To start, *pure* passive income simply means “you are rich”. The only way to earn income without doing a thing (ever) is by having a large sum of money. The good news? There are hundreds of other ways to earn income in both a semi-passive or passive way. Specifically, you can create semi-passive streams that tail off, you can invest in higher risk passive income that *may* generate a return well in excess of inflation and you can always work part time to generate “semi passive” income. Below is an outline of streams of income (what we view as best to worst).
A Landing Page with No Updates: This is the best form of semi-passive income. It means you have a website that *does not need to be updated*! Now we have to repeat that phrase. You create and set up a website that sells a product and *does not need to be updated*. If it needs to be updated then it’s not longer in the tier one semi-passive income segment.
Any website that sells a product that does not require updating could include anything from: vapes, electronic cigarettes, retail clothing, protein powder, cosmetics, jewelry etc. Quite literally anything where you go to a website and the same products are being sold day in and day out. Importantly, the reason why this is the best form of passive income is because of the return profile.
Roughly speaking say it takes about a year to get enough traffic to earn $2,000 a month. This may not seem like much, however, if it only took a year to get done correctly you’re now getting $24,000 a year or the same value as having $600,000 (in a single year!). If you create two of these you can now focus on bigger ventures. This is the primary reason why we recommend online sales as a starting point. If you can just create two of them you’re now free to build something more meaningful and have the money to both live on your own or reinvest the money into paid traffic to a more important venture (important ventures are not semi-passive income as you’ll be grinding away to get past plateaus). In short, a landing page that converts is your best form of semi-passive income.
Management Income: While we prefer having other people manage rental properties for us, there is money in this game as well. If you want to become a landlord you’re going to be forced to commit time (interviewing new tenants, repairs etc.). This means it’s not quite passive income but the time spent can be *leveraged*. This is a key part of this semi-passive income stream. If you own properties with a high cap rate (meaning annual rental income over value of asset) then you can obtain some leverage to boost the returns. This is secondary to landing pages for a key reason… If you go down this route use the static income to cover the cost of the mortgage payments by 2x.
Lets assume you have $4,000 a month in semi-passive/passive income. This means you can take on a mortgage payment of around $2,000 a month (we take a conservative stance and assume your $2,000 payment includes everything). To keep everything simple, this means you can put $80,000 down to obtain $400,000 in real estate value. Assuming your interest rate on the debt is around 4%, your payment is going to hit right around $2,000 a month (we include home owners insurance, taxes and some wiggle room for repairs in this $2,000 estimate). Now you can sleep well knowing your payments are protected and can look for the best possible tenant giving up a few bucks (slightly lower rental income) for a stable semi-passive stream of income.
Updated Information Websites: Yes you can make some money from blogs, but the real money is in paid traffic product websites. We are including this as a form of semi-passive income because we’re sure everyone visits at least one website with updated information not classified as a blog. Let use Coupons.com as an example. Now certainly, no one here is wasting their time clipping coupons. But. Remember that there is a LOT OF MONEY in selling to the masses (hence why motivational seminars always work! Never ending supply of always broke dudes looking to get “amped up!” or “fired up!” or “Hyped!!”). The masses are always looking for ways to cut costs, so you can offer a website that does just that (like the coupons website).
Another good example of information based websites is credit card offerings or something like million mile secrets. No one wants to actually do the work and they correctly advertise with the slogan “Big miles. Small Money”. This barely makes our semi-passive stream since there is a lot of updating here. It is possible to run a smaller scale website like this without working a 40 hours per week. (not easy but doable).
Return Based Passive Income
Now we’re moving onto pure passive income. All of these forms of passive income will not require you to do anything. We’ll ignore you being forced to set it up (less than 4 hours) and assume that you do absolutely nothing going forward. There are many many ways to make money if you have money and that’s a good thing. The reason why this segment is separated out is you should be willing to lose some money if things go south. This is called “higher risk return” passive income versus “risk free” passive income. There is an important distinction because the return profile is higher and you shouldn’t bank on 100% of it being stable every single year.
Owning Properties, REITs and Private Equity Real Estate: Now the difference here is you’re handing over the keys. Unlike the management income where you do it yourself you’re going to outsource everything. You throw money at the property and hand the keys over to someone else to deal with it. This is not a risk-free situation given 1) potential debt load, 2) trust in property manager, 3) interest rate environment and 4) any one time hazard/maintenance issue that kills your yield for the year. We peg a solid return at somewhere around 6-9%. This includes a management company eating into your yield and of course the natural reserve fund for any maintenance issues.
The second option is a REIT which certainly has risk associated to it. While they do offer high yields (distributing 90% of earnings to shareholders), the REIT is exposed to 1) tax rate changes – you’re taxed based on your personal income bracket vs. dividend distribution rate, 2) reliance on debt, meaning more leverage is needed to boost returns, 3) real estate can be extremely location dependent and is prone to cycles just like we saw in 2008 and 4) since it’s an equity product and as a shareholder, we have to realize they can only re-invest 10% of net income since the rest is being distributed. Take a look at REITs and you’ll see they move around in ways un-related to the stock market.
The third option is working through a private equity firm such as a Blackstone, Lone Star or Brookfield. You’re locking up your money for a longer period of time (typically) but the returns should be notably higher as well (double digits). Now there is certainly a wide range of private equity transactions from low to extremely high risk… But. Locking the money up for longer periods of time is generally the theme here. Unless you’re in the Ultra Rich group, it’s one of your best bets to get exposure to commercial real estate (apartment buildings, offices etc.).
