How To Make Your Money Work For You, Part 3: Passive Income 🕶️

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Financial freedom is attained when your passive income exceeds your living expenses. 💰So you have a job. Or a gig or a hustle or a stint. For simplicity's sake, let's just all them all “jobs.”  So here's the basic equation for how you make money from a job. Ready for it? Here it is:

Your Job + Your Time = Your Money

OK, so it's not E = mc2, but it's a lot easier to understand.  You have a job, and the more time you put into your job, the more money you make.  This is pretty obvious if you're paid hourly but also true if you're paid salary.  The more hours you put in, the more money you make.  The more years you put in, the more money you make.

And that's great.  Working is a good thing.  Without people working, society wouldn't function.  Without you working, you couldn't eat or put food on the table or pay off your debt or have the capital to invest in the kinds of investments we're going to be talking about over the next few days.  I still work a job, right now.  I get a paycheck very two weeks.  Could I live off my passive income streams?  Yes, but it'd be a very minimal existence, and I couldn't save much to invest in more passive income streams.  I still work a job so that I can accelerate the amount of money that I can “level up” and put more money into passive income streams.

What is passive income, you ask?  Let me give you the equation:

Your Passive Income Stream + Your Time = Your Money

Notice what's missing there?  The “Your” before “Time”.  Because with passive income streams, it's not your time that makes you money; it's time in general.  Your tenants paid rent today, and give it a month, and your tenants will put that money in your bank account again without you spending any more of your time.  Or let's say you get involved in lending.  Your borrowers paid you their payment today, and give it a month, and they'll pay you again.  It's the same thing with stock dividends or limited partnership distributions or royalties or any other passive income stream.

In summary, a passive income stream is any money-making activity into which you put your own time and money at some point in the past that now generates cash flow for you disproportionate to the minimal (or non-existent) time and money you are putting into it in the present.  Note those two little words cash flow.  This means that the activity is generating more cash output than cash input and putting cash in your pocket throughout the year.  This is different than appreciation, which is the increase in market value of the assets.

To give an illustration of these basic concepts, say at the beginning of the year, you buy 20 shares of stock of ABC Corp for $100 per share for a total investment of $2,000.  ABC Corp pays a dividend of $1.25 per share every quarter, representing an annual dividend yield of 5.00% ($1.25 quarterly dividend x 4 quarters in a year / $100 per share).  At year-end, ABC Corp is worth $110 per share (and assuming the quarterly dividend amount has not changed, the annual dividend yield is now 4.55%).  Your annual cash flow was $100: 20 shares x $1.25 quarterly dividend x 4 quarters in a year.  Your annual appreciation was $200: $10 increase per share x 20 shares = $200.  When I’m talking about passive income, I’m talking about the former, not the latter, because having an unrealized paper gain doesn’t pay the bills or change your lifestyle.

So in our discussion from here on out, we’re going to focus strictly on cash flow rather than appreciation because cash flow from passive income sources is the key to financial freedom.  Why?  Because once you have enough streams of passive income coming in such that your cash flow from these sources exceeds your living expenses, you no longer have to trade time for money, and you can instead invest your time into living free, doing what you want to do.

Over the next few days, we'll be talking about the three major buckets of passive income: paper assets, real estate, and businesses.  You ready?  🙂

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