Here’s the prevailing wisdom on wealth: to become rich, work hard at your job and put money in your 401k from age 25 to 65 until you have a million dollars or more.
(Here at Genius Types, we tend to be very skeptical of prevailing wisdom.)
Average Scenario
Imagine someone who, like most people, works for forty years to put away a million dollars in a 401k. They can’t touch any of their money until they retire at age 65.
In retirement, every investment advisor tells them to move their investments into conservative, capital-protecting, income-producing securities. Let’s be generous and say that their new stock portfolio earns 6% per year, or $60,000.
They’re able to live on this money without having to work, but they aren’t exactly living high on the hog; in fact, they’re living just about like they were before.
Cashflow
By contrast, imagine a person who decides to go against conventional wisdom and instead of putting money in a 401k each month, puts it aside in a special account.
Each weekend, he spends a little time searching for places to put his money. Specifically, he’s looking for deals that produce passive income.
Instead of sitting on the couch, watching TV every Saturday, he’s out pounding the pavement for diamonds in the rough. The first month, he works a deal that produces $100 in passive monthly cashflow. The second month, he finds a similar deal to bring him up to $200, and once he gets the hang of it, he’s able to add about $100 to his passive monthly cashflow every month.
At the end of the first year, he’s passively making $1,200 a month; and in about four years, he builds it up to $5,000.
Since $5,000 covers all of his expenses, he has afforded himself the ability to quit working if he wants to. He has become independently wealthy.
With $60,000 in passive income to free up his schedule, he decides to retire at age 30 and take up the guitar. With plenty of energy, time, and practice; he’s able to achieve his life-long dream of being a musician, and he does it whether it makes him a dime or not.
Our passive income collector was able to accomplish for himself in four years what a million dollars accomplished for our patient 401k contributor in 40 years: $60,000 a year without having to work.
Effectively, a $5,000 passive monthly cashflow has the same ability to create financial independence as a million dollars.
Focus on Cashflow
Conventional wisdom tells you to focus on the amount of money you have while the truly wise investor focuses on cashflow.
Today, too many people are caught up with the amount of money they have. You hear it all the time: “What’s your salary, how much stock do you own, how much has your home gone up in value?”
I focus on cashflow. I care less about how much a house has appreciated, and more about whether or not the rent is covering the expenses. I care less about what someone makes, and more about how much of what they make isn’t lost through expenses.
What’s Wrong With The Market?
While investing in the stock market is much better than investing in nothing, there are better ways to make money without the risks associated with stocks.
No Leverage
It’s difficult to use leverage when controlling your own stock account, and for good reason: stocks are risky. Even if you trade on margin, you can never leverage more than 50% of your portfolio. You could trade options, but who needs the stress?
Out of Your Control
Unfortunately, the fate of your stock portfolio is largely out of your control. Stock prices are set by market forces, which can be very illogical. A stock may crash when investors over-react to bad news, or when it just plain goes out of favor.
I personally would rather invest in things that I have a little more control over.
It’ Too Easy to Shoot Yourself in the Foot
In stock trading, letting your emotions get in the way can be the kiss of death. Falling in love with a stock or panicking at the wrong time can do you in. It takes an almost inhuman ability to curb your emotions to be good at the market, a skill that can take years to develop and still might not help you if you don’t know what you’re doing.
Your Target is Only 12% per Year
The average rate of return over the entire life of the stock market is somewhere around 12% per year. Most people consider this a reasonable goal and are happy to make anything more.
The thing is, it takes a long time to get rich at 12%, especially if you’re starting with nothing. Subtract inflation, and you’re not even in the double digits.
Today’s investment vehicle of choice is the stock market.
I can see why so many people prefer to trade stocks. I even trade a few myself time to time.
Setting up an online brokerage account is easy, it can be managed from the comfort of your home, and it’s glamorous to think of yourself as someone who can control their own destiny by outsmarting the market and striking it rich.
Time Freedom
Real power and wealth has to do with control over your time. If you have enough passive income to cover your expenses, then you don’t need to waste your time with work if you don’t want to.
Having the ability to do work and not care whether or not you get paid gives you tremendous power. A boss can’t control you with the threat of losing your job. A client can’t manipulate you. People can’t tell you what kind of art to make.
