How To Build Passive Income For Financial Independence

Yellow Leaf MacroCreating genuine passive income is the holy grail of personal finance. Not all passive income is created equal mind you. Some streams take much more initial effort to start, such as saving enough to buy your first rental property. But once you start it’s very difficult not to gain momentum.

Everything passive first takes active energy. The time to put in the effort is when we are young and not ravaged by disease or burdened by family obligations. I remember being able to snowboard from 9am until 4pm every day for a year. Now, I’m lucky to last from 11am until 2pm without wanting to go to the hot tub and drink a bucket full of beer! If we can appreciate how lucky we are when we are young, we’ll be able to maximize our vitality and live financially freer when we are older.

With sustainable passive income you can do the following:

* Retire early and travel the world.

* Start a business in a field you are passionate about.

* Find a job that pays less, but is more interesting.

* Stay at home to take care of your family without having to worry about money.

* Volunteer for causes you truly care about.

* Be a big brother or big sister.

* Spend more time with your parents.

* Sit in a coffee shop on a 80 degree day in Paris for hours on a Wednesday afternoon.

* Write the next great novel on the balcony of a cruise in the Mediterranean.

* Eat tapas and drink sangria until 1am on a Monday evening.

* Potentially live longer due to much less stress.

* Experience perfect endless summers over and over again.

There is so much you can do once you generate enough passive income to pay for all your living expenses. I highly encourage everyone to at least try. This post will provide you the framework for passive income success. I’ll also provide an update on my estimated 2013-2014 passive income streams which have grown since retiring in 2012.

THE PASSIVE INCOME FRAMEWORK

1) Save Like Nobody Owes You Anything. Passive income starts with savings. Without a healthy amount of savings, nothing works. Your overall “Money Strength” will be an F- if you do not build a financial nut. In our current low interest rate environment, you must save even more than before. It’s important to also realize that the savings I am referring to is AFTER-tax savings. You need to save money after contributing to your 401k and IRAs since you can’t touch pre-tax retirement accounts without a penalty until 59.5. Ideally everyone should max out their pre-tax retirement funds first, but if you don’t have enough funds and want to retire earlier then a decision to have more accessible post tax money will still work.

What I did: Saved 50-75% of my after tax, after 401K contribution every year for 13 years because I knew I could not last in finance for more than 20 years. Now I am saving 100% of my passive income as I try and bootstrap my online businesses.

2) Find Out What You Are Good At. Everybody is good at something, be it investing, playing an instrument, playing a sport, communications, writing, art, dance and so forth. You should also list several things that interest you most. If you can combine your interest plus expertise, you should be able to monetize your skills. A tennis player can teach tennis for $65 an hour. A writer can pen her first novel. A finance buff can invest in stocks. A singer can record his first song. The more interests and skills you have, the higher chance you can create something that can provide passive income down the road.

What I’m doing: I love to write and invest. Combine these two interests with my ability to get things done equates to multiple investment types and this personal finance site. I understand why some writers go crazy. There’s so much information in my head that I need to write it down or else I might explode.

3) Create A Plan. Mark Spitz once said, “If you fail to prepare, you’re prepared to fail.” You must create a system where you are saving X amount of money every month, investing Y amount every month, and working on Z project until completion. Things will be slow going at first, but once you save a little bit of money you will start to build momentum. Eventually you will find synergies between your work, your hobbies, and your skills which will translate into viable income streams.

What I’m doing: I use this site to write out goals 1) Generate $200,000 a year working 4 hours a day or less, 2) Predict the future to try and make winning investments, and 3) Keep track of my passive income streams. My site and the community helps keep me accountable for progress. It’s important I do what I say, otherwise, what the hell is the point? You should consider starting a site or at least a private journal. Write out your specific goals, tell several close friends and stick to the plan.

4) Treat Passive Income Like A Game. The only real way to begin your multiple passive income journey is when you are making active income. The initial funding has to come from somewhere. Hence, treat passive income as a game that has various levels. If you fail to achieve one level, it’s not the end of the world since you still have active income and can restart. Furthermore, a game is meant to be played with integrity. Using shortcuts (non passive income streams), someone else’s income as a supplement (spouse), or one-offs (capital gains) does not count. The primary purpose of any game is to bring enjoyment to the player and beat the boss.

What I’m doing: I view passive income as funny money to keep myself sane during this long journey. I estimate 2-10 years to get to my goal depending on how active I am. The dollars created are just points one can accumulate. I’ve made passive income goals for each passive income type and check in at least once a year like I am now to make sure I’m on track. Passive income is also carefully managed to minimize tax liability. When you can build a buffer for a buffer, you are then free to take more risks.

5) Determine What Income Level Will Make You Happy. Think back to when you made little to no income as a student. Now think back to the days when you just got started in your career. Were you happy then? Now go over every single year you got a raise or made more money doing something else. How did your happiness change at all, if any? Everybody has a different level of income that will bring maximum happiness due to different desires, needs, and living arrangements. It’s up to you to find out your optimum income level.

What I did: I first identified my favorite places in the world to live: San Francisco, Honolulu, Paris, Amsterdam, New York City, and Lake Tahoe. I then looked up the median rent and housing prices for each city. Then I factored in private education costs for two kids to be conservative given I may not have two kids and public schools are often good enough. After calculating all vital costs, I then did a self-assessment of how happy I was making $50,000, $100,000, $150,000, $200,000, $250,000, $350,000, $500,000, and $750,000. I decided working 20 hours a week making $200,000 a year is the best income balance for maximum happiness. 

6) Always Remember That Everything Is Relative. The best way to determine worthwhile passive income streams is by comparing the likely return (IRR) with the current risk-free rate of return. If I round up, the 10 year bond yield is at 3%. Any new venture should thoroughly beat 3% otherwise you are wasting your efforts since you can earn 3% doing nothing.

What I’m doing: My realistic goal is to have a blended annual return of 2x the risk free rate. With a current 6% hurdle, I am not paying down mortgages that cost less than 5%. Debt at 6% is a wash. My realistic blue sky scenario is a 3-4X rate of return over the risk free rate which can be achieved with property, stocks so far for the past five years, and certain private equity investments. Where I am dragging is my blended average CD interest rate of roughly 3.75%. It’s guaranteed money, but one of my biggest goals is figuring out how to reinvest this large nut starting in the next two years.

