The basics of personal finance can be summed up in less than 10 words: Spend less than you earn and invest the difference.
“Spend less” and “earn more” are two sides of the same coin. Two different approaches to creating a surplus.
When it comes to spending less, “big wins” involve getting your three main expenses of housing, transportation, and food under control.
So what are the big wins when it comes to earning more?
You might think that it involves crossing some arbitrary income milestone, but you’d be wrong.
The biggest win in income generation is divorcing how you spend your time from how you make your money.
Ultimately time, not money, is your most valuable asset. When you’re young you freely trade time for money. This makes sense because you have a lots of time and no money. Eventually, the tables turn. You start to use money to buy back your time. The biggest example of this is retirement.
At the end of your life, you’ll wish you had more time, not more money.
But of course, to live in society, you need money. This post exists to help you untangle a tricky conundrum. You want more money. You want more time. How do you pursue both at the same time?
Passive Income vs Active Income
Put simple, active income is income that requires an ongoing commitment of time and energy. Passive income doesn’t.
Almost all jobs require an ongoing commitment of time and energy and are therefore active income. The easy way to see this is that your pay is based on time. Most people either get paid by the hour (a wage) or by the year (a salary).
In order to switch from active income to passive income, you need to make the leap from worker to owner.
The workers are the ones who make everything happen. The owners are the ones who benefit the most with the least effort.
What are some things you can own to make you money? Here are a few examples:
- Shares of companies (stocks)
- Real estate
- Your own business
- Digital Assets
You might have noticed that the first three are the same as the three ways to become a millionaire (without getting lucky). That’s not a coincidence. The fourth is really just a sub-strategy within owning your own business.
We’re going to go over all four, but first let’s step back and look at the big picture.
Investing Your Resources
The way to own assets that make money for you is to invest your resources.
Remember, you have two main resources that we’re concerned with: Time and money.
Time is a bit of an interesting resource. You can’t “save” time like you can save money. If I save $10 by finding a good deal, I can put it in the bank and use it whenever I want. If I save 10 minutes by doing a task more efficiently, than 10 minutes passes in…well, 10 minutes.
This means that there are essentially three things you can do with time:
- Waste it: This is when you engage in activities with nu current or future payoff such as mindlessly scrolling on social media
- Spend it: This is where you trade time for some benefit, for example trading time for money at work
- Invest it: Practicing delayed gratification as you use your present time to set up a future benefit
When it comes to creating passive income, you want to invest your time and money. Chances are you know about investing your money, but you can also invest your time into creating something you can sell besides time.
Let’s break down how you invest your two resources to create passive income.
Passive Income Through Stocks
While there are other assets you can buy that can provide an income, stocks are an asset class that have provided fantastic returns over time.
The main advantage is of stocks is that the time commitment is extremely limited. It basically amounts to spending a few hours figuring out what you’re doing when it comes to investing.
To get started with stocks, you need to:
- Learn the basics
- Understand why index funds are so powerful
- Minimize your cost
- Think about your asset allocation
In the beginning, you can even get by without mastering that last one. While asset allocation becomes crucial in the later stages of investing, it’s not a big deal when you have little capital invested, a long time horizon, and are making regular contributions to help smooth the ride.
The lack of direct time commitments is a huge advantage when it comes to passive investing. The disadvantage is that it takes money to make money. So indirectly, investing requires whatever time commitment is necessary to get the money to invest.
It’s impossible to know for sure how much money it will take to never work again. But the 4% rule suggests that if you can save up 25x your annual expenses (e.g. your annual spending is only 4% as big as your portfolio), you’ll probably be fine living off your investments.
Passive Income Through Real Estate
When I talk about real estate, I’m not talking about owning your own home. I’m also not talking about flipping houses.
I’m talking about buying and holding rental properties.
This approach is a bit of a combination of an investment in time and money. It takes money to buy properties. It takes time to manage them. But when it comes to real estate, there are strategies to help you limit these inputs.
Real estate is one of the best places to leverage debt to help you get ahead. You don’t need the money to buy a property, you just need enough to close on one. Yes, you’ll owe a mortgage to the bank, but the tenants will pay this down for you.
If you did everything right, the rent you charge will cover all your expenses, build you wealth as the principal on your mortgage is paid down, and provide you with a monthly cash flow.
You can also outsource a lot of the work involved with managing properties. There are companies that will take a cut of your earnings in exchange for marketing the property, screening tenants, scheduling maintenance, and other administrative tasks.