Get Serious About Cashflow
If you’re tired of stressing over your 401k, just waiting for a terrorist strike to wipe it out and not being able to touch it for a long time; it’s time to start looking for passive streams of income. Passive income can give you the same power as having a lot of money, but can be achieved in a much shorter time period.
Start by reading Five Ways To Create Passive Income With Little or No Money to get the gears moving in your head.
Point of Clarification added 9 June 2007:
I just wanted to clarify the hypothetical decision I have posed, because I realize that it’s sort of vague the way I wrote it.
There are two ways you could interpret this decision.
1. Given the choice of being handed a million dollar stock portfolio or a portfolio of passive income sources such as residential & commercial real estate, managed or automated business, and intellectual property; all adding up to $5,000 per month in passive income and requiring little or no maintenance; which would you choose?
or
2. Given the choice of working a job and putting money away in a 401k until you have a million dollars or directing that money into passive income sources; which would you choose?
My Position
I would assume for most people, if the first question were posed, they would choose to be given a million dollar portfolio than be given a $5,000/mo. passive income portfolio; and I consider that a respectible position.
A million dollar portfolio is basically a $5,000/mo passive income generater itself, and it’s a comfortable way to go.
I personally would choose the passive income portfolio because I don’t like the risk of the stock market and I like to have more control of how my businesses work. I also like the flexibility & non-monetary benefits that real estate and small businesses provide, including being able to use the land or enjoy the benefits of owing something like a restaurant.
I think question #1 mainly comes down to preference.
2. The second question represents the spirit of the article. I think it makes a lot more sense to spend 4 years becoming independently wealthy than 40. I also think that getting creative with deals is a great way to generate a lot of wealth quickly.
Furthermore, I still don’t like the risk involved in the stock market. That’s not to say there’s no risk in passive income, I just see it as a way to diversify away from a single investment type.
I will always be in the minority on this issue because I’m a bit of a contrarian; but that’s great because it leaves more deals for me.
{ 13 comments… read them below or add one }
Interesting article especially comparing $5000 to $1M
Aiming financial freedom is the reason why my hubby quit his IT job to become a full time entrepreneur.
The route is tough. He has gone through ups and down. Share his story at :-
http://secretofunlimitedprosperity.com/43/practicing-success-invisible-keys-to-law-of-attraction-my-turning-point/
I believe passive income is achievable and we should all be open to it
Cheers
I understand what you’re getting at but I would take the 1 million stock portfolio for sure. It’s a lot easier to start up passive income streams when you have a million dollar bank account to back you up.
Point of Clarification:
I just wanted to clarify the hypothetical decision I have posed, because I realize that it’s sort of vague the way I wrote it.
There are two ways you could interpret this decision.
1. Given the choice of being handed a million dollar stock portfolio or a portfolio of passive income sources such as residential & commercial real estate, managed or automated business, and intellectual property; all adding up to $5,000 per month in passive income and requiring little or no maintenance; which would you choose?
or
2. Given the choice of working a job and putting money away in a 401k until you have a million dollars or directing that money into passive income sources; which would you choose?
My Position
Ben, from what you wrote I would assume that if the first question were posed, you would choose to be given a million dollar portfolio than be given a $5,000/mo. passive income portfolio; and I consider that a respectible position.
A million dollar portfolio is basically a $5,000/mo passive income generater itself, and it’s a comfortable way to go.
I personally would choose the passive income portfolio because I don’t like the risk of the stock market and I like to have more control of how my businesses work. I also like the flexibility & non-monetary benefits that real estate and small businesses provide, including being able to use the land or enjoy the benefits of owing something like a restaurant.
I think question #1 mainly comes down to preference.
2. The second question represents the spirit of the article. I think it makes a lot more sense to spend 4 years becoming independently wealthy than 40. I also think that getting creative with deals is a great way to generate a lot of wealth quickly.
Furthermore, I still don’t like the risk involved in the stock market. That’s not to say there’s no risk in passive income, I just see it as a way to diversify away from a single investment type.
I will always be in the minority on this issue because I’m a bit of a contrarian; but that’s great because it leaves more deals for me.
It’s funny that you mention Question #2 because I was out for drinks Thursday night with my boss and a few clients. Somehow we got onto the subject of 401k’s and I mentioned that I haven’t started mine yet. So basically I am the person in the Question #2.
