What is Passive Income?
Money advisers and coaches will tell you that in order to truly become financially free, you must have enough passive income to exceed your expenses. That’s great, but what is passive income and how do you get it?
For the sake of simplicity, income can be broken down into four categories (and arguably more): portfolio income, leveraged income, earned income and passive income.
- Earned income, as you probably figured, is income that requires you to show up to get paid. Money is earned from your individual time and energy. This is how most people earn their living – as an employee.
- Portfolio income is the interest, dividends and capital gains that comes from the ownership of stocks, bonds and mutual funds.
- Leveraged income is created when one activity earns more money with larger captured audiences. A speaker at a conference, for example, may largely put in as much effort to arrange and give a speech to 20 people as 1,000 people, but can earn much more money with the larger group.
- Passive income is income that requires an upfront investment and keeps paying over and over while the required involvement dissipates. The initial effort creates a cash machine that brings money in many times over, though the participation becomes minimal.
As you can see, earned income requires your time and, even though you can earn raises and promotions, your income is limited because there is only one of you. With passive income, however, you can create multiple streams of passive income and continue to add more and more cash generating machines. Let’s look at a few examples so we can get started making some of these passive income streams.
- Cash Flow Positive Real Estate: Real estate is what most people think of when it comes to passive income. But, it’s only passive income when the rent you receive is greater than your mortgage, taxes, maintenance and expenses. Otherwise, your rental property is just a liability and you are speculating to make money off the appreciation. Passive income can be generated from residential or commercial properties.
- Become an Author: Copyrighting materials that earns royalties, such as books or e-books, music or lyrics, and photos or images, is another way entrepreneurs create passive income.
- License a Patent: Got a great idea or an invention? License it and get paid anytime anyone uses your licensed patent.
- Pay for Use Items: Vending machines, coin laundries, quarter car washes, video arcades and storage units can all earn passive income.
- Automated Fulfillment Websites: Build an e-commerce site that can effectively process and fill orders with little involvement in order to produce some passive income.
- Build a Successful Business: A successful business in these terms means a business that can run with or without your heavy involvement. How often, for example, do you see the owner of a McDonald’s franchise on location? A franchise that is cash flow positive and has a team to run the business is earning passive income for the owner.
Remember that passive income does not necessarily mean that there is no involvement on your end. Many times it involves a large investment up-front, but that results in much less participation needed after your money machine is established. Also, just because you make an earned income vs. passive income now does not mean you should immediately stop working and start setting up gum ball machines around town. To start building passive income streams you will likely need to keep making an earned income in order to convert that income into passive income by purchasing rental properties, etc.
Once, however, your passive income is greater than your expenses, you can make the decision to stop making an earned income and live the rest of your life financially free.