What is this thing called “passive income?” And where can I sign up to get it?
Speaking broadly, I define “passive income” as “money I do not have to work to receive.” Another way to say this is “income from assets you have purchased.” Or “income from your investments,” such as dividends from stocks, interest from CDs, bonds, savings accounts, and loans, rents from real estate, and book or film royalties. None of this money is truly “passive,” because you either have to earn the money to generate the revenue (and manage the investments once made), or purchase and manage the real estate generating the rents, or write the book that pays you royalties, etc.
But for all of these categories, you do not have to get up and go to an office every day to earn the money. You don’t have to worry what side of the bed your boss rolled out of that morning. You don’t have to worry about the next downsizing, or sweat out a performance review. You have choices on where you want to be sitting when you manage your investments. And you know that as long as your initial investments are solid and diversified (I will devote separate posts to these issues), it is reasonably safe to assume that your income will continue forever from these investments.
And yes, as remarkable as it sounds, it is actually possible to spend your money in a way that creates MORE MONEY in the future. Instead of spending on boats, cars, expensive TVs, jewelry, and other material possessions that will depreciate in value over time, buy yourself a few shares of dividend-paying stocks. Or some high-quality bonds. You will be amazed at what happens. Let’s look at an example. Say you get an after-tax $13,000 bonus at the end of the year, and the money is burning a hole in your pocket. Putting the money in a boring old savings account is out of the question – you need to spend this windfall!
Ok, no worries, let’s spend it. How about a jet ski? A Sea Doo GTI SE 130 Recreation jet ski can be yours now at the end of 2017 for roughly $10,500. You can go buy this with your bonus, and have money left over for gas! Assuming you use it regularly and know how to maintain it, you will have great memories, enjoy your weekends at the lake, and cram countless exciting life experiences into your memory banks. Maybe you will use it every weekend in the beginning, and then monthly and then a few times a year. But even though you use it less frequently over time, you will still have great times. Not a bad way to spend the money.
Of course, the day after you take it home, the jet ski is worth maybe about $8,900. The year after you buy it, maybe you could get $6,000 on the resale market. Three years after you buy it, maybe $3,000. And this assumes that you took care of it, used it regularly, maintained it properly, and it didn’t get stolen, and you didn’t blow the engine, and your friend didn’t borrow it and “forget to return it,” etc.
Philosophy question of the day – do you own your possessions? Or do they own you? Maybe a good topic for a separate post.
Of course, as time goes by, the jet ski is worth less and less, and it will become more and more expensive and time-consuming to maintain. Eventually (maybe in less than 10 years) it will be worth nothing, and will be consigned to the great jet ski trash heap in the sky.
Let’s say that instead of buying the jet ski, you invest that $13,000 in a dividend stock that pays a yearly 2.5 percent dividend that is paid on a monthly basis and automatically reinvested, and the stock appreciates in value annually at 5 percent. Let’s assume further that you don’t redeem the shares, and that you don’t get another bonus (and therefore don’t invest another dime). What is the value of the investment at the end of the three years we discussed above?
At purchase $13,000
Year one $13,990
Year two $15,056
Year three $16,203
So with your $13,000 you could have bought a jet ski that will be worth $3,000 three years later, and will be worth even less as time goes on, or you could have bought an income-producing asset that has appreciated in value to $16,203, and that will be worth even more as time goes by. If you hold those stocks for 20 years, they will be worth over $55,000! Generally a good dividend-paying stock will increase its dividend as time goes by, so in 20 years that 2.5 percent could be 3 percent or more. Assuming 3 percent, your $55,000 would throw off $1650 per year in dividends, without you having to do a thing besides make the initial purchase and hold on to the stocks. Of course, you wouldn’t have the jet ski memories, but you would have your very own FIREhose of cash, for the rest of your life.
Consider this the next time you have money that you NEED to spend (I will address emotions and investing in a future post – this is a whole separate topic that I know altogether too much about, from hard experience). If you NEED to buy something, why not buy an income-producing asset? It will still be fun to own, and you will still spend good times managing the investment. Maybe you have a friend who has a jet ski you can borrow? Or you can always rent one. Let someone else maintain it, and insure it, and keep it clean, and protect it from being stolen, and haul it to the lake, etc. You can still have the great memories, still enjoy your weekends at the lake, and still cram countless exciting life experiences into your memory banks. But you will have paid a fraction of the $13,000 for these experiences, and you will have passive income for the rest of your life, plus an asset you can sell or leave to your heirs.
Remember – passive income will come if you invest in appreciating assets. But you will be working your whole life for someone else if you keep buying depreciating assets. Passive income equals freedom, and the more passive income you have, the more freedom you have.
Let me know in the comments what you think. Thanks for reading!