Passive Income
by Brian Lee. (Visited 27972 times) (35 comments) :: Print This Post
Posted: October 23rd, 2006 under Money, Passive Income.
Passive income is one of the tools that Genius Types use to achieve the freedom to pursue their passion. Recently it has come a popular buzzword to personal wealth seekers thanks to books like “Rich Dad, Poor Dad,” by Robert Kiyosaki and “Multiple Streams of Income,” by Robert Allen. I would recommend these books to anyone who wants to change the way they look at money, and learn how to create wealth.
I grew up in a modest middle class family. I wasn’t even aware that passive income existed until I was in my late 20’s. We worked hard for everything that we had and I thought that I would just have to work harder if I were to become rich. When I started to study successful people, I started to realize that hard work was only half of the equation.
Traditional View of Wealth
The idea of passive income is a major paradigm shift for those of us who grew up with the traditional view of success: go to school, get a job, get promotions, buy a house, contribute to a 401k, and retire at age 65. The concept even differs from the idea of going into a high-paying profession or starting your own business. The problem with this traditional view is that time is traded for money, thereby limiting the amount of money a person can make by the amount of time he has.
The first paradigm shift involves a person’s perception of wealth. Most people see wealth as a dollar amount. These people spend their whole lives trying to achieve a big income because they think it will make them rich. Unfortunately, a big income is worth very little if their expenses are just as big.
When I understood this, I felt liberated. This concept made it possible to build wealth with a lower income. I realized that it wasn’t just how much money I made, it was how I spent that money.
The second paradigm shift has to do with how a person looks at investments. The traditional model is to save in a 401k until you have $1 million. Although this sounds like the American dream, there are several fundamental problems with this view.
One problem with the million-dollar idea is commonly experienced by lottery winners. Most people need instant gratification and therefore, many winners end up spending their entire winnings in two years or less. But even when a person understands delayed gratification, and keeps her million dollars in an income-producing asset, like dividend producing stocks, or treasury bonds, the payout is relatively low. At age 65, most investment advisors would advise her to switch her investments to less-risky assets to preserve her nest-egg.
At current conservative rates, one can expect to earn about five percent per year on these types of assets in retirement. Five percent of a million dollars is 50,000 dollars per year, or about 4,000 dollars per month, which represents her retirement income. At this point she would have time freedom, assuming her expenses were less than 4,000 dollars per month, but it took her forty years of sacrifice to achieve a relatively low amount of time freedom.
The New Paradigm
The new paradigm of wealth is not about how much money a person has, but how long that person could survive without working. If that person had $10,000 in savings and spent $5,000 per month, it would last two months. But, if that same person had $5,000 per month in passive income, it would theoretically last the rest of his lifetime.
With passive income, your money works for you, instead of working for your money. The idea is to collect assets that produce a steady stream of cashflow, month after month, with little or no maintenance. The holy grail of passive income is to collect enough assets to produce an income stream that is greater than your expenses. At this point, time-freedom is achieved. This means you are free to do anything you want with your time and you bills will still be paid.
At the moment of this post, I am not rich in terms of money, but I am rich in terms of how I spend my time. I have built enough passive income to allow me to work out of my house instead of getting a job. I work hard to sustain this standard, but I wouldn’t trade it for anything. I love the fact that I am in control of my time.
Leverage
Passive income is created by using the concept of leverage. Time, technology, and money are all things that can be leveraged; which mulitiplies their power exponentially and produces passive income. Leverage is especially important for people like me, who started without much to invest. By leveraging your time, money, or technology you can make the little you have go a long way.
Leveraging Money
A person leverages money by borrowing to buy an asset in order to produce more money. An important point to understand about leveraging money is that both returns and losses are multiplied under this method, so it is important to find the right asset at the right price to minimize the possibility for losses.
Robert Kiyosaki and Robert Allen are famous for teaching people to leverage money in real estate. They point out that it is possible to buy a $100,000 house with a down payment of only $5,000. This means that a person can control a $100,000 asset without having to save all of that money. If the house appreciates 5% per year, she will be getting a $5,000 per year return on her investment of $5,000. That’s a 100% return.