7) Never Ever Withdraw From Your Financial Nut. The biggest downfall I see from people looking to build passive income is that they withdraw from their financial nut too soon. There’s somehow always an emergency which eats away at the positive effects of compounding returns. Make sure your money is invested and not just sitting in your savings account. The harder to access your money, the better. Make it your mission to always contribute X amount every month and consistently increase the savings amount by a percentage or several until it hurts. Pause for a month or two and then keep going. You’ll be amazed how much you can save. You just won’t know because you’ve likely never tested savings limits to the max.

What I Do: I’ve set up multiple investment accounts outside my main operations bank that deals with working capital e.g checking, paying bills. By transferring my money to Fidelity, E*Trade, and two other banks as soon as it hits my main bank I no longer have temptation to spend on frivolous things. As a result, I can wake up 10 years later and reap the rewards of compounding. My 401(k) is the best example where constant contributions over 13 years has grown to almost half a million without any savings pain given it just became a part of life. Real estate is also a fantastic asset class for the long term. The transaction costs make trading inefficient. Sooner or later, your financial nut will grow large enough that it spits out difference making income. Once you get to that level you will be more inclined to save more. It’s like finally seeing results in the mirror after working out. There’s no going back to flab.

8) You Must Force Yourself To Start. “A Journey Of A Thousand Miles Begins With A Single Step.” Laozi was a great philosopher who penned this popular English translation. Everything great started somewhere and you must set aside one day to tackle your financial independence goal. Circle the date on your calendar and cancel all other distractions. Although starting is most difficult, once you do the inertia of your efforts help carry you forward. If you understand Chinese, his exact words are: 千里之行﹐始於足下 (Qian li zhi xing, shi yu zu xia). Action arises from stillness.

What I did:The first two years of work in NYC was brutal. I told myself there was no way I could work on Wall St for my entire career because I’d probably die from heart failure by age 40. Having an early death in my mind willed me to save 50%+ from the first year onward and devise a CD, real estate, and stock investment distribution system for my savings every year. I thought about starting this site for at least a year before I hired someone from Craigslist to give set me up and push me forward. Hiring someone to get started is totally worth it if you are a master procrastinator. Failure is a part of life. I’d rather fail a hundred times and learn from my mistakes than never try at all. Whenever I’m fearful of trying something new, I remember back to my youth when I did not ask a girl out or when I didn’t try out for the varsity basketball team. These two things might sound silly to you, but to me, I use them as reminders to stop being chicken shit. Embarrassment, failure, and loss of money is much better than regret.

PASSIVE INCOME SNAPSHOT

The below is my latest estimated passive income streams. I consider interest, dividends, rental income, and royalties as the only passive income streams.

FS Passive Income 2013 Estimate

* I use Personal Capital to track all my finances in one place. It’s much easier to use their free software to follow 28 accounts on one platform than to log into various accounts to check my balances. The financial nut that can be assumed from this income stream is roughly $3.15 million dollars if you take $110,216 divided by a blended net annual return of 3.5%. I’m very focused on stable, low risk returns.  To get to $200,000 a year in passive income at 3.5% means I need to grow my financial nut to roughly $5.7 million. The passive income stream excludes my online active income which itself has a business value as well as private equity investments which do not pay any income. 

CD Interest Income: The reason why there are so many CDs is because I’m a rate seeker. Banks are always offering different promotions and it’s up to us to move our capital accordingly. My six CDs have been the same for the past several years because they are all 7-year term CDs yielding between 3% to 4.2%. The last one was taken out two years ago. Every year the CD portfolio grows by over $30,000 meaning I get an additional $1,000+ in interest income a year due to compounding. I plan to only renew my CDs if I can find a 7-year yielding CD for 3% or higher. Capital One 360 with no fees has an interesting savings program with an APR of about 0.75%. I like how I can fund excess liquidity by just linking my checking account.

Dividend Income: The S&P 500 grew another ~20% while dividend payout ratios held steady or increased. As a result, my like-for-like dividend income has also grown by around 20%. The financial sector gained roughly 28% in 2012 which is especially good since I have a lot of deferred stock in my old financial firm. I think dividend income will continue to grow given public companies have record cash on their balance sheets. They need to either mobilize their cash through investments, or return cash to shareholders in the form of a buyback or dividend payout increase.

I invested a large chunk of change in several structured notes in the summer of 2012. The yield to maturities range from two years all the way up to six years. The structured notes are a way to play the upswing in the stock markets while providing downside protection. For example, a large investment was in a Dow Jones structured note at 12,400 that provides 100% downside protection, 115% participation (15% outperformance kicker), but only a 0.5% dividend yield vs. a market dividend yield of around 2%. I’m happy to give up 1.5% in dividends per annum for six years to ensure my money will be there when the note expires.

Finally, I still believe for those who are in the earlier stages of their investment careers to focus more on growth stocks vs. dividend stocks. It’s all about building a large enough capital base so you can generate large enough dividend income. If you’re a 30 year old and buying Walmart and Coca Cola, you’ll probably do OK in the long run, but you aren’t going to see huge outsized growth because these companies are already quite mature. My main goal in investing is capital appreciation and not dividend income at this stage. 

Real Estate: This is where things got really good and why I continue to love real estate. I was able to get a free loan modification for one of my vacation properties out of the blue in January 2013 that lowered my payment by $670 a month. Meanwhile, HOA expenses declined by $80 a month, yielding $9,000 a year / $750 a month in extra cash flow. The other good news is that rents have gone up by roughly 5% on this specific property. I also raised my main rental property’s rent by 11% and my other rental property’s rent by 4%.

Other: It took me four months of absolute focus and two years of data to publish my first e-book, How To Engineer Your Layoff: Make A Small Fortune By Saying Goodbye last summer. The book went through over 30 revisions by four people. The second half of 2012 was my testing period to get feedback from readers and fix any mistakes. The distribution channel is only here and through a couple affiliates. For the next 12 months, I plan to reach out to at least 10 new relevant sites to write guest posts or do book reviews. Income should continue to grow given there is no other book out there that teaches you how to profitably quit your job by negotiating a severance package. For those of you who write good content in the Career or Lifestyle categories, I encourage you to sign up and become an affiliate via e-Junkie.

