Traders in the Cashflow Quadrant

Every Tuesday Chuck releases a new Trader Tip video on YouTube. This week we will uncover which Cashflow quadrant you fall into. 

You can read the episode transcript below or watch the video that follows.
If you have any questions, please reach out to us. We look forward to being a continued part of your trading education!

What is the Cashflow Quadrant?

Well, let’s talk about this. The Cashflow Quadrant was created by Robert Kiyosaki in the context of Rich Dad Poor Dad. And specifically, Robert wrote a book called The Cashflow Quadrant. This is the Cashflow Quadrant right here (shown at 0:29 in the above video). We have E, S, V and I. And this line between the left side and the right side quadrants represents a big shift in psychology. Most of the world sits on the left side of this quadrant in the E and S. Quadrant.

Let’s talk about quadrant one, the E quadrant.

E stands for employee. And in the E quadrant. People who are employees are motivated by fear, insecurity. They’re scared that they’re not going to have any money, and what they really want is the safety of a paycheck. This is most people. Now, employees work for the system, and as such, they are in the most disadvantaged position. They’re in the most disadvantaged quadrant. When you’re an employee, you pay the government first. So when you get paid, the government gets their share, and then you get what’s left. Not only that, you don’t really get to deduct any expenses, you can deduct your mortgage interest, if you own a home, in some cases, maybe some of your medical expenses, but in general, you don’t get to deduct anything. People in this quadrant, they want to have a safe, secure job. In everything that we’re taught, when we grow up, be a good kid, follow the rules, get good grades, go to a great school. If you do all of these things, right, then you’ll get hired for a great, safe, secure job. It’s an illusion. It’s really a lie. But this is where most people are.

Now, we go to the second quadrant.

In the second quadrant is the self employed quadrant. S stands for self employed. People in the S quadrant are motivated by freedom. They don’t want to boss. They don’t want anyone telling them what to do. People in the S Quadrant tend to be perfectionist. They think they do it better than anybody else, and they tend to be distrustful of others. They think they do it better. So why would they hand it off to anybody else. They think everybody else is less than them. This person is the system. So an employee is in the system. In the s quadrant the self employed is the system. In other words, they do everything. Everything revolves around them. If they stop, the revenue stops. The business is relying completely on them.

Now, ironically, in the E quadrant, the employee works for a boss or works for the company, the S quadrant, they want freedom they don’t want a boss. But what’s interesting is a lot of people that leave the employee move to being self employed. They become disillusioned. They become disillusioned. And the reason they become disillusioned is they realize that they swapped one boss for another. As an E, the company, or your boss, is your boss, they’re in charge of you. When you move from the E quadrant to the S quadrant, you now find that your boss is your clients. You spend your whole life trying to make sure your clients are happy because you’re doing everything. You can never take a break. A lot of people in the S quadrant burnout. A lot just give up. They just can’t take it anymore. So the majority of the world falls to the E and S quadrants.

Now we move to the right side. Quadrant three and four will we move from the left side to the right side. There’s a quote here I want you to remember and that is that “the poor and middle class work hard for money and money works hard for the rich.” So the left side, people are working hard for money. On the right side money is working hard for them.

Quadrant three is the B, The business owner.

When you’re a B, your business is built on systems, processes and great people. One of the ways you can tell that you own a business rather than own a job, self employed people own a job. Business owners own a business, one of the ways that you can tell this is that owners can leave in the business and they can come back in the business will continue to make money, it might even be doing better with the owner gone. So then, other characteristics of the business owner is, it’s one of the best ways to create Infinite Wealth because cashflow is high. Businesses kick out cashflow, becoming to become infinitely wealthy, to become truly wealthy, we need cashflow. So businesses are a great way to make this happen. The other thing with businesses is you get major tax advantages. So you get depreciation. This means that you get to deduct your expenses first, then pay your taxes. Rather the employee, the employee paid the taxes, he got what’s left. With businesses, you deduct your expenses first, then you pay taxes. The second aspect is when you own a business or you own stock, it’s not taxed until it’s sold. And then when it is sold, it’s likely sold and taxed at the capital gains rate, which is the lowest tax rate. So you either have no taxes or the lowest tax rate.

Then we move to the final quadrant, quadrant four, which is the I quadrant.

I stands for investor, the investor focuses on rates of return versus risk taken, it’s quite simply is it a good investment for the risk or assume. The I quadrant provides the capital that feeds the other three quadrants. In the I quadrant is tax advantaged through if you look at Wealthy people United States, the wealthiest people in the United States become wealthy one of two ways. One is through real estate, and what’s called a 1031 exchange. So real estate can be depreciated. And then when the depreciation runs out, you can’t exchange it. What that means is you can sell the property. And typically when you sell it, you have to pay taxes. But now with real estate, you can do a 1031 exchange, where you take the profits and you use it to buy another building. As long as you buy another building or buildings equivalent to your sale price. You don’t pay taxes, so you keep rolling your profits tax free, huge tax advantage, that combiner depreciation is a huge advantage. The second way that investors benefit is through long term capital gains. Again, they have long term holds in businesses where they pay no taxes until they sell. And when they do sell, they typically are paying the capital gains rate, which again is the lowest tax rate. So people on the left side pay the highest tax rate. People on the right side pay the lowest or no taxes. People on the left side pay their taxed first and have to live on the rest. Expenses are limited deduction. On the right side, you pay your expenses first where virtually everything can be written off, then you pay your taxes.

