I. What is Passive Income?
Passive income is money coming in with little to no work.
According to Investopedia, there are three main categories of income: (1) Active; (2) Passive; (3) Portfolio Income.
- The first type, active income is money earned by rendering some service or doing business. Of course, this consumes time, energy, and focus.
- The second type is passive income. It involves initial effort or capital, but later, you will reap steady fruits or income.
- Financial author Chinkee Tan differentiates these two by giving an illustration of monggo/mung beans sprouts and the mango tree. Monggo types of income are those that you plant today and harvest tomorrow, or maybe in a few days. For example, an 8-5 job is a monggo type of income. You work for 15 days and earn on the 15th and 30th.
- The mango types of income are those that require huge capital or investments of time or money initially, but after a longer period of time, you will reap the rewards continually.
- Third, portfolio income is not earned through doing a job or service but comes from interests, dividends, and capital appreciation.
- For me, portfolio income is still a type or a sub-category of passive income, because, by the definition, you involve initial capital, and through time, you generate money.
In this blog, let’s focus more on passive income.
For example, you put P100,000 in a “place” where it earns 6% per year. So in a year, you get 6% or P6,000 without virtually doing anything at all. That “place” is known as a “financial instrument” or “fund.” Did you do anything to earn it? Virtually no! You just basically placed in the money. But P6,000 per year would not be enough to sustain your daily needs and you would need a lot more money to reach the average daily needs. To illustrate, to generate P30k per month, you would need to put P6,000,000 into that financial instrument. This is a capital-intensive passive income.
Value of Your Time
According to Rachel Richards in her book: “Passive Income Aggressive Retirement”, Time is our most valuable resource. When we lose money, we may still find it again. But when we lose time, we can never take it back.
We usually trade our time with money. The traditional way is doing services per hour or per month, then we receive a salary.
But imagine when you make money without giving your time. This is the concept of passive income. With passive income, there is a chance that one day, you receive money without spending that equivalent time anymore.
First, she recommends getting the value of your time. This will help you make financial decisions regarding passive income. But how? The formula is very simple. Add up all your earnings and divide that by the amount of time you worked.
For example, your business receives P40,000 every month as your income. So P40,000 / 20 working days / 8 hours = P250 per hour.
So let’s say, you want to decide about your laundry: Should you do it yourself which takes you 5 hours to finish, or just hire a laundry service? The laundry service costs P500 for your whole basket. So, determine your cost: If your hourly rate is P250, multiply it by 5 hours, that makes it P1,250 as the cost of doing your own laundry. If you do your own laundry, you will virtually spend P1,250. But if you let the laundry service do it, it will only cost you P500. So, would you do your own laundry or let the specialist do it?
Should you outsource?
When it comes to financial matters, this is also true. Should you hire a receptionist, a cashier, or a video editor for your business? If you compute your time and determine that you can save, then hire a specialist. This is called outsourcing. Economists call this “division of labor” and in Adam Smith’s Book “wealth of nations”, he said that this is key to progress because it will lead people to specialize. As a result, goods and services become better but cheaper. People will invest in tools or even invent better machines, and better processes that will do better services that are faster and better than you because you are not specializing in it. You also become better at your craft because of the time you spent in it.
But many people are frightened when they will have passive income: “What will I do instead of doing active jobs?” The answer really depends on you. What are you passionate about? Without money considerations, what do you want to do? Raising children, living by the beach, writing, traveling, farming, etc. Passive income may help you find happiness while earning at the same time.
II. Why Do We Need Passive Income? Practical Reasons:
The main idea is that the traditional retirement plan does not work anymore. What are the practical and financial reasons?
(1) Social Pension may not be enough
I say “may not be enough” because it would depend on how you trim down your lifestyle when you retire, how you prepare, how much you contribute, or how simple you will live by that time.
In the Philippines, the government-mandated social security system is called SSS for private employees and GSIS for public employees. If you will depend only on social pensions, how will it look in general?
