investor could use the cash to pay bills or go on a vacation. Or, the investor could actually buy more stock in the company that paid them the dividend at a price of their choice. Warren Buffet never participates in DRIPs and utilizes the dividend income to buy additional stock at his price.

Over the course of my journey, I will be tracking and providing quarterly updates on my dividend income. The goal is to grow my dividend income through two methods. The first will be organic growth of my existing portfolio by companies naturally increasing their dividends over time. Secondly, I will opportunistically invest new money to increase my dividend income.

There are several compelling reasons to own dividend-paying stocks. Dividends are a good source of passive income. Over time, dividends typically outpace inflation which serves as a hedge against inflation while preserving purchasing power. Dividend income has preferential tax treatment compared to wage income. Lastly, dividends have made up a majority of the market’s returns over the last 40 years. Are you collecting dividends? If not, you might want to ask yourself why.

Passive income is the holy grail of financial independence and retiring early (FIRE). By saving and investing over time your money you will gradually accumulate and develop streams of passive income. Eventually, the various passive income streams will provide enough income to meet (or exceed) your living expenses. At such a time you will have ‘FU money’.

Before discussing passive income in further detail, let’s outline why FU money is so great. FU money gives you the ability to tell your boss to ‘F$*! Off” and quit or retire. There are unlimited options when someone has FU money. FU money provides the freedom to stop working, work a lower paying job that you are passionate about, travel full-time, stay at home with your kids, or just veg out and watch Netflix (and chill) all day. In a nutshell, FU money provides the flexibility to do what you want when you want. Who would not want that?

Now what is passive income and how does it compare to other types of income? The chart below outlines the 4 traditional ways to earn income; which are being an employee, being self-employed, being a business owner (others working for you), and being an investor.

Being an employee (top left on the chart) is the most common and possibly WORST way to earn an income (but not a PASSIVE income…. hang with me. we will get there soon).

As an employee, you are trading time for money. Essentially, you are a paid servant to your employer and your livelihood DEPENDS on you showing up to work Monday thru Friday from 9-5. You are sacrificing your most valuable resource (time) in exchange for money.

Sounds… well… HORRIBLE.

Ironically, the worst form of income is also the most common form of income. In the United States, many people never escape this form of income because of the consumer lifestyle and individuals’ tendencies to live paycheck to paycheck. This is also known as ‘the rat race’ or ‘being stuck on the hamster wheel’.

Also see: 6 Steps to Saving a 6-figure Net Worth

Being self-employed (bottom left on the chart) is another form of income. However, like being an employee, you are still trading time for money. Self-employment does provide more flexibility and freedom than working for someone else, which is a big plus.

However, not everyone can or wants to be an entrepreneur. Some people like the safety net of a salary and working for ‘The Man’ (sounds a little crazy). Other people thrive working for themselves and being able to make as much or as little as they want. Being self-employed also allows you to set your own hours and own pace.

The third way to make an income is from owning a business (top right on the chart). In this instance, you are utilizing leverage of OTHER people’s time to make money. Depending on the nature of the business and how well established the business is, this can provide a (mostly) passive income. While it is nice to profit off of others time and effort, owning a business will require at least some oversight.

Also see: 8 ways to crush it after graduation, in your 20s & beyond

Last but certainly not least! Being an investor (bottom right on the chart) provides passive income (WE FINALLY MADE IT!). Now, what the heck is passive income?

Passive income is “income that is received on a regular basis with little or no effort required to maintain it”. What does this mean? It means you are getting paid while giving up little or NO TIME (remember, time is the most valuable resource). Sounds too good to be true, right? But it’s not!!! Passive income is quite commonplace if you know where to look! [hint: keep reading! I am about to tell you about several types of passive income]

Unfortunately, this concept is foreign to many people, especially Americans. According to one survey, a majority of Americans plan to work into their 70s or never retire. Another survey stated, “1 in 3 Americans has saved $0 for retirement.” Clearly, many people do not know about or understand the concept of passive income and what freedoms saving/investing provides (Blame the lack of financial literacy in the education system).

Also see: Offensively Building Wealth Through Earnings & Investing

There are several forms of passive income. Two of my favorite sources of passive income are dividends from stocks and rents from real estate (more types later).

Dividend stocks are an amazing thing! Most dividend paying stocks provide shareholders with a predictable income every quarter (3 months) in the form of cold hard cash. However, some companies offer monthly, semi-annual or annual dividends. Many companies increase their dividends every year and the increase often outpaces inflation. This means you are actually making more money over time without even lifting a finger (say wow)! Additionally, dividends have preferential tax treatment and are subject to the capital gains tax and not personal income tax (read: dividends are taxed less than income earned from a job).  Sounds pretty good, right?

Real Estate or rental income from properties is another form of (mostly) passive income. Personally, I love real estate and the passive income that it provides. Most months, the only time commitment is collecting the rent checks. Over time, like stocks, rents generally increase with or outpace inflation. This equates to greater earnings over time. Additionally, tenants are paying down your mortgage and there are tax benefits to owning the real estate.

Owning rental properties does come with occasional expenses such as repairs and maintenance. Tenants may cause an occasional headache as well. Thankfully, I have been fairly lucky with screening my tenants; most of them are very pleasant people who I have a great relationship with. Individuals may hire a property manager for a modest fee (typically 8-10% of the gross rent) if they do not wish to deal with tenants or repairs. Utilizing a property manager makes owning real estate 100% passive income. I will write more on my real estate endeavors in future posts.

