Passive income. Everyone wants it. Nobody really knows how to create it. Except the people trying to sell you get rich quick courses. But figuring out how to generate a stream of passive income opens up many opportunities tied to your freedom and time.
In this post, I'll show how I think about passive income and share some strategies on how to create it.
Start with low-effort income, not passive income
First, don't think of it as passive income. Think of it as "low-effort" income. Most passive income isn't truly passive. My two rules are that I don't want to spend more than an hour per week on it and that the effort can happen on a river anywhere in the world. I hope to sustain that kind of effort for the rest of my life.
By the way, this constraint is also why I don't currently own any residential rental properties.
If you want genuinely passive income, that exists too. But you need to expect a lower return. For example, dividend stocks provide pure passive income. You might need more of them to get to your total $ of desired passive income—ditto for bonds. Let me give you an example.
Let's say I have $1mm in low-effort assets. I can generate about a 15% return. That's $150k in low-effort income.
Alternatively, let's say I have $3mm in assets but choose a much more passive strategy that only returns 5%. That's $150k in passive income, which is less work but requires more assets.
So my current strategy is to optimize (a.k.a grow) for low-effort passive income and then maybe switch to a more passive approach when my assets have grown.
Low-effort income comes from assets
Ultimately to get low-effort income, you need assets. Businesses are assets. Stocks are assets (which means you own a small part of a business). Real estate is an asset. Even relationships can be assets.
You can buy those assets.
Or you can build them.
Better yet, do both.
Every day, week, and month I try to make a little progress in building businesses and relationships while at the same time buying real estate and stocks.
Set a goal and live accordingly
For many people, the dream is to have enough low-effort/passive income not to have to work anymore. That's a high bar but doable. However, it requires work on two fronts.
One, you need to buy and build enough assets that generate income.
Two, you might need to right-size and optimize your lifestyle.
For example, at this point, if I didn't want to work in a 9-5 job anymore - I wouldn't have to. That's because of a) the assets I've built and bought but maybe, more importantly, b) the amount of money it takes to fund my life is pretty modest.
So, as you think about your passive income goals, make sure you work on your income and expenditures.
Financial freedom = Low-effort income > Your life expenses
For my financial independence, driving a Honda Element and living in a modest home is just as important as owning a bunch of assets.
Diversify your passive income sources
Part of the reason people want passive income is that they don't have to worry about money anymore. You make your low-effort/passive income relatively worry-free by diversifying it. So when a crash happens, you still sleep at night. For me, low-effort income comes from all kinds of places - from business income to software commissions to crypto to ETF dividends and real estate.
Use debt and leverage but with caution
Some of my assets have debt attached to them. That has been a profitable strategy, especially in a low-interest rate environment. It means I've acquired assets that I otherwise wouldn't have been able to buy for quite a long time. So debt used properly can be a great vehicle. But I use it very sparingly because part of the appeal of passive income has always been to not worry about money. Being insanely leveraged tends to have the opposite effect. Hence, I am optimizing for sleep here.
Build a low-effort income flywheel
Last but not least, this is my favorite strategy. I still work and earn an "active" income. That means I don't need any of the proceeds from my low-effort and passive income streams. Instead, those just get invested in buying more, mostly passive assets. Let's say I make $100k of low-effort income per year. I pay my taxes and then use the rest to buy Vanguard ETFs. This way, the pie always gets bigger with time. And as it does, I can choose (or not) to depend more on passive income rather than low-effort.
I hope this was helpful.
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