Last week we talked about defining wealth in terms of long you can go without a job before running out of money. With this definition of wealth we can increase our wealth from two sides. One side is to reduce our spending the other is to increase our savings and our income that isn’t tied to work.
Money that you don’t have to work for is usually called passive income. This includes interest and other types of income that you get more or less automatically. Here is a list of some passive income sources:
- Interest income – Money that the bank pays you for the use of your money.
- Rental income – Real estate lease or other sources of income in exchange for the use of property.
- Royalties – Money for the use of intellectual property.
- Dividends – Profit distribution to owners of a company.
If you can increase your income from these types of sources it reduces your reliance on your job which (in our definition) makes you more wealth because it moves you closer to financial independence.
There are a lot of small things you can do to increase your passive income. For example, if you have a savings account that is currently earning less than 4%, consider putting that money in a bank with a higher interest rate. If you have an average balance of $5,000 per year this will give you an additional $200 per year in interest.
That may not seem like a lot of money, but if you consistently look for ways to maximize your passive income, it shouldn’t take too long to get to the point that one of your bills is paid each month from passive income. The beauty of this type of thinking is that it encourages you to not only increase your passive income, but also decrease your expenses. Instead of just trying to make more money you are striving to have more freedom by working from both ends simultaneously.
Are any of Productivity501’s readers actively trying to do this? If so, what steps have you taken to increase your passive income?
Good management of your finances can have one of the biggest impacts on your productivity because it determines how efficient you convert your time into money into the things you need. On Wednesdays we are discussing the financial aspect of productivity. Watch for more financial posts in the future.
I’ve just recently quit my sales job to start a business of my own. I was making lots of money and had a pretty “good” lifestyle so when my income went away, we didn’t cut our lifestyle fast enough and we have a lot of debt all of a sudden! So I’m in the process of getting rid of that debt as I build up my income from my business. Once that is done, I plan to focus all my effort on building passive income.
No matter how much you make at a career, it can all be done in an instant.
Hi Mark,
For many years I’ve been working towards having the freedom to work from home, and in the middle of 2006 I had enough consultancy income to quit my day job entirely (thanks to an understanding manager there, I was first able to work 3 days a week there for 6 months while I ramped up my other income).
I discovered Robert Kiyosaki’s books myself a few months ago (click the covers at http://blog.azazil.net/library/robert-t-kiyosaki/ for my reviews), and have been interested in building passive income myself for quite some time prior to reading them. Since Kiyosaki talks so much about real estate, I’m currently exploring the mechanics of real estate investment, which I’ll certainly write about as my ideas solidify enough to try them out.
You might also enjoy Tim Ferris’s Four Hour Work Week. I ignored it for a while because the media coverage implies it is all about outsourcing your life. Far from it, he has some really interesting ideas about redefining your definition of wealth… living a millionaire lifestyle without being a millionaire, and ongoing mini-retirements while you’re still young enough to enjoy them.
Cheers,
Gary
Isn’t passive income same as “savings” ?
It is not at all uncommon for people from India, especially the “middle class” to have part of their income invested in Fixed Deposit in banks.
@Mandar: Nope. Where savings might generate a tiny amount of interest as passive income, that is often more than offset by inflation and taxes. In the US, a good savings account might pay 5% interest, gross per annum, less 30% or so in taxes, against the RPI of around 3.5% means that money in savings typically provides less spending power at the end of the year than it did at the beginning.
Real passive income puts money in your pocket regularly, without your having to actually do anything – a web affiliate program, or google ads on your blog; royalties from patents, or a screen play you wrote; rental income from property you own etc etc.
@Gaz – Rental property *can* be a good investment, but I’ve seen very few people that it really worked out well for. If you are handy and like to fix property up, it can be great. If you don’t like handyman type work, it probably isn’t a good place to start.
I’ve seen people read Rich Dad Poor Dad and go out and buy up property only to regret it later. You may be better off working on something that is more closely aligned with your core skill set.
Most passive income requires some type of work. But there is a big difference between checking on something a few times a month and working 10 hour days at a normal job. Google ads on your blog, normally require that you are regularly posting quality articles. Rental income requires getting renters. Royalties from patents often require that you find people to license the patents, etc.
Hi Mark,
You’re definitely right about real estate being a risky investment. Actually, I was bitten by renting out a flat I bought as a student after I’d moved to the other side of the country for my first job… I chose a terrible property manager, who got me a terrible tenant, and then the property crash hit, and wiped out nearly all of my equity. I hope I can be a lot smarter about it this time around.
I would say that income isn’t really passive if you have to work at it constantly, even if it’s considerably less work than a part time job. You definitely do need to put a lot of effort in up front to set up a passive income stream. I still receive (small and diminishing!) royalty checks from a book I wrote 7 years ago. If I sold a piece of software through my website, then it might continue to generate sales (and income) for me long after I stopped updating the site and running advertising campaigns.
Semantics aside, any kind of continuous income stream that can scale without requiring large ongoing investments of your time is certainly preferable to trading your time at an hourly rate.