Learn how to build passive income for financial independence and your happiness will increase. I have been creating passive income since 1999, when I realized I didn't want to work in investing banking forever. Getting in at 5:30 a.m. and leaving after 7 p.m. every evening was too brutal!
Creating genuine passive income is the holy grail of personal finance. Once you generate enough passive income or semi-passive income, you are more free to do what you want.
The key is to start building your passive income as early as possible. Start by identifying what you are building passive income for.
Not all passive income is created equal. Some streams take much more initial effort to start, such as saving enough to buy your first rental property. Please don't confuse active income with passive income. But once you start building true passive income it's very difficult not to gain momentum.
Passive Income First Takes Work
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. When you're young, you can work much longer hours and still be good to go the next day.
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. Passive income is much more valuable than you may realize.
What You Can Do With Sustainable Passive Income
- 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.
- Write the next greatest personal finance book.
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 a framework for passive income success.
How To Build Passive Income: The Framework
Let me share with you eight key ways to generate passive income to eventually live a life of freedom. I followed this passive income framework to retire in 2012 with roughly $80,000 in passive income.
Today, my investments generate roughly $380,000 in passive income. It's the amount necessary to enable my wife and me to stay home and take care of our kids in expensive San Francisco.
Here's the framework necessary to build more passive income.
1) Save Like Nobody Owes You Anything
If the amount of money you're saving each month doesn't hurt, you're not saving enough!
Generating 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.
Today, I still save about 50% of my after-tax income mainly because I've been able to generate sustainable supplemental income from this site. If you stick with things for a long enough time, you may surprise yourself on the upside.
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. Find your X-Factor and be great at it!
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 that generates revenue.
Once you retire, it's a good idea to try and make supplemental retirement income from something you are good at. You want to have purpose and relevancy in retirement.
Also see this post How To Be More Creative: Advice From A Writer, Artist, And Pianist
3) Create A Financial 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 like 1) Generating $400,000 a year working 4 hours a day or less, 2) Trying to make winning investments, and 3) Keeping track of my passive income streams with free financial tools. 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.
Further, 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 online income as funny money to keep myself sane during this long journey. The dollars created are just points one can accumulate. I think convert funny money into real assets like real estate to increase my chances of keeping my wealth.
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
Building passive income is great, but you need to have a reasonable target. Otherwise, you'll just be building passive income for its own sake. You need a purpose.
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 25 hours a week making $300,000 a year was the best income balance for maximum happiness to provide for a family of up to four. Below is a sample family budget making $300,000 a year.
6) Always Remember That Everything Is Relative In Finance
The best way to determine worthwhile passive income streams is by comparing the likely return (IRR) with the current risk-free rate of return. The risk-free rate is currently around 1% (10-year bond yield). Any new venture should thoroughly beat 1% otherwise you are wasting your efforts since you can earn 1% doing nothing.
What I'm doing: My realistic net worth growth goal is to have a blended annual return of 3x the risk free rate. With a current 3.5% hurdle, I am not paying down mortgages that cost less than 3%. It really is nuts to have mortgage rates under 2.5% nowadays.
My realistic blue sky scenario is a 5X 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. In other words, a 5% annual net worth return in the new decade is just fine by me.
7) Try Not To 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 a couple brokerage accounts 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 consistent contributions over 20 years has grown to over $600,000 without any savings pain given it just became a part of life. Real estate is also a fantastic asset class for the long term. It's fantastic to enjoy your home, pay down your mortgage each month, and end up with a paid off asset that has likely appreciated during your time of ownership.
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. You must set aside one day to tackle your financial independence goal. Circle the date on your calendar and cancel all other distractions.
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. You can now learn how to start your own site with my step-by-step guide to save yourself time and money.
And if you want to build a low-risk passive income stream of interest, consider a high-yield savings account or CDs with CIT Bank. They're a safe and reliable direct bank with consistently some of the best paying rates.
Latest Passive Income Streams
Now that you know how to build passive income for financial independence, let me share my latest passive income streams. The goal on Financial Samurai is to always put ideas into practice.
We have used our passive income streams since 2012 to slowly build the life that we want. Our passive income was around $80,000 in 2012, which allowed me to retire early. By 2015, our passive income had grown to about $150,000, which enabled my wife to also retire early.
Today, our estimated passive income is around $380,000 so that both my wife and I can by stay-at-home parents. Our kids are only three and five, which means they need lots of love and attention.
I do not include my online income from my business other than my severance negotiation book because writing takes a lot of work.
Below are my latest passive investment income streams, with a focus on real estate.
* I use Empower 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. Empower also has great tools for x-raying your portfolio for excessive fees, recommending a more optimized asset allocation, and planning for retirement with their Retirement Planner.
Stock Dividend As Passive Income
Dividend income is wonderful because it is completely passive and is taxed at only 15% if you are in the 25%, 28%, 33%, and 35% income tax bracket. If you are in the higher income tax bracket you will pay a 20% tax on your dividends.
My dividend income portfolio mainly consist of dividend equity and bond ETFs such as DVY, VYM, MUB, TLT, and IEF. Total stock and bond income is almost $100,000 a year due to a heavy accumulation of stocks and municipal bonds after selling my house.
Please read The Proper Asset Allocation Of Stocks And Bonds By Age to learn how to best structure your investment portfolio by age. The article goes through the very important “why” so you can invest more confidently for your retirement.
Real Estate Rental Income As Passive Income
I currently own three rental properties in San Francisco, one vacation rental in Squaw Valley, Lake Tahoe (2/2 condo), and my primary residence.
Real estate is my favorite asset class to build wealth because it is easy to understand, tangible, provides utility, and rides the way of inflation. I recommend individuals try and get neutral inflation by buying their primary residence as young as possible. The power of inflation is just too hard to counteract.