Being overleveraged in any asset class is dangerous and a common cause for bankruptcy. For example, consider a person who owns ten investment properties, each bought with no money down. If one tenant decides not to pay their rent for six months, the whole investment portfolio could crumble. Since the homes were each 100% leveraged, he couldn’t even sell one to help save the others.
My first piece of passive income was in real estate. I was able to buy a home with no money down and find a tenant who would pay enough rent to cover all of the monthly expenses. In the first year, I only made about $25 per month in terms of cashflow, but I was amazed to find out that the house had increased in value by over $10,000, and the mortgage had been reduced by about $6,000. On paper, I had earned an additional $16,000 that year with only a signature.
Leveraging Time
One common way to leverage time is to hire an employee to do the work for you. This is how must businesses operate. After developing a proven system for making money, the business owner hands the daily tasks off to an employee who does the work while she focuses on new ways to make money.
Leveraging Technology
Technology is leveraged when a moneymaking tactic becomes automated. The vending business is a good example of a business that exists because of technology that eliminates the need for a person to be there. Today, technology has advanced far beyond simple vending. Computers and the internet have made it possible to set up an entire business online that runs itself.
Creating Passive Income
When I learned about passive income, I was immediately motivated to find a way to create some. The problem was I didn’t have $5,000 to get started. In fact, I had over $20,000 in credit card debt that was making things even more difficult. I knew that if I was ever going to be able to collect assets that would produce passive income, I had to get out of debt first. I started selling everything that I didn’t really need, including my new car.
The best way to build passive income when in debt is to get rid of passive expenses. This means eliminating the debt that is taking your money each month while you sleep, including interest payments on credit cards, car loans, and any other debt you might have. It also means scaling back your lifestyle so that your monthly expenses are at the absolute minimum. While this lifestyle is not very glamorous, it is the first step to freeing up the time and money to work on passive income.
My debt and expenses had built up so high, that I found myself working harder and harder to achieve the same standard of living. The worst part was that even though I had plenty of million-dollar ideas, I didn’t have the time to pursue them.
The activities required to build passive income without much money, are time-consuming at first and don’t pay off immediately. This is why it is important to be free of debt and heavy expenses that require immediate financial resources. This process is a test of persistence and a perfect example of exponential growth. Getting out of debt is a slow process, at first it feels as if nothing is happening. Slowly, a small dent begins to grow and grow until significant progress is made.
After your debt is paid off and you begin to work on passive income, this slow process will seem to start all over again. As you spend time learning and gaining expertise in your area of passive income, it will seem as if nothing is happening. It takes a lot of time to set up the system that will create passive income.
If you understand the principle of exponential growth you know that the more you have of something, the faster it will grow. The more knowledge you have, the easier it will be for you to add to your income; and the more income you have, the faster you can create new sources of income, until the cycle itself becomes automatic. The process is initially difficult; most people lack the persistence or motivation to persevere through the initial hard phase, and onto the easy part.
A really great way to learn about passive income is to play the game Cashflow 101
When I went to my first real estate wealth expo in New York City, I was amazed at how many people were there. We felt a small sense of panic that the secret was out of the bag and everyone else was going to beat me to the real estate punch. Then I realized that, given the map to success, 99% of people will ignore it because the road is difficult at first. Most people are only willing to get rich if they can have it quickly. They don’t realize that the hard part is up front, but the rest is easy.
As of this post in October of 2006, I do not pretend to be as wealthy as Robert Kiyosaki or Donald Trump. I am simply lightyears ahead of where I was a few years ago. At that time I was without focus, drowning in debt, multi-talented, but unable to do anything but work a job to pay my bills.
I knew that something had to change. I decided to learn everything I could about how successful people in the past made their way. As I learned, I began to incorporate the values and principles of successful people into my life. Now, I have reached my first goal, to be able to work for myself. I hope that you can take something from what I have learned and join me on my journey to success.
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