An average Filipino with average employment may rely on SSS/GSIS contributions to save for their retirement. But if you do the calculation, you may be surprised. Simple google “SSS Retirement Estimator” and enter the details.
- Basically you enter your birth date
- Month and year of your first contribution
- And your Monthly Salary Credit (MSC). You can determine this by going to your SSS online account or by your payslip details. See the chart of SSS as to the corresponding MSC.
And let’s look at the maximum pension which is P20,000 for self-employed, you will get this estimated monthly pension:
Again, this figure depends on your birthdate, your start of contribution, the ongoing policies of the social pension by the time you will retire, the inflation, and other contingencies like your future possible loans, and critical illness benefits.
The fact is, a lot of Filipinos were surprised and were not prepared to face retirement years. For example, I have family members who thought that the contributions from their employers for 3 decades would be enough to sustain their monthly expenses. Others I have known who are self-employed thought that contributing for at least 120 months is enough. What I realized was that what was lacking was financial knowledge and advice back then.
(2) Life Expectancy
People are expected to live longer because of breakthroughs in medicine, increased awareness on nutrition and exercise, and other factors. What does this mean if we are expected to live longer? It means that we will be in the retirement years for a longer period of time, and you will need that financial support to sustain it. Without passive income, you may be forced to find a job during your golden years which will be more challenging because you may be considered by a company to be riskier because of your health. It will be harder also because of your failing health.
Researcher Aubrey de Gray coined the term “Methuselarity” describing the point where people will no longer suffer from age-related health problems. If you don’t prepare, you will have difficulty in your retirement years.
(3) Lifestyle Pressure
Social media is highly influencing our concept of lifestyle and self-esteem. It exerts high pressure on what to do, what to eat, where to go, and where to live. Everything somehow must be Instragrammable and hashtag worthy. And if we don’t combat this temptation to “keep up with the Joneses” and don’t ignore conformity to the world, the pressure will affect our future financial situation. As they say, we adjust our ambitions depending on who we will be jealous of.
The “Sandwich” Generation
Sadly, many unprepared people might depend on their children or work non-stop to support their retirement. As a result, their children will need to support both their aging parents and their young children. These children are sometimes called the sandwich generation. If this cycle keeps on repeating, the parents will make their children their retirement fund, it won’t end until a generation will decide to stop it. However, if you will prepare for your retirement, your children in the future can dedicate most of their resources to their own families, and you in your golden years will be financially independent, like a “tree planted by the rivers of water which gives forth fruit in due season.”
III. Types of Passive Income
The two main types: (I) Time-Intensive and (II) Capital Intensive (III) Business
Time-Intensive Passive Income Streams
as the name suggests, these passive income streams are “money machines” that require lots of time to build. If you don’t have much capital or money for a start, these income streams are a good way forward. These are also ideal if you want to pour in lots of time, or don’t want to borrow money to build your passive income stream.
(1) Online Courses
Building your online courses enables you to earn income passively. One day, you will check your account and see payments from enrolments at the courses that you built in the past.
Making online courses is an important way of generating passive income because it allows you to help even at least one life, and this is fulfilling. I believe that as humans, we were created to replicate. It is a human thing to multiply yourself whether it means physiologically through birth or by discipleship.
(2) eBooks
One of the most lucrative passive income is Kindle eBook Publishing. The best price for an eBook is between $2.99 – $7.99, but $2.99 is the most popular. With that price, you will receive 70% royalty or $2.09 plus more if you sign up for KDP Select Program. So if your eBooks sells 10 copies a day, you will receive $627/month which is a decent amount for passive income, and that’s just for one eBook.
(3) Ads through Content Creation
Advertising is one way to generate passive income. This is done by displaying ads to your platform such as your website, video, or any property. Digitally, you can earn through ads by enabling them in your Youtube videos or blog. When someone wants to advertise their product or service, they may go to Google Ads for example, and pay Google to receive views, clicks, or calls.
In order for Google to find this audience, Google will place ads on the content that they host. Google has a way to determine which audience may have interest in the advertiser’s products or services. In return, Google will pay you if you’re the owner of the content where advertisers gained exposure, clicks, or leads.