In the fourth quarter of 2012, I also started investing with Prosper.com. I’m starting slow given I’ve got a year before my first CD rolls off. I look forward to generating realistic 5-8% returns vs. their advertised 9%+ returns. If I can gain the confidence in putting my entire CD allocation into P2P lending, such passive income could double to over $60,000 a year.

MAKING UP FOR THE DEFICIENCY

Hopefully my passive income chart provides you with a good snapshot of how various passive income streams can really add up over time. As part of the passive income framework section, I set out a goal to make $200,000 a year working four hours a day by December, 2015. In twelve months, I was able to grow my passive income stream from ~$80,000 to ~$110,000.

Part of why the goal is $200,000 is because $200K used to be the income threshold where the federal income tax rate would increase to 36%-39.6%. Add on 10% California state tax and other taxes and I’d be paying over 50% of every non dividend dollar I earned to the government. No thank you! Thankfully, Washington DC compromised with a $400,000 income threshold. $200,000 a year should be enough to comfortably live anywhere in the world.

Despite the passive income increase, there is roughly a $7,400 a month / $90,000 a year passive income deficiency. Below are some thoughts on how to achieve my goals.

Allocate CD Income To P2P Lending: P2P lending returns should be able to return 5-7% in a relatively low risk way. Take a look at the various interest returns by credit score and borrower rating in this post. I’m comfortable starting off with $10,000-$20,000, but I don’t have the guts to invest hundreds of thousands of dollars yet. However, if I study P2P lending over the next two years, perhaps I will have the confidence to at least lob $250,000. The $250,000 would see a roughly $8,500 incremental annual income increase if I could get 7%. I recommend starting off with $2,500 and 100 notes average $25 a note for diversification. Build your portfolio as you gain more confidence.

Continue To Raise Rent & Refinance: Real estate truly is my favorite investment asset class. Unfortunately interest rates have ramped higher by 1% from its 2012 lows so I probably won’t be refinancing for a while. San Francisco rents grew by 15% in 2012 and I expect them to grow by at least 7% in 2013 and another 7% in 2014 due to the surge in internet/technology business. Such rental increases will lead to $5,000 a year in additional income. Meanwhile, my mortgage interest payments continue to go down by an estimated $42,000 a year as principal gets paid down, leading to a total positive swing of $7,000-$8,000 a year in profits. Put it another way, if I can pay off all my mortgages I will generate an incremental $42,000 a year in cash flow. If inflation picks up, then the figures should go much higher.

Book/Product Sales: I’m happy to sell 30-40 books a month at $48, but I’ve been thinking about raising the price since I think it provides so much value. How much would you pay to gain back your freedom and walk away with thousands, if not tens of thousands of dollars and do what you’ve always wanted to do? To me, freedom is priceless. But of course I’m biased about how good my book is and should also consider decreasing the price to see if there is elasticity of demand. I will continue to build up relevant articles about career development, severance packages, entrepreneurship, and so forth. I can see book sales double off this low base due to an increased effort in marketing, leading to an additional $18,000 a year in passive income. Maybe I’ll even write another book!

Municipal Bonds: I’ve been fearful of municipal bond funds for a while given what’s going on in Europe. Thankfully, muni bond funds have now gotten hammered thanks to a drastic rise in interest rates. I’m going to spend a good amount of time researching any laggard muni bond funds with tax free yields of 4% or greater. If I can allocate a third of my CD money in munis, I might should be able to easily beat a 4% gross return (2.8% net at a 30% tax rate) since muni bonds are tax free and regularly yield over 4%. Muni bonds could generate an incremental $5,000 a year, however, I could also easily lose principal value.

So far, I’ve come up with a realistic way to generate roughly $33,500 – $38,500 a year in additional passive income in two years. Unfortunately, I’m still $55,000 short of my $200,000 a year passive income goal! I’d like to continue keeping my estimates conservative in nature because it’s better to end up with too much than too little.

WHAT ABOUT OTHER INCOME STREAMS?

As part of the Passive Income Framework section, we are playing the game with integrity. It’s no fun beating the Big Boss with a cheat code or super weapon that annihilates all enemies with one click of a button. The goal is to develop income streams that keep rolling in if we do nothing at all!

Income streams that don’t count:

* Capital gains: Unless you can repeatedly sell stock for profit, capital gains is a one off item. It’s just as easy to lose money in the markets as it is to make money, so stop pretending like you are Warren Buffet.

* Freelance writing: Quality freelance writing takes tremendous effort. Ironically, the better the quality of your writing, the more you don’t want to freelance and just keep the articles for your own site. Freelancing is a great way to earn side income, however, it’s not really for me. I’ll probably take on one or two freelance jobs maximum per year and write no more than four articles a month elsewhere.

* Financial Consulting: $1,250 for the FS Steele Package requires hours of preparation before the three calls and hours of preparation after the call to make sure there is follow through. Furthermore, a client gets five comprehensive e-mail consultations in between sessions which takes time as well. Consulting is very rewarding because there’s nothing better than helping someone understand things. It just takes a lot of preparation because I want to give the best, most tailored advice to my clients as possible.

* Selling anything: If I decide to one day sell my Roberto Clemente rookie card for $800, I’m not going to include this in my passive income streams because I’ve only got a couple of them. Same thing goes for selling a watch or electronic device.

* Blogging: This 4,259 word post has taken around eight hours to write with a dozen revisions just while I’ve been in Mexico alone! Content does not magically appear out of thin air as some might believe. It takes a tremendous amount of effort, consistency, and creativity to come up with helpful and interesting content. The only people who really appreciate how much it takes to be a blogger is another blogger, not even a freelancer. We’ve got to take pictures, edit, market, build a brand, guest post, and network. Compare this with our journalist friends at any other major media publication who get to write assignments, submit and be done with.

It’s easy to get lazy if we do not compartmentalize our income streams. We must be honest with our income streams so our income can be honest with ourselves.

PLAN AND START ALREADY

“He who fails to plan is planning to fail.” Winston Churchill

If I didn’t have a plan, I wouldn’t know what passive income level to shoot for nor would I have a clear idea of what I need to create or where I need to optimize. With all my accounts tracked in one place, I know exactly what I must do to achieve my goals. It’s taken me 14 years to get to my current passive income stream. As a result, it may be somewhat optimistic to double my passive income in just two and a half years. That doesn’t mean I’m not going to try because it’s much easier to make money once you’ve built that financial nut.

