Generating enough passive income to cover your desired living expenses is the holy grail of personal finance. The problem is, the goal post keeps moving thanks to inflation and life. This post explores what is considered passive income so we can remain disciplined on our journey to financial independence.
I’ve been trying to build passive income since 1999 when I first graduated college. I knew when my boss told me to get in by 5:30 am that I wouldn’t be able to last for decades in finance.
It wasn’t until around 2017 that I felt I truly had accumulated enough passive income to take care of my wife and son.
However, after my daughter was born in late 2019 I once again felt more pressure to provide. My family planning forecast only assigned a small chance we’d have another child due to our advanced ages. It’s funny how life turns out sometimes.
Then, when the government started unleashing trillions of stimulus in 2020 and 2021, the feeling of having accumulated enough began to fade. With volatility back and interest rates getting compressed, the desire for more capital as a safety buffer increased. In addition, the income-generating potential of various assets are under pressure.
We’ve already seen a slow decline in P2P lending returns, bond interest rates, CD rates, and savings rates. Stock dividend yields and real estate rental yields might not be too far behind.
When it comes to personal finance, you never want to get too complacent. It’s important to always try and anticipate the future.
Passive Income “Cheating” Grows
Given it’s becoming more difficult to generate enough passive income, the natural tendency is to start “cheating” on what is considered passive income. For example, some have begun to include all their side hustle income, such as delivering groceries, as passive income.
You’re seeing this cheating phenomenon occur with the creation of various definitions of FIRE. Back in 2009, there was only one definition of FIRE: when you have enough passive income to cover your desired living expenses.
Today, people have become impatient. Instead of following the definition of FIRE, people have made up new definitions of FIRE. A couple interesting ones include:
Barista FIRE: Where you’re working a low-paying job that at least pays for healthcare to help make ends meet. If you’re struggling to make ends meet, perhaps you aren’t financially independent.
Wife FIRE (WiFI): When you say you’re retired, but you’re really just living off your working spouse. Stay at home mothers don’t say they are retired when they have a working spouse, so why do men? Fascinating.
I get it. We want things and we want them now. Instead of toiling away for years, we want to graduate college and go straight to the corner office. When we see our friends or peers getting ahead, we want to keep up! This is just human nature.
However, I encourage you to stay disciplined. The only person you’re really cheating is yourself.
What Should Be Considered Passive Income
Passive income should require little-to-no-work to generate. The less work the better. I say if you are spending more than one hour a week on average to earn investment income, it should not be considered passive income.
Younger investors may find one hour a week to be too stringent. While older investors may more likely agree with my one hour a week maximum criteria.
In addition to spending little-to-no time on generating passive income, you should also aim to not have to think about your passive income. The less mental real estate your passive income sources take, the better.
Ideally, you want to be constantly surprised when receiving passive income. For example, only when you get a rent check do you remember you own that rental property. This way, you know the investment is truly passive. Your surprise also reflects your sound spending habits.
Finally, it’s best if passive income is reoccurring. You may only get a one-off payout from a particular investment. But if you get reoccurring one-off investments from various investments in that asset class, perhaps those payments can be considered passive income
Favorite Passive Income Sources
I’ve currently ranked stock dividends as the #1 passive income source partly because there is no work involved. However, if dividend stocks tank again, it may lose its #1 spot due to a decline in its Volatility score.
Less volatility and a steady income stream are the reasons why I have real estate as one of the best passive income sources. But owning physical real estate takes work, which is why owning real estate is more a semi-passive income source.
The solution I’ve found to owning a less volatile and higher-yielding physical asset with no work is through real estate crowdfunding. However, individual real state crowdfunding investments can also get crunched as we are seeing with hospitality commercial real estate during COVID-19.
My favorite real estate crowdfunding platforms are:
Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing.
CrowdStreet: 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, higher rental yields. They also have potentially higher growth due to job growth and demographic trends.
I’ve personally invested $810,000 in real estate crowdfunding since 2016 to diversify my investments. It’s nice to earn income 100% passively as I spend more time taking care of my children.
