Building Or Buying? The Only Two Ways To Produce Passive Income

Understanding Passive Income
Passive income is the only way to create a truly financially free life. I learned this lesson early from 'Rich Dad, Poor Dad' as many of us have. Robert Kiyosaki teaches us that the goal for financial freedom is to get out of the “rat race.” To do that you must have more passive income than monthly expenses. That way you will receive enough to pay all your bills without the need to work. Sounds easy, right?

Defining Passive Income vs. Residual Income
Before we get into the only two ways to produce passive income, let’s define what passive income is. Many investors confuse passive income with residual income, which could be the same but is often very different.

What is Passive Income?
Passive income is earning money without any of your effort. Often referred to as “mailbox money” because it will show up in your mailbox whether you went to work or not. There are many low-effort investments that produce income that is often confused for passive income. Rental property, for example, but true passive income is zero effort. The money will be there without work, effort, decisions, or stress.

What is Residual Income?
Residual income has different meanings depending on the context. In business, this is income that can be relied on. Rental property is a great example of this because after subtracting for vacancies and maintenance, there is a reasonable expectation of income. Businesses that produce residual income in this context are more valuable. Examples include management companies, software companies, franchisors, or any subscription-type service like Netflix, Apple Music, subscription food services, or gyms. Businesses with little residual income rely on transactions, such as realtors, flippers, or fee-based lenders.

In personal finance, residual income is the income you have left over after all your expenses are paid. If you make $5,000 a month in active and passive income and have expenses of $4,000, you have residual income of $1,000 per month.

Building vs. Buying Passive Income
Obviously, it is great to have high passive and residual income. The more residual income that is invested for passive income, the faster you will get out of the “rat race.” Here are the two ways to generate your passive income and achieve a life of freedom.

Building Passive Income
As we start our careers and our pursuit of freedom, we may not have a ton of money or residual income to invest. In that case, you only have one choice: build your passive income. This simply means putting in your effort upfront to create something that will produce income with no further effort. Normally this means starting a business of some kind but could include creating or inventing something that people will pay for. Maybe you have an idea that can solve a problem, a book you want to write, or a song that you could write or produce. 
Maybe star in a movie?

Buying Passive Income
Building passive income can have a huge upside but is also hard and could come with a high degree of risk. A far easier approach is to put in effort for money, which could be as simple as wages from an employer, and then use the money to buy your passive income. If you invest your residual income into passive income-producing assets, you will generate more passive income. Continue to do that, and you will experience compounding and accelerated growth.

Best Investments for Passive Income
I understand real estate well, so I tend to lean toward real estate-backed assets to generate passive income. This includes investing in other people’s projects, land leases, tax liens, private lending, or investing in a mortgage fund like ours. There are more traditional investments that will work also, such as high-yield savings accounts, bonds, dividend-paying stocks, and annuities. Each investment comes with different return expectations and risks, so it is important to look at many options and diversify.

The Role of Rental Property
I know I mentioned that rental property is not a passive investment, which is true, but that does not mean it is a bad investment. Quite the opposite. I think real estate is one of the best investments you can make. It is relatively safe, with multiple ways to increase returns, and is a great way to accelerate your financial freedom.

A Successful Strategy for Financial Freedom
A strategy I have seen used with a high likelihood of success is to own real estate while you are accumulating assets and, when ready, sell them and invest the proceeds into assets that no longer require your effort. Alternatively, own some rentals and invest in passive real estate investments for income today and to help diversify a portfolio. Either way has proven to be an effective plan to financial freedom.

Support on Your Path to Financial Freedom
Because we help both active and passive real estate investors, please let us know how we can support you on your path to exiting the “rat race.”

By Kevin Amolsch, Short Term Lending Expert, info@pinefinancialgroup.com pinefinancialgroup.com