(4) Affiliates
Number four, affiliates. Affiliate passive income allows you to earn commissions by marketing another. This is usually done online by placing links in your content and leading people to another company’s service or product page.
For example, you may build a Facebook group on cats and create a reputation in that online community that you are good in helping cat owners. You constantly review and recommend products. You sign up for an agreement with a company, let’s say Amazon in the US, or Shopee, Lazada, or Alibaba in Asia. They will then provide you with a special link for certain products which you can promote. Every time people click that link or buy using that link, you earn passive income.
But be careful because it’s unethical to post affiliate links without transparent notice that they are affiliate links. Some customers may believe your recommendation is in good faith only, hence creating a bad experience and may cause you to lose audience. Social media platforms are now requiring people like influencers or celebrities to disclose whether the product they are promoting is a sponsored post.
You can also do this not just in Facebook but through blogs, Youtube, or TikTok videos.
(II) Capital-intensive (Portfolio Income Streams)
Next are portfolio income streams. As stated earlier, portfolio income is one that comes from interests, dividends, and capital appreciation. I also submit that this is a sub-category of passive income because it requires initial capital investment but you can earn without doing active work later.
Here are different types of portfolio income streams:
First is the stock market. A stock market is a place where buyers and sellers meet to exchange shares or ownership of publicly-traded corporations. It’s like a wet market like Divisioria in Manila or Libertad in Bacolod City, but instead of buying stuff like chicken or rice, you buy a certain portion of ownership of a corporation.
There are two basic approaches to stock market investing: (1) First, Capital gains; and (2) Second, dividend Investing.
Capital gains mean that you are after the growth of the value of the shares. Hence, your aim is to buy a stock at one price, and hopefully sell it at a higher price later on. On the other hand, dividend investing is buying the shares of a company today that pays steady dividends, usually paid every quarter or every year.
(5) Capital Gains – Stocks Investing
Next is stock investing for capital gains. Best selling author Matthew Kratter said that “the stock market is the greatest opportunity machine ever created.” There are two kinds of people in the stock market:
- First, those that love the dopamine, the rush, the excitement for quick money gains while trading stocks. They buy and hold the stocks for hours, days, or weeks and then sell them – these are called traders.
- Second, those that want to get rich slowly and quietly over the years. They buy and hold the stocks for years – these are called “investors.”
Whether you are a trader or investor, or hybrid, there is room for you in the stock market.
What is a stock? It is a share of ownership of a company. For example, when I buy 100 shares of SM Malls, I become a partial owner of SM. I am called a “shareholder.”
Another way to understand this is to think that the whole SM is one whole pie, and this pie is divided into 1.2 billion+ slices (also called outstanding stocks). As of the time of this recording, each slice costs P800. So multiply that to 1.2 Billion and the worth of the whole pie of SM Malls is around 960 billion pesos. This is called market capitalization. If I buy 100 shares now, I own 100 out of 1.2 billion shares, or around P80,000 worth of SM Malls today.
The most important decision in evaluating a business:
When talking about investing, you may have heard about Warren Buffet as one of the world’s most successful investors. He is the “god” of the stock market. He owns Apple, Coke, Goldman Sachs, Moody’s, and Wells Fargo, among others. But how does Warren Buffet invest?
In general, he typically invests by buying a share at a wonderful price which is below a the company’s actual value or worth, with the expectation that the company will grow over the long-term.
But what is a “wonderful company?” For example, he owns shares in Coca-cola since 1988, but how did he know back then that Coca-cola will grow big?
Number one is hindsight. It’s the ability to predict the company’s marketability in the coming years. He picks companies that will be around 20 years from now or so. But what is the most important factor that Warren Buffet uses to say it will sustain?
This is the most important factor: Pricing Power. He wants to own companies with good pricing power. What is pricing power? Pricing power means that a company has the power to raise prices without losing customers.
He said The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.