If you own physical real estate, consider refinancing your mortgage if you haven't done so in a while. Mortgage rates in 2020 have fallen to six-year lows, even after a 10+-year bull market.
Other Passive Income Sources
How To Engineer Your Layoff – In 2012, it took me four months of absolute focus and two years of data to publish my first e-book about helping people negotiate a severance.
The book went through over 30 revisions by four people. Then I updated the book for 2021 with 80+ more pages (200 pages total) using more successful case studies and highlighting more strategies for those who want to break free with money in their pocket.
If you want to make some extra money at home, self-publishing your own ebook could really help.
The book now generates about $42,000 a year in passive income and has helped numerous people walk away with nice severance packages and healthcare benefits so they can pursue their dreams. Below is a snapshot of my Paypal account highlighting books sales.
I also published an instant Wall Street Journal bestseller with Portfolio / Penguin Random House called Buy This, Not That. If the book sells more than 22,000 copies or so, it will begin to generate royalties. BTNT already became an instant Wall Street Journal bestseller. And is the best personal finance book on the market. I hope you all buy a copy!
Venture Debt As Passive Income
I invested $120,000 in my business school friend's venture debt fund. He started his own after spending 8 years at one of the largest venture debt funds as a Managing Partner. I'm very focused on income generating assets in this low interest rate environment. The true returns are yet to be seen, as the fund has a 5-7 year life before it returns all its capital.
Real Estate Crowdsourcing Is My Favorite Source Of Passive Income
After selling my SF rental house in mid-2017 for 30X annual gross rent, I reinvested $550,000 of the proceeds ($810,000 total) in real estate crowdfunding, $600,000 in dividend stocks, and $600,000 in municipal bonds.
My goal is to take advantage of cheaper heartland real estate with much higher net rental yields (8% – 12% vs. 2% – 3.5% in SF) and diversify away from expensive coastal city real estate.
As of 2023, I've invested $810,000 in a portfolio of 18 different commercial real estate projects across the country through real estate crowdfunding. My investments have returned over $624,000 in passive income so far.
The two most popular real estate investing platforms today are Fundrise and CrowdStreet.
Fundrise enables investors to invest in private eREITs for diversification and exposure. They offer a simple way for all investors to diversify into real estate through private funds with as little as $10. Fundrise has been around since 2012 and manages over $3.3 billion for 400,000+ investors.
Fundrise is my favorite platform because it invests primarily in residential and industrial properties in the Sunbelt, where valuations are cheaper and yields are higher. The spreading out of America is a long-term demographic trend. For most people, investing in a diversified fund is the way to go.
CrowdStreet offers a way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. These cities also have higher growth potential due to job growth and demographic trends.
If you are a real estate enthusiast with more time, you can build your own diversified real estate portfolio with CrowdStreet. However, before investing in each deal, make sure to do extensive due diligence on each sponsor. Understanding each sponsor's track record and experience is vital.
There is a multi-decade demographic shift away from expensive coastal cities and into the heartland of America due to lower costs, the rise of remote work, and technology that enables telecommuting. I believe secondary cities like Memphis, Austin, and Phoenix will outperform cities like New York City and San Francisco.
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. Therefore, stop pretending like you are Warren Buffet. Although, there's a chance you might have recurring capital distributions if you invest in private funds. These distributions could be considered passive income.
Freelance writing: Quality freelance writing takes tremendous effort. Ironically, the better the quality of your writing, the more you don't want to freelance. Instead, you just want to keep the articles for your own site. Freelancing is a great way to earn side income, however, it's not really for me. I know that if I'm ever in the dumps, I can make some extra money freelance writing.
Financial Consulting: I used to do four financial consulting sessions a month on average for $1,500 each session. In 2018, I stopped in order to focus on taking more care of my son and now daughter.
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 3,500 word post has taken around 22 hours to write with a dozen revisions. 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. That said, I enjoy blogging so much and I commend everyone to start their own site.
Build Passive Income Already
“He who fails to plan is planning to fail.” Winston Churchill
Now that you know how to build passive income, you've got to get going. Building passive income takes a long time. The key is to create a plan, save as much as possible, and just get going.
Start investing in assets where you are most comfortable. Always start small and work your way up. Also consider creating your own income producing products.
Do something long enough and good things will happen. All the best in your passive income journey!
Favorite Passive Income Investment
Once you've purchased your primary residence you are considered neutral real estate. Since you have to live somewhere, you will simply ride the real estate cycle. To be long real estate you must own investment property in addition to your primary resident.
Currently, my favorite passive income investment is real estate crowdfunding. Once I had my son in 2017, I decided to sell my PITA rental house and reinvest $550,000 of the proceeds into real estate crowdfunding. The goal was to diversify my real estate holdings across lower-cost areas of the country and earn income 100% passively.
Track Your Finances Carefully
One of the best ways to build wealth is by signing up with Empower. They are a free online platform which aggregates all your financial accounts in one place. This way, you can optimize you finances.
Before Empower, I had to log into eight different systems to track 28 different accounts to track my finances. Now, I can just log into the Empower Personal Dashboard to see how my stock accounts are doing. I can also see how my net worth is progressing and where my spending is going.
One of their best tools is the 401K Fee Analyzer. It has helped me save over $1,700 in annual portfolio fees I had no idea I was paying.
They also have an incredible Retirement Planning Calculator. It pulls in real data from your linked accounts to run a Monte Carlo simulation to output the most likely results of your financial future. I strongly suggest you run your own numbers. Play around with the income and expense variables and see how you stack up. It's all free and easy to use.
How To Build Passive Income For Financial Independence is a Financial Samurai original post. I've been writing about achieve FIRE since 2009. To learn more about building passive income, here are the best passive income streams ranked using multiple variables.