It’s important to avoid the temptation of spending your nut while you’re young and full of hope. It’s like eating your golden goose for short-term pleasure. I promise you that 10 years from now you will be absolutely grateful for the financial steps you take today.

Recommendation To Help Achieve Financial Independence

One of the best ways to build wealth is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts on their Dashboard so you can see where you can optimize. Before Personal Capital, I had to log into eight different systems to track 28 different accounts (brokerage, multiple banks, 401K, etc) to track my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing, how my net worth is progressing, and where my spending is going.

One of their best tools is the 401K Fee Analyzer which has helped me save over $1,700 in annual portfolio fees I had no idea I was paying. You just click on the Investment Tab and run your portfolio through their fee analyzer with one click of the button. Their Investment Checkup tool is also great because it graphically shows whether your investment portfolios are property allocated based on your risk profile. Aggregate all your financial accounts in order to get a good over view of your net worth and start building those passive income streams! It only takes a minute to sign up.

Regards,

Sam

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

You can sign up to receive his articles via email or by RSS. Sam also sends out a private quarterly newsletter with information on where he's investing his money and more sensitive information.

Subscribe To Private Newsletter

Comments

  1. says

    I learn so much reading these articles but it reminds me how much of a mess I am in financially. Now the questions.

    1) Can you just raise the rent whenever you want? We have restrictions in Canada.

    2) We have GICs which are very similar to your CDs. How often do your long term CDs pay the interest? My one little GIC pays on the maturity date.

    3) The only terms I can get ok interest rates on GICs/CDs are 5 year terms. Do you feel anxious about tying your money up for such long periods of time when other opportunities may arise.

    • says

      Hi Jane,

      To answer your questions:

      1) If your property is not under rent control, you have the ability to raise rent to market prices with proper warning. In SF, I have to give tenants a one month warning for up to a 10% increase and a two month warning for up to 60%. Rent control limits to an inflation index, usually around 2% a year, which is why initial pricing and tenant turnover is important for better profitability.

      2) CC interest can be paid monthly, quarterly or annually based on what I’ve got. Sounds like you have a “bullet” payment where all interest is paid at end of term.

      3) I don’t feel anxious tying up my money. Instead, I feel relieved. I don’t like having excess money to waste on things. I can’t anxious when I have too much money earning 0.2% savings interest. The feeling of having little money gives me motivation to try harder in my ventures. It’s too easy for me to fall off the wagon and go on a bender.

  2. nbsdmp says

    Awesome article…if this does not give somebody a clear roadmap, they probably were never going to get there in the first place! I’m kind of like you trying to figure out where to place “new” money and maturing CD’s in this low interest environment. Rates have to go up eventually…I dream of the days again where you can build a laddered bond portfolio paying 8%. I plan for a 5.5% blended rate of return, with big downside protection.

    • says

      5.5% return with good downside protection would be a great return.

      One of the things I’ve done is put a lot of capital to work in structured notes. One note I’m investing $20,000 today is a STOXX50 note that pays 5% per annum for two years if the STOXX50 doesn’t close down worse than 30% from here.

      • nbsdmp says

        I don’t really know much about those…I should take a look from a diversification standpoint. If you don’t mind me asking, what do you target for your net effective tax rate on your passive income? Also, I’m sure you’ve probably covered this somewhere, but how do you deal with healthcare? One more dumb question…have you found that you spend more or less money than you anticipated once you retired?

        • says

          As low as possible. The best is income from a business because of all the shields. To create a lifestyle business where you have to enjoy experiences, hopefully good to generate revenue is the pinnacle in my mind.

          Health insurance is pretty inexpensive, read http://www.financialsamurai.com/2013/03/08/cheap-health-insurance-options-for-the-unemployed-self-employed-or-early-retiree/

          Finally, you need less in retirement than you think to be happy. One also continues to adjust to his or her new income and maintain a happy state regardless of income above a certain subsistence point. I was very happy about this discovery.

        • nbsdmp says

          Thanks for the info…I kind of figured it is really not that expensive to live if you are not an extravagant person. I could definitely figure out how to funnel expenses through a part time business…I think I keep thinking along the lines that I’m going to be paying the same tax rate after retirement, but reality is you could get pretty lean and mean if one focused on it. On a scale of 1-10 with 10 being utter panic mode, how worried are you about your “pile” lasting through a 50 year retirement now that you are a couple years into it?

          • says

            I would say I’m at a 1 because this is only my passive income which I’m saving 100%. I’m working on some entrepreneurial endeavors and I might discuss active income in more detail next year. But I really am focused on trying to get my do nothing income to $200,000 so I can take even bigger risks while living in expensive San Fran or Honolulu.

            Not sure if I can live for another 50 years either! I understand that taking a leap of faith after earning a lot of money every year for years is scary. But I can truly say that we have a remarkable ability to adapt and grow if needed.

        • nbsdmp says

          o.k. I’m 100% with you…I save 100% of my passive income and probably 60% of my “salary”…so only question now is are you living on your online income only or consulting gigs? You mention $200k is your target…and you are at $110k passive, are you living off less now or is your other income stream enough?

          • says

            There’s another income stream that I didn’t mention in this article because it is finite, but it is my deferred income from severance. It is very meaningful and why I would like people to read my book and never quit.

            I’ll write another post on multiple income streams. But each persons living standards and cost of living is different so my numbers are probably irrelevant to yours. Best for you to figure out your numbers instead.

            Would you be interested in writing a post here and sharing your story and strategies? Would love to have it. You can just shoot me an email when it’s done. Thanks!

    • nbsdmp says

      I do remember you mentioning that & how it was your ticket to exit softly and give you time to build the passive income side. Most likely when I do exit it will either be through a sale of the business which would come along with a employment contract or if a worthy successor(s) can take it over, then the business is just another annuity throwing off income. Anyway, I’d enjoy writing a guest article after I survive the next few weeks of work and weddings.

  3. says

    Yes, I do enjoy these type of updates, so keep them coming!

    We are going to start working on passive income very soon. We do little things now, but not enough as to where it matters.

    • says

      OK, I’ll probably do an update once a year or so. At the very least it’ll help check progress.

      I encourage everyone to try passive income because eventually everybody tires of work. It’s a race to see if one can generate enough passive income before they get tired or some bad exogenous financial event happens.