Now let’s relate this to traders. Because people don’t think about trading really as a profession, but it is. How does it relate to the quadrant? This should stimulate some thought for you.

Quadrant one is the employee trader quadrant.

Well, there are employee traders. People don’t really think about this, but it’s true; traders at banks, at pension funds, at hedge funds, at some proprietary trading firms, at mutual funds, they get paid salary, w2 salary and bonus. Then there’s other people who are what they call execution traders. Execution traders are people who don’t necessarily trade. They don’t trade for profit. They trade to execute a strategy on behalf of the company they work for. So you have execution traders at financial institutions like insurance companies, we mentioned pension funds and mutual funds, but you also have the big corporations, corporations that are like energy companies, agricultural companies, food producers, a lot of different commodity businesses, they have execution traders who help execute what needs to be done. And again, people in quadrant one get salary plus bonuses.

Then we go to Quadrant two, which is the self employed trader.

Now, this is the majority of traders, especially those who want to be traders, they typically become self employed. They trade for their own account, or their proprietary firm traders. We have proprietary firm traders in group one, and there are prop traders in quadrant one where they get salary bonus. But there’s also prop traders in quadrant two that get profit shares. And those have some tax advantages. They don’t really get a salary. They might get a dropped, but they get really advantageous splits.

The big thing, though, it’s important to note is a lot of people who want to get into trading make the classic shift that like people do from the US. They don’t like their job, they don’t like their business. So they want to come to trading to meet some need. One of the biggest needs I see is freedom, freedom from a boss, freedom from clients. But when you move into the S, you just traded one job for another. You now have a job as a full time trader, and just like in the self employed quadrant, when you’re a self employed trader, you make money if you trade, and you don’t make any money if you don’t, so the whole thing is relying on you again. So a lot of people that come into this, they become disillusioned because they can’t believe how many hours they have to spend and how hard it is to make money.

Now we jump over to quadrant three, to the business owner trader.

same thing, you can own a trading business where you have traders that work for you, you have systems that work for you, you processes that run the whole thing. And you as the owner can support other traders who create cashflow for you, the owner. So proprietary trading firms are classic examples of this. One of the disadvantages of business owners is they typically underwrite the mediocre traders and lose the great traders. So what happens is you have a trader, you back them, they lose money, you sit with the loss, they make money, sure you make some money, but when they get really good, they want to go totally on their own. So you kind of have this continual process that your best people want to leave, and you eat all the losses of the bad ones. So that’s a challenge.

The fourth quadrant is the investor trader.

This is when somebody invests in other traders, other firms like hedge funds, or prop trading firms, or mutual funds, or they invested funds themselves, like hedge funds. Their big work is done through both the due diligence to find the investment, and then the ongoing risk management to make sure that their money is safe. But if they do this, this provides excellent returns that act like cashflow, once they get this right, it doesn’t take very much time, and they can make a lot of money without doing much. This could be the path to incredible wealth with little work, but you got to have the money up front.

In my career, what’s interesting is I’ve been primarily in quadrants two and three.

I never really was in one, I was before I started trading, but once I started trading, I really moved into two, and I’ve been a four, but when you look through my career where I’ve made the most money in my career, by far is being a three, being a business owner. Training traders, putting them into my business and my system made me a lot of money. I can remember making $400,000 on a Thanksgiving night when I had a trader make a million 2 in the euro. Thanksgiving night when the markets are dead in the United States. I was on vacation with my family. Life was amazing. It was down to Miami, my condo, and I made 400 grand on Thanksgiving night, doing nothing. That’s the advantage of being a business owner. I had a day that I made a million dollars in a single day. As a business owner I wasn’t even at work that day. Okay, so that is the power being a business owner.

Then one interesting things is I made a switch that was not even really cognizant that I made, which is that I sold out my interest to my prop trading firm, to go start a fund. What I was actually not even aware of is I went from being a B, quadrant three B to a quadrant two S. I had this vision of what I wanted to do, being a macro fund manager I built out, I wanted to build out the systems, but I was at the hub of it. Then what was happening is, if I traded really well, we made money. If I didn’t trade well, or if I was working on research or other projects, we didn’t make any money. Because I basically swapped a business for a job. That was a big epiphany for me. So when I think through this, currently, I am a three, and I am a four, a three and four and a little bit of a two, I have all three going. But I’m focused on being a three and a four. That’s where my focus is now.

So what quadrants are you in? Have even thought about this? Did you even know about the quadrants? Now that you know about it, what quadrant do you fall into? Be honest. And where do you want to go? A lot of people love the idea of being a three, like I want to build trading systems that I could just go to golf course. Building trading systems are hard. They’re hard. They take a lot of work. You have to really know what you’re doing, and there’s a whole gambit of what is a trading system. I want to caution you on this, it’s easier said than done. But if you do get it right, and intention is everything. If you want to be a three, you can be a three, you can build it that way from the beginning, you can work towards that and your processes and your goals and your reviews. What quadrant do you want to be and why? As I said most traders want to be twos, that’s actually not a great way to go. So how can you not be a two instead be a three or four? That’s a much better life. Think about the answers those questions, and continue to tune in for trader Tip Tuesday, every Tuesday. Be on the lookout we have some really good content coming out. There’ll be a PDF that we’ll be launching soon. That is the 10 Irrefutable Laws of Trading Success. You definitely want to check this out. It’s something that I spend frickin millions of dollars, 1000s of hours to learn the lessons that make up these 10 Irrefutable Laws of Trading Success. So check those out.

Have a great week. God bless and I will see you next week. Bye.

~Chuck Whitman