What is Passive Income?
Published on Forbes September 16, 2019. See the full article here.
Have you heard the term passive income? Do you know what it is and how it is generated?
You may have also heard passive income referred to as mailbox money. Another common and closely related term is passive investing. To develop your own passive income strategy, the first steps are demystifying the terminology and forming a framework.
My aim is to set the record straight on the fundamentals of passive income: It is not a myth. It is real. Individuals who have worked hard to build corporate careers only to plateau and wonder what's next deserve a road map on how to jump-start their quality of life and break through the plateau. The most common reasons that you would want to generate passive income include:
• To have more time with your children, family and friends.
• To gain the confidence to execute and innovate in your primary career.
• To have time to pursue personal passions.
• To be empowered to travel and live with geographical flexibility.
• To have the financial wherewithal to deal with life’s setbacks and surprises.
• To gain the financial means to give back charitably.
• To earn the financial means to upgrade your lifestyle, categorically.
As an experienced technology executive who actively works two jobs, balances family life with young kids and a strong marriage with my wife and business partner, passive income has become a core tenet of my personal investing strategy to achieve financial independence. Passive income is income that requires no effort to generate on a recurring basis. Most people prefer monthly passive income because it arrives frequently enough to significantly improve the quality of life.
If you are in one of the following categories, passive investing may be what you've been looking for:
• Dual income, no time or sleep: You and your spouse both work full-time jobs. You have kids. Time and sleep are scarce. You are years into a career, but surprised that you don’t have more disposable income and free time.
• Nervous retiree: You are approaching retirement age or have already entered retirement. You saved throughout your life and career, but are realizing that you could have done more to prepare. Now, you are nervous about making your nest egg last for the next 10-30 years.
• Career rock star: You are focused on your career and don’t understand why people keep telling you to contribute to your company 401(k). You are wrestling with the fact that you are putting cash into an account that you can’t touch for more than 30 years. You refuse you believe there is not a smarter way to put your excess capital to use than a high-yield savings account, 401(k) or index fund.
Active Versus Passive Income
Think about this as a spectrum: On one end, you have active investments of time and effort, and on the other end you have fully passive investments.
Active income refers to activities where you are trade your time for money. If no time and effort are invested, income stops flowing. For example:
• W-2 work, or your “day job.” This is how most Americans generate their primary income.
• Fix-and-flip real estate investing. This is the most active of any real estate investing strategies.
• Consulting or 1099 contractor work.
• Rental property investing in which you buy a property and act as the landlord.
• Entrepreneurship or building a business. This is considered the most active type of income, since it often requires 24/7 responsiveness from the owner.
Passive income includes income produced without the investment of time and effort throughout the life of the investment. For example:
• Cash flow from investing in a commercial real estate syndication as a limited partner.
• Distributions from private lending.
• Ad revenue from digital or shareable content that you created.
• Revenue from selling something online that you created, such as a book or product.
• Rental property investing in which you buy a property and employ a property manager. (This may be better described as semi-passive income, since it requires an occasional investment of time and effort.)
To Build It Or Buy It?
You may have noticed a theme has emerged. Passive income streams can be generated in many ways, but they can be bucketed into two strategy types: buy or build. You can take your money and use it to purchase a monthly passive income stream, also known as passive investing. Or, you can use your creativity, relationships, resources and hard work to create a monthly passive income stream.
If you are a career professional and want to start generating passive income, you will likely want to opt for the strategy to buy rather than build. Time is scarce, but you can likely find ways to earmark excess capital for passive investing.
Why Does Passive Income Matter?
Passive income can be accessed now and reinvested to create more income streams. It has a “snowball effect” for the investors who use this strategy. You can cover your expenses when you deploy a strategy of building multiple passive income streams over time. It's also taxed less than W-2 income when it is generated by real estate. As a high-income earner in a W-2 job, you may pocketing just 60 cents of each dollar you earn. Would you rather keep 100% of each dollar you generate? When you combine the power of goal setting with measurement of monthly passive income, you create a compass toward financial freedom.
There is a wealth of information available on how to find, vet and acquire income streams with reputable partners. The most important first step starts with educating yourself.