  4. Laura says

    Great post, Sam. I like the idea of thinking of passive income as a game… the money in my accounts doesn’t feel like “real money” anyway since I won’t be touching it for some decades!

  5. says

    This is a great article. It nicely lays out where your money is coming from and how much each investment is producing. It would be great if you could write a complimentary article where you outline how much you have invested in each asset, that way readers could get an idea about ROI for each.

  6. says

    This one is the key for me – Never Ever Withdraw From Your Financial Nut. Well, I’m willing to withdraw when I’m 60. Why hoard all the money? You can’t take it with you. Share the wealth a bit.
    Some people are money magnet and you’re one of them. Great job and good luck making up the deficiency in a year or two. I don’t know if we will ever get close to your goal. Good luck!

  7. says

    And to think you wrote this while taking a break in Mexico. I do enjoy these type of update, lots of information to digest. I’m not focused on any major passive income streams at this time, as I continue to work on debt repayment. Hope to soon be working on more residual -passive income streams in the future

    • says

      Good luck with the debt repayment! It feels crazy wonderful to finally slay individual debt accounts. I wrote 70% of the post before my trip but did write the rest and edit the post a dozen times while on the ship. It’s fun and I’m a stickler for trying to get the content as thorough as possible. Typos abound no matter what.

  8. says

    Killer article here Sam.

    The reason it is so good is due to transparency. You are giving real numbers and sharing a huge part of yourself with your audience. Plus you went all out and gave a fantastic amount of detail. This makes for a really, really good post.

    You have inspired me to try to do the same (both with my finances, and with my writing). Thank you.

  9. says

    Amazing that you saved between 50% to 75% living in NYC…I think that is one thing holding me back…the cost of living here. I’d like to invest in real estate, but I can barely afford to buy a place to live. I don’t need a large income to be happy, but I probably do need an income to support living in NYC as we don’t plan on leaving. The only thing I’m doing at the moment is saving in my 401K, IRA and a I dabble in stocks and P2P lending.

    • says

      It was painful for the first two years. But living in a studio with another guy was like living in a college dorm room, so it wasn’t that bad. Worked a lot and finally escaped to SF after the second year. So hard to save in NYC!

  10. Jorge says

    Awesome article… Just wow..

    It’s loaded with information and definitely helps me use it as sort of a guide line during my planning process. Time to really get off my rear and do something!

    Please feel free to hit us with posts like this in the future!

    Thanks Sam!

    • says

      Hah! If only it was so easy to write these types of articles on a frequent basis! But I’m glad it helps you get motivated to start. That really is the biggest thing and second is to not fall off the wagon once you see your passive income fund grow.

      Maybe you’d like to write a post on your current financial situation and plans! Let me know. It’ll be fun to publish and get feedback from the community.

  11. says

    So many great tips in this big post, thanks! I think it’s so true that people should focus on the things they do well at and are interested in. And yes save, save, save in the beginning and throughout. I have several interest and dividend earning investments and am looking to expand further. Diversification is a great goal for all of us so we can avoid having all our eggs in one basket.

  12. B says

    I vote focus on real estate for increasing your passive income. It appears to be where you get your best returns, and that’s without building in speculative gains and tax savings. I practice real estate law and do all my investing in real estate, so I’m biased.

    I’m looking at accepting a professor job. It’ll be more than a 50% pay cut. But I’ll have the same life you describe – endless summers and an entire month every winter to ski. I’m thinking in the end, eventually, I might even end up wealthier in more ways than one. Happy people tend to be the most successful. I have no desire to diversify. Dividend stocks allude me. CDs seem like a good choice for older people, but I have time on my hands and real estate knowledge, so I’m sticking with what I know, despite the fact that most people will tell me it is foolish and I should diversify.

    • says

      A real estate law expert. Love it! Care to share in a guest post your thoughts on the RE market or key things investors may not be focusing on? Loopholes or risks perhaps? I think your insight would be fascinating!

      I think I’ve reached my limit for real estate as I no longer want to spend one minute more on managing RE. But you are right, RE has treated me very well and I wish I had more. But as I get older I want to be more free so online is where I am focusing.

      • AJ says

        Have you considered more passive real estate?
        There are options that give you the cashflow, capital appreciation, tax advantages, but none of the management. Being accredited helps there.

        • says

          I have actually. One of my tennis buddies was raising money for his real estate investment company where he buys, remodels and flips. I’m just worry of allocating more of my net worth to property now. I’ve had friends lose 100% of their $100,000+ investments before.

  13. says

    I am still working on my passive income, however I like multiple income streams even more. My favorite is capital gains because it is one of the lowest rates. One of the best passive income streams is a pension/Social Security. As I near retirement, I like the concept of it supporting my needs and my 401k supporting my wants. In addition, my brokerage accounts are all at capital gains rates. Don’t misunderstand, I am still working on adding more because I like multiple income streams!

    • says

      One has to think what is the end goal. To work for money or have money work for you so you can do other things. Having multiple income streams is great, but not if you have to work for them.

      Social Security is going to be a great bonus for folks under 40 if it is still there when we reach our mid 60s.

  14. bob iver says

    Hey Sam,

    Quick question. I’m 21 years old and currently working full time (50 hours a week averaging about 12 dollars an hour. I was working 35 making enough to get by and save a little, but I read your post on the notion of working more than 40 to get ahead and decided a third job was best while I’m getting residency to get lower- instate tuition at OSU. So props, you had a direct influence on my life.)

    I want to develop a passive income stream in the next 4 years, nothing grand, maybe an extra 500-1000 dollars a month, but I’m not sure how to go about it so I was wondering if you had any tips. I’m so-so as a writer, and am currently finishing up my second book (just write as a hobby), and in the past made about 30-50 dollars an hour as a free lance writer but that was a couple of years back, it was only for about 10-20 hours a month, and the gig just dried up. I just got particularly lucky with that. I’ve tried online poker as a means in the past, and which I learned A) was not passive income but hard work and B) I have an addictive personality which resulted in me losing the 4g I earned in 6 weeks over the span of 72 hours so that’s out of the picture. I also partook in some illegal selling of things when I was younger, but being a little older and wiser the risk-reward ratio for possibly ending up in Jail just doesn’t match up. I tried making three businesses (dog walking, house cleaning, and personal assistant) and while those all were succesful to varying degrees and earned me about 15-25 dollars an hour, they weren’t mobile and quiet honestly I don’t have the time to be a full time dog walker or run a house cleaning operation seeing as I’ll be in school, work, and athletics.

