I’ve been to more seminars and read more books about passive income than I can count. They make it sound so easy. When you set out to generate more for yourself, you may find that these seminars and books have left out some critical information.
First, it’s important to know what passive income is and what it isn’t.
Passive income is income that comes in whether you’re working, sleeping or playing. The America Internal Revenue Service defines it as income from “trade or business activities in which you do not materially participate.”
Some examples include:
- Rental income from real estate
- Earnings from a business that doesn’t require direct involvement or participation from the owner
- Royalties from publishing a book or from licensing intellectual property
- Earnings from internet advertisement on your websites
- Dividend and interest
- Interest on private mortgages
- Income from vending machines that you own
- Income from an online business that you have put on autopilot
When I heard about this type of income for the first time, my whole world changed. I started looking for ways that I could buy or create assets that would generate passive income for me. If I wanted to buy a car, I stopped focusing on saving money to buy the car. Instead, I focused on generating enough income for my assets to buy the car for me.
At the time, I didn’t have a lot of money. But everyone has to start somewhere, right? My first experience in this realm, other than interest on my savings account, was buying a candy machine, filling it with M&Ms and placing it in the lounge at my fencing club. I calculated the cost of a single M&M and figured out how many M&Ms I would give the other fencers for their 25 cents. Since I then knew my profit margin per sale, I discovered that I was making an average $25 per month in passive income after donating 10% back to the junior fencing program.
Some people think they are receiving passive income when they are actually receiving residual income. For example, an insurance agent may earn residual income as her clients renew their insurance policies. However, if the insurance agent leaves the company, that income goes away.
If you’re involved in a networking marketing or multi-level marketing company in which you have to continue to work the business in order to receive income, that’s not true passive income either. If you can stop working the business all together for as long as you want and still continue to earn income, that’s passive income.
The big myth about passive income is that once you buy or create an asset that produces it for you, you’re done. You may be under the impression that you don’t have to spend any more time on it or manage it.
The truth is that there are varying degrees of “passive.” For example, you can receive passive income from rental real estate, but real estate can be extremely time-consuming. Typically, when you buy a property, there is an initial stabilization process that can include anything from doing repairs to finding and screening new tenants. Once the property is stabilized, you may be able to sit back and just receive rent checks for a while, but then a tenant moves out, or the water heater breaks or a tree falls on the roof, and you have to spend time on the property again.
That’s very different from a certificate of deposit at the bank where you buy it, and that’s it. Of course, your potential income on the rental property is much higher than the potential income on the certificate of deposit if you know what you’re doing.
Be conscious of the difference between passive and residual income, and of how exactly how “passive” an investment really is.
Why is passive income important?
Imagine if you didn’t have to depend on a job, a spouse, your family, the government or anyone else for money. That’s what this kind of income can provide for you.
In many traditional financial planning models, you’re encouraged to figure out how much money you’ll need by the time you want to retire. Upon retirement, you spend that money. This plan has some serious flaws. First of all, what if you live longer than you expect and outlive your money? Second of all, what if after putting in so much energy to save that money, you would prefer to leave it as a legacy instead of spending it?
The key to financial independence is this:
PI > E
When your passive income (PI) is greater than your expenses (E), you are in complete choice about what you do with your time because your assets will continue to pay for your lifestyle whether you work or not.
The truth is that to be financially independent, you don’t need to be debt free, pay off your house, make a ton of money or be a millionaire. You just have to have more income than expenses.
It’s that simple.
Passive income allows you to have MORE CHOICES. You can choose to live out of joy and freedom instead of debt and obligation.
On a more serious note, what if something terrible happened and you couldn’t work anymore? How would you pay your bills? When you have enough passive income, you also have more peace of mind.
There are two parts to this formula. To become financially independent faster, you can increase your passive income, and you can also examine how to decrease your expenses.
So how do you get more passive income?
There are two main types of passive income. The first type is passive investment income. In order to receive passive investment income, you need to have funds available to invest in these income vehicles. If you have funds available to invest, you need to focus on doing an appropriate amount of research and due diligence to decide which of these passive vehicles are best for your situation and risk tolerance.
The second type comes from creating your own income vehicle with little or no money. For example, you might start a website that generates revenue from ads or join a network marketing company that will allow you to continue to receive income when you are no longer actively working the business. Or you might start your own business or become an affiliate of someone else’s business.
If you have money to invest, you will probably be able to generate income more quickly than someone who doesn’t. If you don’t have any money to invest, you have to be willing to contribute time, energy, skills, resources, creativity or all of these.
In my experience, the most realistic way to build passive income is to focus on incremental growth. Start by taking one small step. Don’t try to generate an additional $10,000 per month in passive income right this minute. Focus on what you can do to generate $10 per month in passive income and go from there.