While investing in your own house is not actually the way to get started with real estate investing, it can be with a creative solution called house hacking. Essentially, you just find a way to turn part of your residence into a rental.
Passive Income Through Starting a Business
Here’s the downside of starting a business: A business that requires you to operate is just a fancy job.
But the upside of a business is that if you can get it to the point where it can run without you, you get the profits without needing to keep putting in the work.
It might sound intimidating to do this, but the key is to start small. Start making money. Start making sales. Then figure out how to scale. Then figure out how to operate.
This isn’t something you do with a fancy business plan. Most business plans don’t survive their first contact with the market. This is something you do by taking action. By experimenting. By starting small and seeing what works.
Since we are talking about divorcing time from income, I love to think about how to leverage the internet to help us make money. The internet has the unbelievable power to connect you with customers and to automate tasks that you you would have had no chance of automating 30 years ago.
That brings us to our next category, really just a sub-category of this one: Digital assets.
Passive Income Through Digital Assets
What is a digital asset? Well, this blog is a good example. So is a YouTube channel. Or a podcast.
The idea is that I own this blog, and the blog has the potential to earn money. Any money it earns, it earns for me.
When it comes to making money from a digital asset, there are two main things to think about:
- Attention acquisition
In other words, you need to get peoples’ attention, the convert that attention into revenue.
There are a few ways to go about attention acquisition, but here’s the most powerful formula:
Content creation + time = traffic
In other words, you need to create enough valuable content for your digital asset to actually be useful to people and to let enough time pass for word of mouth to spread or for Google to acknowledge your site’s value.
I’ve often used the example on this blog that a website with one post is virtually worthless (to both the reader and the writer), even if that post is quite good. A blog with 10 posts is more valuable, but one with 100 is more valuable still.
The more content you create, the more value you offer to the reader (or listener, or viewer).
Of course, it takes time to create a large body of content.
It also takes time for people (and search engines) to acknowledge that you exist. When you first start out, literally nothing differentiates you from the hundreds of millions of amateurs who have started a blog and then quit before their hundredth post.
By the time you post your hundredth post, that feat alone by definition separates you from the masses who quit.
This will be the 103rd post on this blog and I only just started to see a trickle of traffic from Google after two months and 55 posts.
As it stands right now, only a handful of the first few articles that I wrote rank on Google.
But that will change. The more time that goes by and the more posts I publish, the more I will start to see my articles rank. Eventually the result will be a flood of traffic.
Once you build the attention of an audience, you need a way of converting it into revenue.
Essentially, there are five main ways of doing that:
- Advertisments: Sell your audience’s attention
- Affiliate Marketing: Sell someone else’s stuff
- Products: Sell your own stuff
- Donations: Sell your mission
- Subscriptions: Sell access
You can choose one, or dabble in them all.
The long term plan for this site is to use ads as the primary monetization vehicle. If you’re reading this in the future and there are ads, it worked. If you’re reading this and there are no ads, check back later.
I have a sort of love/hate relationship with ads. On the one hand, ads are annoying. On the other, they’re the most passive way to monetize, and the only one your audience isn’t paying for. Those two benefits seem worth the mild inconvenience.
The Power of Digital Assets
It takes a long time for digital assets to become profitable. But once they are, they work around the clock to make you money.
Once I have a ton of articles that rank on Google, my articles will start making money through display ads every day regardless of whether or not I do anything.
Sure, the flood of free traffic will eventually run dry if I don’t do anything ever again, but at a certain point I will have successfully severed the link between spending time and making money.
The money I make will be a function of the value of the asset I created, not of how much time I spend working.
This is the real test of passive income: Can you make money while you sleep?
Short Term Sacrifices For Long Term Prizes
If there were ever a tag line for personal development it would be this: Make short term sacrifices to win long term prizes.
That’s the whole game when it comes to personal growth. It’s also the whole game when it comes to passive income. Don’t spend all your time. Don’t spend all your money. Invest your time and money into systems that divorce how you spend your time from how you make your money.
Like anything good, these strategies work via compound interest. Your early efforts produce no visible results. But over time with consistent effort the results stack up like magic.
For me, the short term sacrifice is waking up early to publish a blog post every morning. I’m drinking my own kool-aid and making short term sacrifices to win long term prizes. I didn’t want to get up this morning, but I did. and if you’re reading this, my 103rd post is officially published.
Hopefully this post has given you ideas of how you can make short term sacrifices to win long term prizes. When the prize is passive income, it’s worth the sacrifice of getting up early.
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