Overall, we’d say if you looked at this group in aggregate shooting for high single digit to low double digit returns is doable with the right background research. Many people make a handsome living in the real estate industry (there are even executives who read this blog and have emailed us!) and there is a clear reason for it.
High Yield Bonds: If you know your industry extremely well, you can start dabbling into higher risk bonds. We wouldn’t recommend going into the low end of junk bond territory unless you’re extremely savvy but you can begin looking at items with a yield closer to the BB range. We’d emphasize that high yield bonds are for a special type of person 1) a person who is looking for additional yield given that they are already financially independent or 2) a person with significant domain expertise that knows the industry’s cash flow dynamics like the back of his hand. If you’re in one of these two positions you can find yields that are around 6-8% or so (sometimes even 10% if you’re extremely savvy and know the space well!). Importantly, our view is to wait on this one since rates are likely going up a few more times, but it is good to get your hands into the mix now to figure out which corporate bonds are good investment vehicles.
Crowd Sourcing and Peer to Peer Lending: This is another interesting one since the risk profile is not well understood today. You’re essentially lending to other consumers or you’re piling in your money with other smaller scale investors into specific projects. This is a hot topic today given the advancements in social networks and trust amongst strangers online. The key to this investment vehicle is you’re making a call on the risk profile of the investment vehicle versus the printed sticker return. If the return is the same as a high quality corporate bond the only thing setting your idea apart is the assumed risk (a clear example would be Lending Club).
The basic items include: car loans, mortgages and credit card debt. You’re essentially acting as the bank and again, we think the real differentiator is the spread on the assumed risk you’re taking on. The yields are somewhere in the mid-high single digits.
Dividend Paying Stocks and the S&P 500: The last bucket is another one for long-term investors that we have already spoken about in the past. Buying index funds that mirror the S&P 500 (ticker: VOO) or dividend yielding stocks (ticker VYM). You’re taking a long-term view and are willing to take the sharp downturns during an equity market pull back. The main risk here isn’t that the stock market will stop going up over the long-term… the real risk is emotional distortion when the selling begins. The vast majority do not understand what it means to invest in an index fund as you’re assigning equal weight to the same old set of 500 companies. To explain this in extremely basic terms “If everyone decides to buy the same 500 companies every month is that an efficient market?”. The answer is of course not. Sure companies move in and out of the S&P 500 but everyone should see the point, with more money in this strategy the downturns will be more severe. Related: Explaining The Warren Buffet Passive vs Active Bet
Protection Based Passive Income
Government Bonds: This is the most basic form of protection based Passive income. Specifically, protection based passive income means you’re only protecting the principal values (more or less). If you generate a low single digit yield of 3-4% or so, you’re essentially getting nothing back once the year is done. You’re taxed at your normal tax rate and on top of that you have to strip out inflation of somewhere around 2% per year or so. We don’t think inflation is that low (1-2%) so we’ll go ahead and say all 3-4% of it just goes to stave off inflation. Boring stuff guys. This is to be used for asset protection. Instead of putting money into a savings or checking account where the value is being eaten up by inflation every year, you can throw that safety net amount into government bonds instead. No we don’t own these today.
Treasury Inflation Protected Securities (TIPs): Now in theory, many of you read the prior paragraph and said “well buying TIPs will protect me the best from inflation” this is certainly fair in practice. The problem is the long-term view on allowing an instrument to be pegged to what the government says inflation will be! Since we don’t even believe the current inflation estimates we wonder if the future adjustments to inflation numbers every single year will really make any sense. If you’re interested in protecting assets and have a more positive view on the assumed rates of inflation on a year to year basis then these instruments may be useful for you (ticker: TIP). No we don’t own these today.
Certificate of Deposit: A whopping 2% return! Honestly that is where the higher end CD rates are and if you want to track them yourself then you can check out bankrate.com they have a solid overview of the interest rates. Notably, the one benefit of CDs is your ability to stagger. This means you set aside one chunk of money, lets say one 5-year CD at 2% and then every year you buy the same one. This way once you’ve done this four times, you’re constantly getting back the investment and the return as a safety precaution. We do stagger CDs at a rate of 4 months of annual income expenses. This means once you have a healthy financial portfolio you have about 2 years worth of income earning a small return but peace of mind that every single year you can take a 6-month living expense hit and not worry about it. We think this is an extreme safety precaution and it can be done with much less in a money market account.
Money Market Accounts: If you’re not ready to set aside 2-years worth of income like a pack rat then you can also go down the money market angle. Nerdwallet.com gives a solid overview of the money market options and also provides basic overviews of credit cards, mortgages, loans and insurance. We don’t operate with a money market account but we’d use this as a “worst case scenario” area for safety. If you’re in this camp, 3-months of savings is likely good enough because you should be reinvesting thousands upon thousands of dollars into your real business.
Your entire net worth and income stream is no different than a sales funnel or building a pyramid. We’ll say it once and we’ll say it again. You’re either building someone else’s dreams or you’re building your own. With that you should be looking at the framework as follows:
1) You build a business and put every cent into making it grow whenever you see a risk reward opportunity that favors you
2) During your free time you build a few landing pages to sell products that are known to be high quality and get them to generate a few thousand dollars a month
3) If you struggle to do step 2, move to a managerial or information based product where you’re constantly updating, it’s a grind but all the money is being invested in item 1 where you’re looking to buy traffic
4) With excess money flowing in, start building out a recurring income portfolio of “return based” passive income. We have no major preference at this time (we used to prefer dollar cost averaging) between the four items but we do recommend a mix of at least two of the ideas
5) Depending on your risk profile look at protecting a couple of years of income by investing into low risk passive income items.
There you have it every important as it relates to passive income into a single post.