For example, if Apple wants to raise its prices, or sell its iPhone for a higher price than Android Phones, people won’t bother because it is Apple. It has a strong brand with a strong pricing power. Apple has less competition also because it’s the brand that has a complete computer ecosystem ranging from phones, desktops, laptops, watches, earphones, and even software like TV and arcade games.
In contrast, if you sell gasoline, and you try to increase the price, people will complain and will most likely leave your gasoline station and go to your competitors. This means that you do not have good pricing power. So, for Warren, a good company to invest in now, is the company that has a good pricing power.
In contrast, a company with a weak pricing power cannot help but to lower their prices and margins, hence lowering their quality. It will then result in being eaten up by the competition.
To invest in stocks, you can use the Robinhood app or website in the US. But if you want to invest in US stocks but does not live there like me, you can use financial platforms that offer foreign investment solutions like ATRAM of GCash in the Philippines where you can invest in US tech companies like Apple, Microsoft, Visa, and Google.
(6) Dividend Investing from Stocks
Next, dividend investing. Buying stocks that regularly pay dividends, and holding them for a long period of time is a great way to build passive income.
There’s no better feeling than waking up in the morning and suddenly finding cash in your account which came from dividends.
What is a dividend? To understand it, you must first know what company profits are. When a company makes profits, it will usually do two things: (1) One, to reinvest the profits back to the company such as buying new assets or upgrading facilities; (2) Two, distribute some of the profits to the stockholders.
You can also check out the website of the stock exchange. For example, the Philippine Stocks Exchange shows not only the historical dividends but also the upcoming or projected ones. This gives you idea what dividend stocks to consider and buy.
Here are tips from dividend investing in stocks.
(7) REITs
Number 7 are REITs. REITs mean Real Estate Investment Trusts. These are companies established for the purpose of owning real estate projects such as apartment buildings, office buildings, medical facilities, hospitals, hotels, resorts, highways, warehouses, shopping centers, and railroads, among others. REITs allow the public to buy shares of ownership. If you invest, you will enjoy consistent dividends.
This is a form of indirect rental income because REITs are required by law to distribute the rental income to investors, unlike the typical companies where it is up to the Board of Directors to distribute dividends or not.
In the Philippines, REITs are required by law to distribute at least 90% of their income to the investors each year. So, you with REITs, as long as the company has made an income, you are assured to get dividends.
If you don’t have enough money yet to pay your equity for a real estate property, you can invest it first in REITs, then, you may feel that you are already a real estate investor in some way.
(8) Mutual Funds
Next are Mutual Funds. Unlike other forms of investments, mutual funds are managed by highly qualified and experienced professionals, hence they are considered safer. Instead of you studying the markets, monitoring the charts, and current events, you simply determine (a) what type of investor you are, and (b) when you would need the money. The, you may either call your mutual fund company or buy through your online broker.
Mutual fund companies gather money from multiple investors, this is called pooling of funds. The person that manages it is called a Money Manager or Fund Manager. Every mutual fund has its own set of guidelines or prospectus, and the fund manager must follow this document, otherwise, he may be liable of an offense called style drifting. So, this gives you confidence that a certain Fund Manager does not just haphazardly make impulsive decisions along the way.
Mutual funds are also regulated by the government, particularly the SEC, but unlike deposits, your money is not insured by PDIC or deposit insurance.
Mutual funds allow you to invest in multiple or various companies with a relatively smaller capital. This allows you to enjoy diversification. Again, diversification is “not putting all your eggs in one basket,” so that you won’t suffer great losses if one industry goes down because it can be mitigated by another industry.
However, the top disadvantage of mutual funds is that it charges you fees. These may include annual fees, sales charges, taxes, and management fees which will be charged even if your funds suffer losses.
There are different types of mutual funds depending on the risk appetites and time horizon of investors.
For example, Money Market Funds are restricted by the government to low-risk and high-quality investments only. But since the risk is low, the returns are also low. The one caveat for low risk investments is that the rate of inflation will eat up the growth of your investments, hence you end up losing money.
