Active income is much more enjoyable than passive income due to the positive feeling of purpose. We want to know our actions make a difference no matter how small the scale. So for those of you who fear retirement expediting your demise, don’t worry. Every able bodied retiree will naturally gravitate towards doing something useful to keep themselves healthy.
When my total income was dominated by active income I was thrilled but felt there was NO WAY OUT. The only way to flourish was to work hard and constantly stress about being the best to continue getting paid and promoted. I’m already quite disciplined, so to add high expectations from managers only compounded the one more year syndrome. It wasn’t until passive income hit about $3,000 a month in 2008 when I began to see the stars.
$3,000 a month wasn’t enough to live comfortably in my current house in San Francisco, but it felt good knowing I could survive on my own if absolutely necessary. Worst case scenario I’d sell my properties and rent a studio for $1,400 a month. With $700 a month left in disposable income after taxes, I’d wait it out until an opportunity came along.
Progress begets progress. Once I started thinking about the worst case scenario I became hooked on creating better worst case scenarios. I won’t be able to easily send more than one kid to private school in SF if need be, but my current worst case scenario is OK. Besides, I was told there is need-based scholarships for families who make less than $100,000 a year per child so that’s good! Fingers crossed for a studious and smart kid.
I’d like to quantify a framework of happiness between passive income and active income as a percent of total income. The goal is to provide motivational goals for those seeking financial independence. I’ll share with you some of my thoughts along the way so you get a sense of how the journey feels.
THE IDEAL PASSIVE AND ACTIVE INCOME SPLIT
90%+ Active Income As a Percent Of Total Income: When you have more than 90% of your total income as active income it’s easy to feel like a slave to your job. Stop working and you starve, it’s as simple as that. Most people in America, if not the world are in this bucket where their job is their only source of income. The need for money and healthcare trumps one’s dissatisfaction for work. The trick is to increase your passive income to coincide with the decrease in the desire to work. It’s the same idea as paying off your mortgage completely by the time you retire.
I was in this stage for eight years after college (1999-2007) and it was fine because I was full of energy until 2009. But the 2009 downturn really beat my motivation to a pulp. If I was still trying to kill it during my 11th year of work without a reasonable passive income stream I’d be depressed because I would need to work another 10 years to get to financial freedom as a less enthusiastic worker bee.
60-89% Active Income: You’ve begun to taste the sweetness of passive income. You aren’t generating enough passive income to do whatever you want yet, but you know that if you stay the course for X amount more years, you’ll get there. To stay motivated, your passive income is earmarked to cover particular expenses such as vacation, food, clothing, or shelter. Once you find a purpose for your passive income, you gain more appreciation and motivation.
I was in this stage from 2008-20011, but instead of spending my passive income I just kept plowing the proceeds back into my investments. There was still a lot of anxiety because of the downturn so I felt the need to work as hard as ever. One motivational thought I kept on thinking was that every $10,000 dollars saved was like giving myself a $400 a year raise so I kept on going.
40-59% Active Income: You are now generating as much passive income as your active income. Thoughts are now dancing seriously in your head about whether you should quit your job and do everything your heart has been desiring all these years but couldn’t. Half of you take the leap of faith because you’ve been dreaming about this day ever since you started this passive income journey so many years ago. The other half of you stay at your job because suddenly, your job feels so much more fun without all the pressures to perform!
I probably would have continued working for another four years if it wasn’t for the fact I was able to negotiate a severance package which allowed me to walk away with deferred compensation, severance, and health care. I was never able to get passive income to equal 41-60% of my total income largely because of my day job income amount.
20-39% Active Income: With the majority of your income coming from passive sources, you’re only working because you find the job stimulating. You enjoy your co-workers and can’t see yourself doing anything else with the majority part of your day. You feel that your day job income is now bonus income because you can easily live off your passive income. The feeling of making “double money” is exhilarating. However, sooner or later your enthusiasm starts to fade. You begin to do some soul searching to find more purpose in life.
I wrote in 2013 that a part of me longed to go back to work in order to make “double income” now that the good times are back. I held off going back to work because I wanted to finish out the year with full dedication to entrepreneurship. Now I can say I gave entrepreneurship everything I had in 2013 and look back with no regrets.
<20% Active Income: There’s now really no need to work at all for a living. If you are working, you start feeling a little guilty about taking up a position that someone younger and hungrier would love to have. Doing something for money feels off. As a result, everything you do that provides compensation adds some value to society.
Given I no longer have a job, it’s much easier to have passive income dominate my total income stream. Based on reclassifying income in an online income contest, passive income was 80% of total income all throughout summer when I went traveling for six weeks. It felt great when I was distracted with travel, but once I returned home I longed to get active again. Now I’m considering part-time work to fill 25 hours of free time. I’m pretty confident that anybody in the 61%-100% passive income range will long to work again if they aren’t already.
Note: There’s somewhat of an illusion that day job income is completely active income. One’s day job income eventually starts feeling like passive income because we take our job income for granted. Day job workers make money over the weekends, holidays, and when sick. We tend to always get used to everything we have. Passive income can also be classified as semi-passive.
STRIVE FOR A GOOD MIX OF PASSIVE AND ACTIVE INCOME
Consider leaving a job you dislike when your passive income produces enough to take care of you and your dependents or when your passive income equals 30% or more of your total income. Obviously the greater your total income, the less passive income percentage you will need to survive.
At 10% passive income as a percentage of total income, you’ve got your savings habits down pat, and you’ve also got room to grow your passive or semi-passive income streams if you dedicate your time. When I left Corporate America in 2012, my passive income was roughly 25%-30% of total income. The figure is on the low end of my chart, but I had the courage to make the move because of the severance and deferred compensation, as well as having a clear idea of what I wanted to do.
If I were to go back to working in finance now I should be able to achieve a roughly 50/50 passive/active income split which I think would make me feel ecstatic coming into work every day. Each paycheck would feel like winning a small lottery. But instead of going back to work in finance, I’ve decided to try my hand at something new!
Recommendation For Building Wealth
* Manage Your Finances In One Place: The more passive income streams the more you have to keep track. I aggregate all 32 of my accounts with Personal Capital so I can easily stay on top of my finances. Not only is it free, Personal Capital tracks my net worth automatically, allows me to manage my cash flow month-to-month, and has a fantastic Investment Checkup tool that highlights how much you are paying in portfolio fees and how you can optimize your investments.
They also recently launched an amazing Retirement Planning Calculator that pulls in your real data and produces realistic financial outcomes using Monte Carlo simulation. I’d definitely give it a try to see how you’re doing. It’s the best free financial tool on the web today.
Updated for 2016 and beyond