What is passive income?

Today I would like to clarify a few points regarding the term “passive income”.

There is probably no financially successful person in the world who would not preach the mantra of protecting your financial future by having multiple streams of regular income. Relying on your job alone is a risky endeavor. You are dependent on your boss, on your companies success, your colleagues, your health, and so many other factors that could trigger a chance of losing your job and your income.

Not being prepared and without other sources of income, you might struggle to pay your rent, medical bills or even sending your children to school. Even if you are prepared and have some savings left, being unemployed may eat up these savings before finding a new job and destroy possibly years of diligent saving within just a few months.

Therefore, having several sources of income is very important. Since our daily time capacity is rather limited, these income streams should be set up as passive income streams. Meaning: One should not have to put too much (or even for the better: any) work into it.

Here is where the misconception may already start and where one should never forget the basic rule of any investment: If you don’t put anything into something, chances are you don’t get anything out of it either.

We all dream about it: Receiving money and doing nothing for it. Well, it does sound wishful but not easy. And it is not easy indeed. The thing about passive income is the time and effort you have to invest to start creating it in the first place. There is no magic bullet or “trick” how to get around it: In order to create passive income, you need to invest time, effort or money – or all of it. This is especially true for the type of passive income that I am promoting: Dividends.

Let me be clear about it: Passive income is not a side-gig. I think it’s great if you have a hobby and use it to generate some extra cash which you can use either for investing, to build up more savings or your next vacations. But passive income needs to be an automized source of income that requires no more than an occasional adjustment. That’s it. You should not have to sit in your cubicle for 9 hours daily just to move to the next cubicle after that for another 3-4 hours to ensure you have an extra income. That’s not how it’s supposed to be.

Before I talk about dividends, let me give you some examples of passive income which do not include financial instruments:

  • Referral payments from your online blog
  • Royalties from your e-book
  • Income from registered patents or issued licenses
  • Paybacks from your participation in a lending club

All these examples have the characteristic that you don’t need to actively do anything all the time to receive payments. They may be not all reliable, but they are automated and generate income in as small or as big amounts as they turn out to be successful.

The more money you would like to receive from your e-book, the better you have to write and promote it. Once. You want your patented reading lamp to be a success? Make it awesome and find some distributors. Once – or – a few times but not daily. The lending club shall pay you back monthly with interest: Borrow them your money. Once. Unless you want to get more. I think you get the point.

So the key element is, that you have to put some time, effort or money into your future source of income first before it starts generating anything. And there is no guarantee it will work. This makes it so tricky and is ultimately the reason why it scares off so many people: It requires a lot of time to start, you need to invest (time, effort, money) and it does not offer any immediate gratification. All the things that our brain responses positively to are not given.

This is even more true for dividends. Because to receive dividends, you have to invest it all: Time, effort and money. Money that you earned in your daily job and money that you understand to be your immediate reward for the work you put in during the whole last week or month – depending on where in the world you live. So why should you put your hard earned Euros or Dollars or whatever currency you use into something that seems so complicated, far off and that feels much less rewarding?

I admit, the psychological gap is hard to surpass. Investing in Stocks, REITs or whatever financial instrument you go for is an abstract model. The stock market doesn’t feel real to us, it’s nothing that we associate with our true needs. Having some stocks of a company doesn’t make us feel of being a company owner. Even though this becomes our entitlement to a tiny fraction. It is nothing we can eat, or dress or even put into the garage if we don’t want to use it anymore. And yet, it is possibly one of the strongest and most rewarding instruments to create wealth that almost anybody in the world has access to.

The dividend season in Germany is starting now, and in 2018, the biggest German companies alone, which are grouped in an index under the name DAX, will pay out approx. 34,3 Billion Euros to its shareholders. Let me write this number down in its full beauty:

34,300,000,000,000

That’s quite some zeros. And not only this, but you should know that this number grew by approx. 13% compared with the year 2017. This is cash money that is being transferred in tiny fractions to all shareholders who are invested in the DAX. Money that you can withdraw, without touching your stocks, and spend on whatever you want or need. Why would anyone not want to be a part of it and to get some piece of that cake?

Buying stocks/shares is not a highly sophisticated financial process. It is as easy as buying a piece of cake. Literally. Or figuratively. However, sincerely speaking, the piece you buy in the beginning will probably be very tiny and it will most probably not fill your stomach at all. It takes time for it to grow to a level, that it will be truly fulfilling your needs. But the good news is: Once it’s there, chances are that it will last a lifetime and if constructed in a clever way, it may even support your family for generations to come. The sooner you understand this concept, the sooner you will be able to profit from it.

This is why in a previous post I explained The Time Replacement Model (TTRM). Every stock you purchase that generates dividends replaces a tiny fraction of the time that you spend at work. The more dividends you receive, the more time gets replaced until you reach the point that you don’t need to work at all. Unless you truly want to. And it is truly passive because putting your money in the right stocks will still let you sleep well at night. No matter what happens in the world. I will get back on the SWAN stocks (Sleep Well At Night) at a later point.

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