The more passive the income source, the more I tend to like the asset class. As we get older, our free-time gets diminished. When I was in my 20s, I enjoyed screening for tenants and maintaining my rental properties. Today, I just don’t have as much time or energy with two young kids.
Blogging Is Not Passive Income
Some have asked why I haven’t included blogging as part of my passive income rankings. The answer is clear: these posts don’t write themselves!
It often takes hours to come up with a topic, write a first draft, and revise it multiple times before publication. Even after publication, there are often errors that need fixing. Then I’ve got to filter through all the spam comments and answer questions.
You can even get carpal tunnel if you write too much. Therefore, I’m trying to pace myself. The only thing I include from online income is my severance negotiation book proceeds. The book is updated once a year and sells itself.
To make blogging passive, I would have to pay for an editor and hire a bunch of freelance writers. Many have done just that to great success. If I start to burn out and lose interest, I will likely do the same.
Easier Passive Income Streams
With the increasing difficulty to generate enough passive income, you might wonder whether stock sales and other financial windfalls count as passive income.
The longer you spend investing, the more of these potential windfalls you might start receiving.
I used to think stock sales and other financial windfalls didn’t count as passive income, but now I’m not quite so sure.
Like I said, the desire to cheat and include new sources as passive income is increasing!
A New Source Of Passive Income: Stocks Sales And Financial Windfalls
Given passive income should require little-to-no-work to generate, a stock sale or a financial windfall may be considered as a passive income source. A stock sale only requires a couple clicks of a button. A financial windfall tends to just fall in your lap.
Let’s discuss each potential new source of passive income using some recent examples.
Stock Sale As Passive Income
Thanks to a bull market, many of us have stocks that have appreciated greatly in value. To increase my chances of holding onto my wealth, I’ve often taken some profits and bought real assets.
Recently, I sold some Tesla stock. I did nothing to help the stock appreciate in value. I rode the rocket ship passively. Then I took some of the profits to pay for a ground floor remodel at one of my rental properties.
I never would have invested in Tesla if I hadn’t joined a Meetup Softball league several years ago. Therefore, all the gains didn’t feel real. They felt completely passive and free.
For as long as I shall live, I plan to keep taking some stock profits to pay for a better life. My plan is to always stick to my desired net worth stock allocation to feel more at peace no matter the economic environment.
Investing in a stock that pays dividends is considered passive income. Why isn’t owning a growth stock and selling it for a profit not also considered passive income?
The only way you can realize any gains on a growth stock is if you sell. Therefore, an argument can be made that selling a stock for profit can be considered passive income.
Venture Capital Investment
I’ve been on record saying Just Say No To Angel Investing. Without connections, you will likely end up losing money. The rich and connected tend to get the best deals. The rest of us are left with scraps. Oh the stories I could tell you about how allocations of hot private rounds continue to go to the people who already have the most.
Back in 2014, two years after leaving my day job, I did some part-time consulting for Personal Capital, my favorite free financial app.
I used their product and I was interested in fintech. I also wanted to learn more about online marketing, given I ran a personal finance site. Personal Capital offered a decent consulting wage and they had an office in San Francisco. Therefore, I figured why not join them.
The gig lasted on and off for about 18 months until the latest CMO decided to switch things up. She wanted a permanent hire instead of a freelancer. The irony was that the CMO only lasted six months before she joined another firm.
I was fine with moving on because I had already gotten my fill of the startup world. I had learned what I wanted to learn and had helped the company grow its affiliate business. In early 2015, I had helped my wife successfully negotiate a severance. Therefore, we were ready to do more international traveling again.
Upon my exit, I had a nice conversation with Bill Harris, the Co-Founder of Personal Capital. He offered me shares in his firm. I took him up on the offer and decided to buy them within 60 days of my departure.
A Surprise Financial Windfall
It wasn’t a lot of shares, but it was nice to own some equity in a company I believed in. If the company was one day sold, I wanted to be invited to the acquisition party.
Well, it turns out five years later on June 29, 2020, Personal Capital was sold to Empower Retirement in a deal worth up to $1 billion! Dang, I wish I worked there full time for many more years so I could have received many more shares!
