Managing money, keeping track of your income and expenses, increasing your savings, plus having an abundance mindset is a few things we touched upon in our past posts. And it’s true, you need all that to be in control of your finances and to reach your financial goals. Yet, I want to tackle the elephant in the room… WEALTH CREATION.
Let’s be honest, having income, money to pay the bills and save a bit for your next vacation is great, though it won’t give you the financial freedom you are going for. Your day job income is ACTIVE INCOME. If you are not ready to work nine to six till you drop, you have to find an option of how you’ll be able to ‘Netflix and chill’ also at the age of 80.
Essentially, wealth creation is an accumulation of assets over time. Retirement plan, financial market, and P2P investments, rental property are all examples of wealth creation. These are also examples of PASSIVE INCOME SOURCES!
”Never depend on single income. Make investments to create a second source.”
Warren Buffet
And empirical evidence has shown that most millionaires have at least seven sources of income! (you heard me right, SEVEN!) Can you say the same about you? Unfortunately, I cannot… YET!
What’s Active Income and Why We Need It?
The active income stream is usually income earned in our daily job. Active income represents the financial reward you receive for your time invested as at that moment. Based on the position, responsibility level, company, industry and labor demographics your active income/salary amount will differ. Essentially, it offers us a sure proof way to pay monthly bills, create an emergency fund, and create savings to invest farther on.
In addition, think about how you are feeling when you receive the paycheck in your account. Happiness, joy, and positive endorphins spread in your system. Active income is associated with a positive feeling of purpose. And the purpose is what gets us moving! That also shows why there is a need for active income in people’s lives from a psychological perspective.
Though active income alone might create a feeling of being in a rat’s race as well. Why so? Let me remind you about all the monthly invoices and possible healthcare costs again (sorry for a reality check here). What happens if the economic conditions change and you lose the job? Most people are still living paycheck to paycheck and losing the only source of income is their worst nightmare. You basically feel like you work to live, but is it the purpose?
The key to success though is to increase the proportion of passive income.
What’s Passive Income and Why We Need It?
The idea of passive income is it is money received that requires little or no effort to maintain the flow of income once the initial work has been done (think about it as money you earn while you sleep). Common examples are:
- Rental income
- Royalties from publications (books, songs, other original works)
- Earnings from Internet advertisements in a blog or on a website you own
- Dividends from stocks, REITs, equity mutual funds or other equity securities
- Interest from owning bonds, certificates of deposit or money markets, P2P investments or other cash and cash equivalents
- Pensions.
And do you know what is the main selling point for passive income?
Freedom
First, it spares you time to do other things you enjoy. Is it relaxing with your friends and family, traveling or reading books, there is no need to worry because you know you are earning money as you breathe.
Of course, in the beginning, you need to invest time to build up a passive income stream. It takes time to create, market and continuously update your blog, it takes time to create a diversified investment portfolio so you can earn interest and dividends. In addition, to develop a passive income stream, you might require a significant capital influx upfront to start and grow it. Though it is well rewarded in the end.
Diversification
‘Don’t put all eggs in one basket’ is a common expression in the investment world. Taking a lesson from these financial professionals, why would you want to rely on one active income source?
Creating passive income streams will get you out of the rat’s race. And depending on the proportion of passive income from your total income it will definitely improve your worst-case scenario and give you a layer of safety.
A great overview of the ideal proportion of your passive income is described in Sam’s post from Financial Samurai. He shows the psychological side of having a different proportion of passive income.
Conclusively, the golden middle way is having between 40% to 60% of total income as active income. This ensures having best of both worlds: feeling recognized and rewarded in your daily job and knowing that you have an option to fall back if necessary.
Continuity
It’s a human need to stop, regain energy and go back to work. The passive income growth, though, never stops. It’s continuous independently of what you do.
So when the age comes and you are not willing to spend all of your days in the office, you can feel covered and know that the avocado toast and latte will still be yours to enjoy.
Tax environment
Depending on the country of residence, the taxes you pay on passive income streams (e.g. tax on capital gains) might be lower than the tax on your salary/active income. The reasoning behind the idea is it gives people an incentive to invest in assets that will help grow the economy and create jobs. So killing two birds with one stone.
By now you know I believe having the right mindset can get you very far. Well, that’s the first step if you want to create a passive income stream as well. You need to:
- Be willing to think of ways how to create a passive income stream for you.
- Understand it will take a lot of time upfront.
- Be open for opportunities coming your way for additional income streams.
- Understand many ideas might fail, but you have to keep trying.
- Believe in yourself that you can reach your goal of being successful and living off of your passive income streams.
I’ve been in the labor market for 5 yrs now and don’t get me wrong, knowing the theory and executing it is two completely different things. I also lived with one income source for a while and while you have the energy to go for it is great. Though using it to develop passive income streams will give you much better ROI in the long term (investment being your time and energy).
I started developing extra passive income sources only throughout the past three years since joining Mintos (which, by the way, is a great passive income source in itself). Still, I’ve only just dipped my fingers and am ready to take on any opportunities coming my way. I’ve already experienced how much time and commitment it can require from you, but I believe it’s definitely worth it!
So how about you? Are you ready to take on a goal to develop at least 1 additional passive income stream throughout 2019? It is never too late to start (as generic and cliche it may sound), although the earlier the better.
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