    I’m hoping to have about 10g saved by this time next year, which I know is nothing huge but seeing as I’m at 2.5g right now and owned 3 dollars to my name on Aug.9 I’m pretty happy with my progress :). But at my age, without a stable career, while working part time and having to go to school full time, what is a realistic path I could pursue to create passive income online, or even income that requires effort such as writing, but one that is more flexible than working in a stationary low-paid position for 10 dollars an hour? I need to work for now to show taxable income for the government to get my residency, but after that I know my time could be better served than earning 8 dollars an hour, I’m just not sure where to go from here. I considered flipping domain names, or penny stocks, or sports gambling, but again that’s not passive income and in reality they are more or less just forms of me gambling.

    Any hints or Ideas?

    Regards,

    Bob Iver

    • says

      Hi Bob,

      First of all, big props to you for working 50 hours a week while going to school full -time! Now that is work ethic which will bring you far in life. As an employer, if I knew you worked even just 20 hours a week while in school I would be impressed.

      Here’s the thing I want to impress. Please make sure your academics are priority over work. If you can get great grades while working, awesome. But if you are working so much and getting bad grades then unfortunately you’re being counter productive.

      The big alpha in your income will be the job opportunities after college. Join some clubs in areas of interest and crush your grades. I only graduated with around $3,500, but it was my first job that really gave a boost to income. Money is tempting as a student because we have little. But I would try to not focus on money as much.

      How are you doing in school now? Is there a minimum amount of hours or money you need to earn to establish residency? Good plan, although i thought living for one year and paying bills sufficed.

      • bob iver says

        Hey Sam,

        Nah you misunderstood me. I’m working 50 hours a week now to get residency and only taking a couple of classes. I’ll be working 10-20 hours a week when I go back to schoool full time a year from now. I tried working 35 hours and school full time but got burned out last year so no more of that. My grades are so-so. I got a 3.7gpa in all my GE’s and really on a conservative basis planning to remain around there which would mean 1 B for every 2 A’s. To get residency realistically I got to earn 300 dollars in taxable income a week for a year, and in the meantime am allowed to go to school part time given the fact that I can pay for school with the money I have earned within the period I began to establish residency, so no outside cash because my bank accounts will be audited at the end of the year.

        And I understand the whole idea of that first job really boosting up income, just wish there was a way I could focus my financial efforts on something more long term in the mean time :/.

        • says

          Ah you missed out the only taking a couple classes part. Ok, I suggest you at least register your name online and work to build your brand. The longer your website is around, the better. Out your profile and resume up.

  15. Gina says

    great article,

    Can you write on Master limited partnerships? I am curious about them. I feel your are a lot like Bill Clinton, an expert explainer of stuff!

  16. says

    While it is important to find something that you love to do and turn it into a money making business, you do have to be cognizant of the return as you pointed out. There are many opportunities that I found and tried out that at the time seemed great. But when I took a step back, I realized that I was working a lot for very little income whereas other things I love doing brought in much more money.

    This isn’t to say you should pick what brings in the most income. You have to look at how much time and effort you put into it, how much it pays and what the income potential is down the road. Something might not pay well at first, but once established, could be a cash cow.

  17. says

    Awesome article Sam. Generating a passive income is not that easy. It takes time and patience before you can really relax while watching the money comes in, the key to making any financial move we make successful is to plan everything very well.

  18. AJ says

    Thanks for this post Sam, impressive stuff.
    How about one more column in your spreadsheet that shows return on investment (where applicable). Then you can calculate your overall return on investment.
    Seems with a bit more risk you could boost your returns to your goal. When you get to this level I guess it is all about balance of risk/return, eh?

    • says

      Might be good, but it’s largely academic so long as the returns are st least 2x the risk free rate. If I was going to manage people’s money this calculating specific returns will be good.

      How’s your financial or passive income progress coming along?

      • AJ says

        Interesting perspective vs the risk free rate.

        As for me, I started focusing on passive income last year, but have owned rentals for 5 years. $25k now outside retirement accounts in mostly real estate. Looking to invest another $500k cash into real estate to get about $65k, and then 1031 under performers next year to hopefully boost that a bit higher. Heavy in real estate, but feels lower risk than the stock market to me if you have cashflowing properties. Real estate is inflation adjusted, and built in cashflow raise when the loan pays off.

        Thanks again for sharing your stuff.

      • AJ says

        Interesting perspective vs the risk free rate.
        As for me, I started focusing on passive income last year, but have owned rentals for 5 years. $25k now outside retirement accounts in mostly real estate. Looking to invest another $500k cash into real estate to get about $65k, and then 1031 under performers next year to hopefully boost that a bit higher. Heavy in real estate, but feels lower risk than the stock market to me if you have cashflowing properties. Real estate is inflation adjusted, and built in cashflow raise when the loan pays off.
        Thanks again for sharing your stuff.

  19. says

    This is a meaty post, Sam, and it is appreciated. I’m posting one tomorrow that lays out our current 4-5 year plan and solicits advice and criticism.

    After my ups and downs with online income, the “passive” income I’m most interested is exactly the type you show here: book royalties, stocks, rental properties, etc. I’m pouring as much as I can (convince my wife!) each month to get us caught up!

    Great post!

    • says

      It’s fun isn’t it? $500+ in online income still counts as income so don’t sell yourself short. I would really focus on branding. What makes your site unique. Good luck! Will check out the post when I return.

  20. says

    Sam,
    I alwyas enjoy your posts in regards to actual financial numbers. You demonstrate how dividend stocks aren’t the end all to passive income as most people think. Real estate is your best bet especially with inflation and a strengthening economy. Keep posting things like this.

    • says

      I don’t mind dividend stocks at all. I just think you folks looking to retire early investing mostly in dividend stocks are on the wrong end of the risk spectrum for what they want to achieve.

      Honolulu’s median household income is like $80k right? If so, it means we need much more to be comfortable unfortunately.

  21. says

    I get excited every paycheck because I know my investments are going to increase by a decent chunk. I use Mint to keep a close eye on what the current value is at and make goal marks to hit. Every time I hit a goal, I do a little happy dance and decide what I want my next marker to be and when I want to hit it by. I’m nowhere close to being financially independent or even debt free, but it’s exciting to see the ground work being laid and watching it grow.