Bond funds are not restricted therefore it has higher risks, but higher possible returns.
In the Philippines, there is a Home Development Mutual Fund (or PAGIBIG), where employers are required to contribute mandatorily partially for their employees. The charter or the law creating the said fund requires that 70% must be used to finance housing for the citizens. It also offers MP2 or Modified PAGIBIG II Savings which offers a higher dividend rate to contributors encouraging everyone to save.
Investing in government-mandated contributions can be considered a more stable passive income stream because the State itself requires businesses or individuals to contribute to them, and ordinary people can loan from them and thus customers are guaranteed. Even if a customer cannot pay, the government may find other ways to pay its debts. So you as an investor can be confident that government-supported funds can stay there for a longer period of time.
(9) Dropshipping
Dropshipping is like doing e-commerce like Amazon, Alibaba, or Shopee. You generally have a physical product sold through an online interface. The magic here is that you don’t carry or manage a physical warehouse or inventory. When someone buys from your online store, you then purchase the items from a third party and ship the item directly to your buyer. As a result, you as the seller or merchant never touches the product itself.
Dropshipping allows you to sell products without investing thousands or millions in keeping an inventory and maintaining huge warehouses.
There are two ways to dropship: Number one, find existing products to sell and dropship; Number 2, create your own product, find a manufacturer and dropship.
To achieve the so-called “passive income”, you need to find a product that has long-term marketability, and not just something that is hot and trendy now but will only last for a while. If it’s not long-term, it’s no longer passive because you will keep updating them.
The go-to platform for dropshipping is Shopify. They have a service called Oberlo that will guide you through the setup. You may also find and buy existing Shopify stores. You may also checkout existing e-commerce platforms in your country if they allow dropshipping or not.
According to Rachel Richards, the #1 secret to success is to invent your own product, find a manufacturer, and test the market. In the e-commerce space, if you sell a product, people can see your price but they can easily search for competitors offering the same at a lower price. If your product is not unique, they will go to your competitor.
So the solution to this is to increase your pricing power. Create new, unique, and hard to imitate, so that your competition is low and you can dictate the price of your product without fear of losing customers. Sell gradually, test your market always.
(10) Real Estate Income
One way to earn passive income is by buying real estate property. In fact, this is the most widely-available opportunity for everyone. Real estate investing is every man’s opportunity to build wealth. Yes, there are people that got rich through tech and apps business, but with real estate, everyone can achieve it with a bit of grit, patience, and wise moves.
Business
Monthly income: 45% – 65% of Revenue (expenses for salaries, supplies, overhead already taken out)
Some may suggest that building a business is a source of passive income. But building a business is not for the faint hearted. It requires a lot of time and sacrifice.
Money can be gone in an instant without the right amount of discipline, wit, and sacrifice. One may need to work beyond 8 hours and for 6 days a week to sustain a business.
Conclusion
When your passive income has reached the amount of your cost of living, experts call you as a 100 percenter. But to be a 100 percenter or beyond, there are two common objections: These are (a) No time; (b) and no money.
Don’t have time? Sit down, look at your schedule and identify the time wasters. Maybe we are spending too much time on streaming devices or social media. Can we cook instead of eating out? Can we cook all our food in 3 days and put them in the freezer? Maybe we can hire someone to do some tasks. View your time like money. Budget it. Create a Google Calendar, and find time to create. Cut off anything that wastes your time.
Don’t have money? You can either decrease your spending or increase your income. Can you schedule your grocery or shopping during the sale? Can you get rid of certain appliances? Can you look for a higher-paying job?
These ways of creating passive income are good, but they’re meaningless unless you take action.
Starting can be difficult, but it is in starting that you can succeed. You may make mistakes, you may fail but… what if you succeed? Make time. Save money. Develop grit. Along the way, you will compile experiences that will make you better and smarter. Don’t self-prophesy of failure/ This is a world of opportunity. Take risks, and enjoy the journey. See yourself enjoying time and financial freedom, making the world around you a better place.