How does passive income work?

Simplest explanation

The “easiest” way to explain passive income is to compare it to what it’s not, in this case, the opposite of passive income is typically getting paid dollars for your efforts and hours. Most employees are paid active incomes, and if they ever get laid off or too sick to work, this type of active income stops. ie active income is paid or payable only when you turn up and work.

Passive income is income that is paid to you regardless of

  • you turning up to work
  • you putting in more or less work (in some cases, some passive income can increase with more works and efforts, I’ll cover this in a bit)

And this is the main reason why I like passive income and most of what I do is geared towards

  1. increasing the amount of passive income streams
  2. increasing the amount of passive income paid
  3. decrease the amount of recurring expenses whenever possible

How does passive income work?

Generally passive income is made by building or acquiring assets or businesses that provides value even if you’re not there. Examples are:

  • rental homes where tenants can use and live even if you’re not there
  • businesses with employees that can serve customers even when you’re not there
  • online businesses that uses technology to provide value eg information
  • etc
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How to generate passive income

There are 2 very broad ways of generating passive income: build or buy assets that generate you passive income and they are:

Buying assets that can generate you passive income.

Assets are anything that can and does make you money without you working it.

One of the simplest examples are buying dividend stocks, such as REITs, ETFs or business trusts, and in turn, they will pay you a percent of their profits every 3, 6 or 12 months. These dividends can vary from 1% per year to high levels of 8-10%.

Dont just choose high-paying dividend stocks only, because dividend payouts need to make sense and be sustainable.

Other assets you can buy to generate you passive income:

  • rental-to-lease (rental) properties, vehicles, carpark spaces
  • intellectual properties such as rights of songs, books / ebooks
  • etc

The easiest is generally dividend stocks because it’s the least amount of direct work (most passive, in that sense).

The 3 problems with buying assets for passive income

  1. you need a lot of it to generate a meaningful amount to sustain yourself (moreso if you have dependents)
  2. that’d mean more money and/or more time to accumulate
  3. rental properties can be illiquid (hard or slow to sell); stock prices can fluctuate

even that being said, I am still happy with my dividend stocks. In Singapore, dividends are non-taxable so it’s really delicious when it gets banked directly into my personal bank account. If prices drop, I just buy more =)

Building assets is the key to wealth and passive income

The fastest way to wealth and more passive income is learning how to build assets, for 2 reasons:

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#1 Direct

If you can build assets that put more and more passive income in your bank account, that’d directly and immediately add to your passive income bottomline, and this is very valuable, leading to

#2 Buyers who will pay premium for your assets

Say you build a business (online or offline) that can pay your $1000/month – do you know that there will be buyers that will pay a good 40-50x of that monthly net profit?

So

  • a business that makes net $1000/month you may be able to sell for $40,000
  • a business that makes net $5000/month you may be able to sell for $200,000
  • etc

Which you can then take the sales proceeds to buy more passive income stuff instead AND then build more passive income assets.

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