The path to wealth is becoming clearer and clearer now. Hopefully by now, you have started or finished paying off your credit card debt and you have started to automatically put together an emergency fund that is growing each month. At the end of the day, nothing has changed in your income but your Net Worth is already growing and you are starting to see additional money that can be used for the next phase of your adventure. Maybe you even went to your boss and got that raise or promotion and you have all of this extra cash just sitting around accumulating.
JUST HAVING MONEY WON’T BUY YOUR FREEDOM
Young grasshopper, it is now time to start understanding how really rich people make their money and live a life of freedom. Here, I am going to explain that having a lot of money doesn’t buy freedom or retirement. In other words, while your net worth is a great gauge for how much you’re worth at any given time, the number itself means nothing and won’t contribute to you being able to live life with no financial worries. What the heck does that mean? Here is an example of what I mean.
Let’s say for example you live in a middle class neighborhood and your monthly expenses are $10,000 per month. This covers your mortgage, your family’s expenses and all of the money you need to live every month. As the money-making asset in the family, you and/or your wife need to generate $10,000 in income to cover your expenses. Any money above expenses can be automatically saved for an emergency or maybe put into investments. Well, let’s say tomorrow you win $500,000 in the lottery (after they take out a bunch of taxes). Does that mean you get to quit your jobs? Does that money buy you financial freedom? Unfortunately, it doesn’t. Let’s say you and your wife quit your jobs because you’re loaded with cash now. If you never changed your lifestyle at all and your expenses are still $10,000/month, that lottery money would run out after 50 months – a little over 4 years. That’s not a very long time.
The example shows that just having a lot of money will not allow you to live a life of freedom. By the way, using that same example, even if you won $1 million, it would last just a little more than 8 years if you had no other income. That assumes you didn’t change your lifestyle at all, didn’t buy any toys, didn’t upgrade your home, etc. So, if just having a lot of money won’t help you achieve the freedom you want, what will? The answer is PASSIVE INCOME.
UNDERSTANDING PASSIVE INCOME
What the heck is passive income you ask? Well, passive income is money that you earn without lifting a finger. It’s money that you earn by breathing and sleeping and doing close to nothing. How amazing is it that you can make money in your sleep and doing almost nothing at all? The American dream provides the opportunities to do this in a number of ways. First it’s important to understand how this works and then I’ll go over how you can generate passive income.
There are many opportunities where you can invest extra money into places that will give you a return on your investment. The most common ways (actually the only three ways I know of) you can earn money in your sleep are the following:
- Owning a business
- Real Estate Investment
- Stock Market Investment
That’s really it. There are only three ways to earn enough money to be financially free. When you look at the richest people in the world (Jeff Bezos, Warren Buffett, etc), you will notice that every single individual made their fortunes in one of these three areas. If you want to be wealthy and you want to live a life of freedom, you need to have passive income and these are the only three ways to do it.
So, how does Passive Income work?
The concept is fairly simple. In the example above, we had a couple with expenses of $10,000 per month. In that example the couple are the only asset generating money. That’s it. Two people making over $10,000 per month in their jobs. The family doesn’t have any other way of generating money. The concept of passive income is that if that couple were to put money into opportunities like the ones listed above and those opportunities generated money back to the family, all of that money could start to offset the $10,000 in expenses. If that couple put so much money into opportunities that those opportunities generated over $10,000 per month in income, then guess what? They would not only have assets/investments (in their net worth column), but they would have enough income from those opportunities to not have to work anymore. What do I call this? FINANCIAL FREEDOM!
The minute your passive income covers your expenses, you have arrived at the middle of the mountain! You can work when you want, where you want or do whatever you want knowing that your passive investments will cover your expenses. Technically, if nothing changed in your financial picture, as far as expenses you could actually retire (assuming you will never need more money for health reasons or other surprises).
EXAMPLE OF PASSIVE INCOME
Here is an example of how passive income can start to help offset your expenses. With the advent of the internet and crowd funding, there are companies that purchase and rent out apartment buildings and residential homes. In the past, it took hundreds of thousands of dollars to invest in an apartment building or to purchase investment property. Now, through companies like fundrise.com, you can invest with hundreds of dollars in apartment buildings all over the United States (they do require a $500 minimum investment). By crowdfunding from hundreds and thousands of small investors, they can combine the small investments into large amounts of capital they need to buy and manage buildings. They buy the buildings and manage the tenants and the maintenance and you get a small percentage of the profits plus a small piece of ownership of the real estate. Based on how much you give them, they pay out quarterly dividends to you based on the profits they make. For purposes of our example, let’s say the couple gave FundRise.com $1,000 for investing. According to their web site, they generated a return of 13% last year. This is a really high return for an investment, but we will use this rate of return for our example.
Let’s do the math here. The couple invested $1,000 with Fundrise.com. At a return of 13% annually, that means the couple would generate $130/year in interest or $11/month. The couple still has their initial $1,000 investment, but they are getting free money – $11 per month. It doesn’t sound like a lot of money, but here is where compound interest starts to kick ass and generate even more money.
WHAT IS COMPOUND INTEREST?
The couple in the example above invested $1,000 into the investment and if they took the $11/month and put into their bank, they would always get $130/year. Fundrise pays out every 3 months so this couple could get a payment of $33 every three months back to their bank account. We are going to assume now that the couple probably doesn’t need the $33 so they could leave the $33 in the account and that could add to their $1,000 investment and generate interest. After the first three months, the couple would now generate FREE MONEY interest on $1,033. In another three months, the couple would be generating FREE MONEY interest on $1,066. If this couple leaves that initial money in their account for three years and never added a dime, in 3 years, that $1,000 would be worth $1,467 and in 10 years (assuming the same interest rate above of 13%), the couple could have $3,594. So, for an initial investment of $1,000 and not doing a thing except sleep, they made 3.5x their money in 10 years. If you knew that you could more than triple your money by not doing anything, would that be something that would interest you? Does compound interest sound cool yet?
Let’s go back to our previous example in step six (click here). Here, we had a couple that was able to save $1,000 every month. Based on the power of compound interest, if we assume an interest rate of only 7% per year, a couple saving $1,000 every month and putting that into investments would have $71,798 in 5 years. So that couple would have invested $60,000 and received $11,000 in free money! Now, let’s say after 5 years the couple stopped putting in any more money monthly, but they let their money sit in that account and just reinvested the dividends only. Starting at $72,000 and at 7% interest, that money would grow to $100,983 over the next 5 years! So, this couple put in $60,000 and with the power of interest would have $100,983 over 10 years. If that couple continued to donate $1,000 per month over the entire 10 years, they would have $171,951. To reiterate, they put away $120,000 in savings and got FREE MONEY interest payments of $51,951. Do you see a pattern here? Free Money.. Free Money… Free Money…
That is a large amount of money. Time and patience and focus and choices can make that happen. The only problem here is that this amount of money is great, but it’s not going to be enough over 10 years to allow the couple in our example to retire. The next step discusses your timing and your goals.