  22. Siv says

    Hi Sam, is whole life policy a good option to consider for tax free retirement income? The returns are projected by my FP to be around 5% through mass mutual. What are your thoughts on whole life insurance ?

    Thanks

    • says

      Generally not the most efficient way to invest due to the fees and selections. However, if you have maxed out your pre retirement accounts, have a healthy after tax financial nut in investments, and have lots of excess liquidity with a family to protect, whole life is a decent financial diversification.

      What’s your situation now?

      • Siv says

        I invest about 5% of my pre tax income in 401k that my employer matches. Have close to 70k in cash in checking. Also,I liquidated around 40k in my 401k and not sure where to invest that in (bonds vs stocks) because of stocks trading at record high. Have a rental property that is paying itself now and I will pay off the mortgage completely in 5 years. My immediate concern is the cash in checking acct that’s not doing much. Thanks for your reply and appreciate your work. I am learning a lot

  23. says

    $57 on p2p? From all your previous posts about it I thought you were way more involved than this. I need to diversify more and go more conservative. Having all that money in CDs would drive me nuts in search of a better return. Still your 3-4% rate is pretty solid.
    Enjoy Mexico!

  24. jeddy0120 says

    A+ Blog!

    Great Article, very informative. These types of articles always inspire to get to a better place financially.

  25. says

    You have some great goals, Sam! Big goals like yours are the type that people accomplish, because they were set by ambitious people to whom the goal is important. I love passive income. It’s definitely something that we should all be striving for.

  26. Splash says

    Great article Sam, really opens my eyes up. I am 38 yrs old and very skewed to liquidity / cash as I work in the financial industry. I witnessed the 2007 financial debacle of almost losing everything including the firm in worked at. I am conservative to say the least.

    I need to create a passive income stream that has a definable risk profile.I have $250k cash as a safety net in my savings account getting a measily 40 bps but I am somewhat ok with this as it is Not at risk or fluctuation (walk street is tougher nowadays). i have 270k in equity in my house, thinking of paying off the mortgage but probably does make sense since my rate is 3.125 on a 30 yr. I have 275k in my 401(k) and another 45k in a brokerage account that is invested in stocks that pay dividends.

    In terms of buying real estate, I am not sure if I want to become a landlord per say. I would be happy generating 5-10k of passive income to reinvest to cover other expenses/ debt payments such as my mortgage principle.

    What are your thoughts, am I too conservative and should I not be focused on paying off mortgage? I want to invest, but I use my 401k and brokerage account for my equity exposure.

    • says

      I understand the cash portion given financial services employees are highly levered to the whims of the market.

      $250,000 cash is quite a lot as a percent of your net worth. I would ask your banks private wealth arm to speak to you about hedges investments that protect on the downside but still provide 5% returns or more. This is what I’ve done with structured products at Citibank.
      If it weren’t for structured products I would not have invested a couple hundred grand in the markets last summer as I’m pretty conservative as well with 80% of my net worth.

  27. joe says

    To your point about Municipal Bonds, my concern is tax reform. While everything is mostly being worked behind closed doors (and likely wont ever see the light of day). There is still the chance they propose to limit the amount of the tax free nature of these bonds. While I dont sen panic in the streets, I do see a scenario where bond prices get additional pressure because municipalities have to increase rates due to people putting their money to work elsewhere.

  28. says

    I am in the very beginning stages of building my passive income for financial independence, but loving the challenge.

    I wish I could just convince many of my friends to start. Hopefully if they ever read my blog they can start to see even the small start that I am coming from, and how it is helping my towards my future goals.

  29. says

    I see you include rental income, e-book sales and P2P loans as part of your passive income. Do you not consider your other internet income as passive? Is that why it’s not in the chart? Or did you not include it because you would rather not reveal it at this point? (I apologize if this question was already answered – I didn’t read through all the comments, and it’s been about a week since I actually read this post via Feedly on my phone)

    • says

      Hi Matt, correct. I don’t include blog income as passive. This 4,300 word post took around 8 hours to out together over a couple weeks.

      My focus of this post is on earning income where you basically don’t have to do anything.

  30. says

    Very enlightening. I like that you have a number of discreet passive income streams working for you. I”m not sure about such a large CD/ bank holding though, though it looks as though its giving you a fairly healthy income. How do you feel about a rising inflation rate on your effective real cash return? I’m looking to diversify beyond my current dividend passive income. Rental income is what I expect we’ll be harvesting next. P2P lending is a little too out of my comfort zone. I had a lot of exposure to consumer credit risk models at a prior role, and it scared me the heck away from consumer lending!

    • says

      Having CDs is less than ideal in a bull market, but they are great in a bear market. I plan to continue having a decent chunk of my net worth in risk free assets bc it makes me feel very comfortable.

      The CD amount is also less than 25% of my net worth so that should provide better perspective. Good you are diversifying away from just stocks. One never knows!

  31. says

    Sam –

    Perhaps you’ve covered this in the comments – I didn’t read them all – but one thing I’d apppreciate knowing is the amount you have invested in each of the categories above. If you could add one more column to your chart that listed “amount invested”, then we (I) could see the sort of return you’re getting on each passive investment.

    The difference it makes?

    *If you generate $100k a year on $1 million invested, I’m impressed.

    *If you generate $100k a year on $10 million invested, I’m not so impressed. :)

    You’re probably in the middle of those two, but I’d like to know where…

    • says

      You’re right. It’s in the middle of those two figures. Good thing I’m not here to impress anyone either. :)

      Once you start getting into absolute figures you then got to go through risk parameters. Then there’s debt levels/mortgages/etc and it gets very complicated.

      The goal is to build enough passive income to be free to do whatever. $110k is enough now, but i’d like to get it to 200k for more breathing room. I don’t plan to withdraw principle.

  32. says

    Awesome article Sam. This really spells it out fully how someone can create some passive income, but the creation of a goal is super important.

    My passive income is slowly growing, but not anywhere near where I want it to be. It will take time, but it will be worth it in the end.