There are countless other types of passive income. Bonds provide passive income through their regular interest/coupons payments. Peer 2 Peer lending, which has grown tremendously in the past few years, can also provide passive income to investors.

Royalties are another form of passive income. A royalty is a small payment received by a creator every time an item is purchased or a song is played. Individuals can invent a product, write a book or song and receive royalties for the intellectual property they create.

Banks will pay you interest on your deposits held at their firm. Additionally, Banks offer a product known as Certified Deposits or “CDs” for short. Banks also pay interest for money held in a CD. Both of these are examples of passive income since your money just sits there MAKING YOU MORE MONEY. Historically, interest rates for deposits and CDs have rewarded savers/investors. However, given the current low-interest rate environment, many individuals would be better served putting their money elsewhere.

In conclusion, there are four traditional ways to earn income. Some methods for earning income are very time intensive while others are very passive. Working for a company or individual provides income in exchange for time. Stocks, bonds, and real estate are a few of the many ways to generate passive income. Time is the most finite and valuable resource that we all possess. By saving money earned as an employee, we can invest the savings into assets that will provide passive income. Over time the passive income will grow, provide financial freedom and give you the flexibility to spend your time as you please.

Currently, I find myself positioned in all 4 quadrants on the chart above. Unfortunately, a majority of my income comes from the left side of the chart. I value my time more than anything and am working towards leaving the ranks of an employee. As a result, I am focusing my efforts on growing my passive income through investing in dividend stocks, rental properties, and other passive income producing assets. No one has ever laid on their death bed and said, “Gee, I wish I spent more of my life working.” With that said, what quadrant do you want to be in?

Let me preface this article with there is no absolute right or wrong answer regarding front-loading vs. dollar cost averaging contributions into a 401K or other tax deferred accounts. Decisions are mostly preferential and partially situational. Madfientist and Enchumbao both offer their views on why front-loading works for them. Both authors provide great insight and are worth reading.

1. Losing Free Money

The first reason why I do not front-load my 401k? My employer does not offer a “true match” for my contributions.  My company is rather generous with their 401k match; they provide a 6% match if we contribute 4%. BUT I will loose out on FREE MONEY If I maxed out my 401k in the first quarter of the year.

Assuming I maxed out my 401k in the first quarter, my employer would NOT contribute a 6% match based off my pre-tax income for the entire year. Rather, my employer would only contribute 6% based on my pre-tax income for the first quarter. By spacing out my contributions over the entire year, I will earn the full benefit of my employer’s match. This is an example of a situational reason for not front-loading a tax deferred account. I fully recognize that this does not apply to everyone.

Additionally, I like the predictability of the same lump sum being deposited into my checking account every two weeks. Front loading my account, though easily manageable, reduces cash flow for 3-6 months out of the year. I prefer constant cash flows, which allows me more flexibility to invest elsewhere (Real Estate).

2. Timing the Market

Generally speaking, I prefer my portfolio allocation to be overweight low-cost index funds (benched marked to the S&P 500) along with individual stocks that demonstrate strong fundamentals and dividend growth. My 401K contributions are allocated to index funds since my employer’s plan offers limited investment options.

By front-loading investment accounts, you are betting that the first half of the year will offer better buying opportunities than the second half of the year. This is considered “timing the market”. I do not believe in timing the market for index fund purchases, HOWEVER, I do believe in timing the market for individual stock purchases (more on my stock purchasing process in a future article). As a result, I elect to periodically purchase index funds 26 times a year (paid every two weeks 52/2 = 26) via my 401k account. This is an example of a preferential reason to dollar cost average 401k contributions.

Spreading out contributions evenly throughout the year allows for everything to be automated and function like clockwork. This systematic approach removes the guess-work out of investing and allows for a consistent paycheck all year long.

Several individuals argue investing a lump sum right away if you are comfortable with the market risk. I am comfortable with market risk but am not comfortable with this strategy. Some years this method pays off. Other years, this would cause you to miss out on substantial returns.

Lets start off by looking at 2015. The S&P 500 was down 2.15% for the year, which is not a stellar by any metric. The chart below shows the market was mostly up for the first part of the year, however, the market experienced a strong pull back during the fall and dropped 9.7%.

S&P 500 Performance 2015:

If an investor elected to dollar cost average throughout the year, they would have enjoyed the benefits of the market pull back. In fact, the S&P 500 rebounded 7.96% from the August 25th low (see chart below). In this instance, dollar cost averaging proves to be more beneficial than front-loading.

S&P 500 Performance August 25th, 2015-December 31, 2015:

Let’s look at another example. In 2011, the the S&P 500 was up for a majority of the first half of the year but finished the flat. The market dipped by almost 15% in August from it’s recent highs. The market also dipped significantly in September and November. Dollar cost averaging would have provided an investor substantial gains in the last 6 months of the year. Likewise, a front-loader would have lost money and missed out on these great buying opportunities.

Alternatively, some years present great opportunities to front-load investment accounts. 2013 is one of the best examples for front-loading tax deferred accounts. The S&P 500 was up 31.3% for the year and did not experience any major pull-backs (see below). An investor would have benefitted by maxing out their accounts as early as possible and enjoyed sizable gains.

S&P 500 Performance 2013:

In conclusion, there is no right or wrong answer on wether an investor should front-load or dollar cost average contributions throughout the year. There are dozens of examples where each method would have been “better”. Timing the market is a fool’s game but can sometimes be beneficial (see the graph for 2013). Dollar cost averaging throughout the year provides systematic  approach that removes the guess-work out of investing and allows for a consistent paycheck all year long. Selecting a method is mostly preferential and partially situational. Which method is for you?