I thought I was going to make up to a 100% return on my investment given I thought I had gotten shares when it was valued at ~$500 million. But it turns out my memory was off because while I was consulting, Personal Capital was valued closer to $275 million. As a result, I made a 300% return instead.
In my mind, the extra 200% return is a financial windfall. In fact, perhaps the entire 300% return plus principal can be considered a windfall given private equity investments often don’t work out. Funny enough, I didn’t even remember investing the money until the purchase announcement was made.
If you don’t even remember you made an investment years ago and you suddenly get a chunk of change in your bank account, it sure feels like passive income to me.
With this financial windfall, I plan to buy Moose, my SUV, two new 22″ tires. I’m also going to buy an inflatable pool and put it on our deck because it’s going to be hot for the next three months.
Your One-Off Gains Will Continue To Come
After over 21 years of investing for passive income, I’ve come to realize that one-off financial gains will keep happening on a regular basis.
Let me demonstrate how one-off financial gains could turn into a regular passive income source:
- Year 1: One of your private equity funds has a nice distribution of $30,000
- Year 2: One of your real estate crowdfunding funds has a random $4,248.03 distribution in August after a $9,714 distribution in May 2020.
- Year 3: You take $40,000 in profit on a stock that has gone up massively to buy your baby some new Gucci diamond shoes
- Year 4: You sell a minority interest in your business for $500,000
- Year 5: An angel investment in a gin company gets sold and you collect $97,000
- Year 6: As part of your severance package, you get to keep 100% of your $40,000 investment in a distressed asset fund that pays out $120,000 in seven years
If you don’t have a diversified net worth, then you might not have these one-off financial windfalls. For example, if your entire net worth consists of 50% dividend stocks and 50% your primary residence, then you’re likely only going to earn dividend income and the occasional stock sale proceeds if you decide to de-risk.
Having a concentrated net worth is fine if you can stomach the volatility. However, if you’re interested in receiving regular financial windfalls, then a diversified net worth is necessary.
Side Benefit Of Private Investing
One of the fascinating things about investing in private funds and private equity is that after a couple years, you tend to forget you even made these investments. Yes, you’ll still get quarterly or annual updates. But once you make a private investment, the tendency is to write off the investment.
Then usually, years down the road, you’ll end up receiving distributions and principal back. Because you’ve written off these investments from your mind, all the money you receive from these investments feels like gravy.
Perhaps a good analogy is paying into Social Security for decades. Then one day, when you’re in your mid-60s, you start collecting a nice income stream. Even though you paid into the system, the money feels like a nice windfall, especially the longer you live.
Future One-Off Passive Income Streams
I don’t know what my future one-off passive income streams will look like. However, I do know these one-off passive income streams will continue given I’ve got investments in various funds.
All I know for sure is roughly how much capital I have left in each of these funds. From there, I can assign a probability of how much of the principal will be returned.
It is important to accurately predict your passive income if you want to minimize taxation and maximize your happiness. Make sure you review your passive income sources each quarter and keep track.
In conclusion, I don’t think it’s wise to model any potential financial windfalls into your passive income forecasts. If you do, that’s kind of like modeling an inheritance or government stimulus checks as passive income.
It’s best to just tally up your quarter passive income and estimate what the next quarter’s passive income will be. You could annualize the quarter to get an annual passive income estimate. However, even that might be too aggressive since dividend payments or windfalls can be erratic.
Manage Your Passive Income Better
The best way to manage your passive income is by signing up with Personal Capital. Is is a free online tool which aggregates all your financial accounts on their Dashboard. This way, you can see where you can optimize your wealth.
Utilize Personal Capital’s Retirement Planning Calculator. It uses real data to come up with various financial scenarios based on Monte Carlo simulations. There’s no rewind button in life. Get your finances right the first time.
So I ask all of you again, what is considered passive income? If you’re regularly getting “one-off” financial windfalls from your investments, should they be considered passive income? If you do consider these one-off windfalls to be passive income, how would you model your future passive income streams? Is selling a stock for profit considered passive income?