Thursday, December 13, 2018

Is Passive Income Just A Fluff?

How easy it is to create passive income in our life so that we don't have to depend on our active income anymore? To be honest, it takes time and its not easy but its possible if we take one step at a time. Many years back, when I first got to know the concept of financial freedom and creating passive income, I was inspired and motivated to achieve it. However, after awhile, reality sets in and I realise its not as simple as it seems. There are some lessons which I learnt over the years which I thought will be good to share in this article.

Is Passive Income Just A Fluff?

Passive income is money earned even when we are not working on it while active income is money earned through exchanging it with time. All of us have jobs to earn money for our daily living. We use time to exchange it with money. It may be 8 hours or 10 hours a day. While passive income also requires time to build, the time spent is not fixed to certain hours and more often than not, the time spent to create passive income should be much lesser than active income.

Passive income can come from dividends from stocks, rental income from property, online marketing etc. I've seen people who actually have more than enough passive income to sustain their lifestyle without depending on their active income. This is achievable but what does it take to achieve it? Let's look at dividends from stocks as a form of passive income first.

Dividends from stocks as passive income

One of the most common form of passive income is dividends from stocks. There are people who are already getting a few thousand dollars from dividends every single month on average. This is like getting a salary every month without going to work. However, when we look at their stocks portfolio, it is often at least $500K or more.

A $500K stocks portfolio with 5% dividend yield will generate $2083 in dividends per month. This most likely will not be enough for a family to get by, so to depend wholly on dividends to sustain our lifestyle, we will need a $1 Million stocks portfolio. This is the reality which we need to accept and then we can work towards this target step by step.

Rental from properties as passive income

The next common form of passive income is rental income from properties. In the past, people who bought properties at a low price and rent it out are earning good passive income from their properties now. Because of the low price back then, those who bought good properties will most likely get quite a good positive cashflow even after paying their property loans.

If you've read the book "Rich Dad Poor Dad", you'll learnt that properties need to generate positive cashflow for it to be a good asset. Assets put money in our pocket while liabilities take money out of our pocket. Nowadays, its getting harder to generate positive cashflow from properties in Singapore as price is high and rental is not as good anymore. Also, with multiple government cooling measures, it makes it even more difficult to invest in good properties now. Yes, we can still earn money from renting out properties but the yield may only be a low of 3%-5% per year.

How to start creating passive income?

Focus on active income and saving more first

We need capital to create passive income, the more the better. with $10,000, there is only so much passive income you can create out of it but with $100,000 or $500,000, the passive income we can create is much greater.

Building active income requires time and effort but the more we earn and save, the faster we can create more passive income for our future. Active income will always be lower at the start of our working life and only increases as we get more experience and upgrade our skills. I'm in my 3rd job now and have made a conscious effort to plan and upgrade my skills in order to earn higher income.

Start small in building passive income

We have to start somewhere in building passive income no matter how small it is. Even when I just had $10,000 savings, I started investing in stocks. The dividends I get is probably only less than $50 a month back then. Starting small is important as we will make mistakes and earn along the way. Its better to make small mistakes at the start, losing a bit of money, than losing a lot of money when we start investing only when we have more money.

Back then, losing a few thousand dollars in the stock market seems like a lot of money to me when my savings were little. It forced me to learn the hard way and get better in investments. Thinking back, if I had started investing when I had more money now, my losses could have been tens of thousands.

Make the passive income sustainable

The key to building passive income is making it sustainable. This can only be done over the years by building a strong foundation. Finding the right stocks to invest in which has sustainable dividends is important. This requires some research and monitoring to be done. For example, when investing in REITs, we have to look at the location of properties it has, the industry it is in, the dividends track record, the rental reversion and many more. All these will help us determine if the dividends given out will be sustainable.

Even for investing in properties, if we bought the property at a bad location, we may not even get enough rental income to cover the loans we have to pay. It requires some homework to do the math and get our sums right before investing in it.

Creating Passive Income Instead of Active Income - How Easy It Is?

Creating passive income takes many years to build. It may take 10 years, 20 years or even 30 years to create passive income which can sustain our lifestyle indefinitely. We can start small, work towards a goal and see it happen before our eyes in the years to come.

After years of increasing my active income, I've made myself more busy and I realised time is always not enough if I continue creating active income. There is a limit to how much active income I can create or increase. Even with a higher salary, it often comes with more work and many more hours spent on the work itself. With this, I would be shifting my focus more towards creating passive income again for next year.

Its not a difficult task to create passive income but it definitely takes patience and sone work to see it being fulfilled.

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  1. "if I had started investing when I had more money now, my losses could have been tens of thousands"

    If you have a portfolio of a million or hundreds of thousands, you need to be comfortable with paper losses of tens of thousands, or even hundreds of thousands especially during bear markets. Important to have sufficient emergency funds & sufficient amount of cash/safe bonds, so that mentally can stay the course & also dry powder to buy good assets at big discount.

    1. Yes i agree. Have to always plan ahead and prepare for the worse in investing. Never invest money we cannot afford to lose.

    2. Passive income for freedom. Good article my friend.