Anyway, both my boss and the clients went on and on about how I should start investing in the 401k now, because in 40 years when I’m supposed to retire it is going to add up to a ton of money.
While I ended up agreeing with them (if only to end the conversation), in my head I was thinking how crazy they sounded. They had all convinced themselves that they needed to work and save for 40 years before getting any benefit from all the hard work.
My plan is to build income generating websites. In my mind, I am much better off investing my extra income into growing websites that bring in steady cash. There is so much money to be made right now on the internet that I would be crazy to accept a measly 10% annual gain from the stock market.
I think you’re right on the money, Ben. While I do have an IRA, it’s not my whole investment plan.
Ken, that’s a great addition to this discussion. You definately have to allow a few years of struggle into the equation.
I also agree with your point that you shouldn’t just abandon the 401k, you should just diversify your income streams. Even though I prefer passive income, I still have an IRA.
I share the same sentiment, even though I do both the 401k thing and the passive income thing too.
Although I think a more realistic outlook of the passive income timeline is
month 1: lose $1000 trying to make things work.
month 2: lose $500 trying to make things work.
month 3: lose $100
month 4: lose $20
month 5: break even
month 6: break even
month 7: make $50
month 8: make $100
month 9: make $500
and so on…
In reality you’re not losing it unless you decide to quit. If you’ve got your heart in it, and you’ve got some sense, you’ll come out on top eventually with the passive income approach.
Network Marketing is not a joy ride get rich quick scheme, tax liens/deeds are not joy ride get rich quick schemes, blogging and adwording for affiliates isn’t a joy ride get rich quick scheme. They’ll all follow that same path, but in the end, they are all worth it.
Kevin, you bring up a couple of very common reasons why people never take the leap from the comfort of their jobs. I had the same struggle until I found an independent health care plan for less than $100 a month.
Paying a little more for health care and your 401k are just part of the cost of doing business. As a business owner, you take on more responsibilities.
On the other hand, you can deduct a LOT more as a business owner. When considering that your phone/internet/gas and your home office might be write-offs (consult an accountant to be sure), you might just be saving more money after all.
Ultimately, I agree that you should “Diversify” your income streams. I encourage people to build passive income during their nights and weekends and keep their day-jobs until they can comfortably switch over.
I love this article and how it forces me to think outside of the box.
Brian, just a little devil’s advocate here:
1. What about considerations of company benefits? For instance, your passive income does not come with full health insurance. Often times this is why people come out of retirement to work in corporate America again. You may have good health now (hopefully), but health is also fleeting.
2. One good thing about the 401k is the employee’s company typically gives away free money in a matching program! The average is 3% of employee contributions I believe.
I think you’re spot on with the passive income argument. Personally I would take a mix of the two, which in itself is a diversification play.
Great, good points. Thanks for the quick reply.
Interesting article. But I am thinking of following points:
* as far as I know (I am not American, so I don’t have 401K account), one can only invest certain amount of money every month to 401K ($100-200?), so he can still invest the rest of his spare money in stock market outside of 401K, which he doesn’t need to wait for a long time to access.
* It’s amazing if rent covers monthly payback of the loan, but when market changes (like interest rate, etc), the money paying back to bank may change accordingly (rent can also change though), so this is a kind of risk; there are also times when nobody rents the property, this is another kind of risk; and no matter happens, owner has to pay the bank periodically, since the property is leveraged by using the mortgage. Personally I have a concern of these, but for stock market, if the nature and financial status of the company haven’t changed, I don’t care about the fluctuation of its stock price (in fact, may buy more if price is under estimated due to over reaction); and, it’s easier to get out of an investment in a stock than that of a rental property.
That’s right, Brandon. I always calculate a vacancy fee (8-12%) and maintenance fee into the costs associated with a property. I make sure that all of these costs are covered by the rent to ensure positive cashflow.
Worried that you might not have renters periodically? Worried about market changes?
Why not factor that in as one of your costs of doing business? Imagine this scenario:
You have enough of a down payment that allows you (with a little help from your great credit history) to take a loan which requires monthly payments much less than your rent. You become the landlord and manage the property and are in a position to make a profit.
Except you don’t. You take the extra money and create an emergency fund for off-periods and bring the monthly payment down to an insignificant sum.
You might even find a way to avoid paying taxes on the profit that you make by pouring it back into your investment or crossing off chunks of it as the cost of doing business.
Could that not be done?