  33. says

    I think it is important to highlight realistic expectations. If you are making $50K it is going to be very hard for you to save 50% of your income and as such the time frame you set up may seem impossible to someone else…Just a thought

    • says

      But if you are only making 50K, then living on less than 50K is all you need. It works, b/c I lived off $40,000 in NYC and managed to put away $10K in my 401(k) and save more in after tax money. It’s about choices.

      It’s definitely going to be harder saving more the less you make. But the point of the article is to start and to categorize and make an effort. If you save 30% of the 50K, you are living on around $35K a year. Achieving a 35K passive income stream is therefore all you need. You don’t need the 200K I’m shooting for. It’s pretty relative.

  34. BigC says

    Great Article! I like the quote “He who fails to plan is planning to fail.”

    Here’s another one “Plan the Work, and Work the Plan”

  35. says

    This is a great post! I am totally on board on having a plan and building a strategy to live from the income of my assets! I am really just starting now with my dividend income.

    Thanks for sharing. I am just above $6K in dividend income at this point.

  36. M says

    This is the best post I’ve seen on passive income streams. I’m similar to you in that I worked in IBanking for a few years but wanted out. My approach is a little different, instead of starting with the CD’s, I’m trying to build up my net worth with riskier asset classes such as stocks and real estate to get the benefit of compounding. Then, as I approach my retirement year goal, I’ll start moving them into CD and bond ladders. In theory at least, it’s best to have the highest net worth just before retirement, then convert them to risk free passive income. You’re method is more patient and probably more practical than mine. I guess I’m willing to take more risks.

    • says

      Yep, it’s really all about risks. I have low risk tolerance for anything that could hurt my major financial but. For my trading portfolio in my rollover IRA, I’m churning and burning!

      Please like on FB and share around if you like the post! Thanks

  37. says

    Great post, there is a lot to digest here. Your passive income stream is impressive, to put it mildly. Very impressive.

    I just want to point out a less known fact about Roth IRAs. The contributions to a Roth IRA can be withdrawn, at any time, for any reason, without penalty. I had to dig into the IRS publications a bit to confirm this.

    More information here: http://www.williamsgodfrey.com/early-withdrawal-from-roth-ira/

    Thanks again for the great info.

  38. Frank says

    I’m just curious why you have so much money invested in CDs instead of low-fee index funds. I am a new reader and was surprised to see about a million dollars in CDs (if my math is serving me correctly).

  39. art says

    I wonder if you have looke at I-bonds as a alternative to CDs or cash. I would like to find an article that lays out the problems with I-bonds becaause I do not see any.
    Thanks
    ARt

  40. says

    Hi Sam,

    Thanks for sharing your insights and strategy. It also looks like you’ve spent quite some effort in diversifying the source of your income stream which should give you some buffer when one doesn’t perform as well during certain times of market cycle. Keep up the good work and hope you reach your 2015 goal.

  41. tu says

    Hi Sam,
    Thank you for sharing your article! You did a great job saving and putting your money to work for you. Like you, I share the same financial dream of having 150-200k in passive income and traveling the world stress-free! :) Right now I’m saving about 80-90% of my active income and put it toward ETF funds and value growth stocks because I’m seeking capital appreciation. And I can tolerate a lot of risks because I’m still in my early 20′s. By the time I reach 30 something I’ll start looking into blue chips stocks that pay dividends and REIT. So I want to be where you are by that time lol. Anyways, that the plan and I’m sticking to it. Good luck on achieving your financial dream!

  42. David Michael says

    Sam…just read this article and I want to say that this is the best posting on passive income I have ever read…in a blog, article, or book. Thanks for making a difference and being an inspiration as to how it can all be accomplished. One of the great benefits of the internet is that people are willing to share their stories and experiences with each other online. If we had this when I was working professionally (20-40 years ago), it would have saved me from making some rather poor financial decisions that affected my retirement income. In a way, the internet is making up for the loss of financial security in the loss of The Defined Benefit Plan for retirement. Bravo!

    • says

      Thanks David. I’m always searching the Internet for knowledge and new ideas. The Internet has done the most to level the playing field.

      Please share the post with younger friends who could benefit from this post. Thanks!

  43. Grisell Plasencia says

    Very surprised to see your money in CD. My are invested on RE, index funds, ETF. No need to touch any principal, that is why I am looking into IRA inheritance law and irrevocable trust. Trying to skip the death penalty.

  44. M says

    I enjoy how you lay out real numbers. A lot of people wouldn’t do that. While you admit that you are somewhat conservative, I think the $1M in CD’s is just too conservative. Assuming you don’t need the cash flow now (which you say you just save anyways) then all that could be invested for potentially higher returns. For example, what if you bought San Francisco real estate along the way instead of CD’s. Or, an SP500 Index fund. I bet your average return would have been higher than 3.75%. Sure you could lose it, but the point is if you don’t need the cash flow now, you should try to increase that nut as high as possible until the day you actually need it. Your nut could be $5M right now if you had invested in asset classes other than CD’s for the last 14 years. Don’t get me wrong, you have done far better than me, but I guess I would take a little more risk if you don’t rely on that cash flow.

    • says

      It’s cool.

      It’s easy to say do XYZ in hindsight, especially now that we are back to bull markets. But I’m just going to continue being methodical in my diversification, including building my online business.

      Everybody thinks they are a genius in a bull market. But I will never forget 1997, 2000-2003, and 2008-2010.

      At some point, I realized I had enough. It’s different for each. And it’s all about capital preservation with a little low risk growth for me. I feel like I’m playing with the houses money as I build my business and earn consulting income on the side too. Check it:
      http://www.financialsamurai.com/consulting-for-a-tech-startup-part-time/

      Also, my financial nut is higher
      than what you said. I just don’t reveal all my assets.

      What’s your story? Eg age, passive income, net worth, industry? I’m also curious to learn more about my readers.

      Cheers

  45. says

    Great article and I only got to step 3 or 4 and had some questions, had to write them while they are fresh.

    1. Just so I’m clear, you saved the 17.5K pre tax and this does not include any of the 50-75% savings included in after tax. ie make 100k, now 83.5k after 401k, 50% of 41.75k in savings?
    2. Treat Passive Income like a game, cheating is using your spouses income in this game. I understand some of the premise behind this, but I’m married, my wife has an income and we have a rental house that we consider ours. I’m not sure how I would count this since we also use another part of our own home(also rental income) to pay down the Rental house.

Leave a Reply

Your email address will not be published. Required fields are marked *