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The Truth About Passive Income
| | Thursday, June 29, 2006 @ 08:01 AM EDT
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Contributed by: A. A. Smith
A. A. Smith Properties
Read more archived articles about Credit and Finance
If you search the internet for "passive income", you may find
a definition or two, but mostly, what you find are websites trying to sell
you on the passive-income-flavor-of-the-day.
It's frustrating, I know. I don't know about you, but before I jump
into any opportunity or even before I take a trip, I like to do my research.
That being said, there are a lot of good opportunities out there. But before
you start spending money, let's discuss what passive income is and, most
importantly, what it isn't.
Webster's dictionary defines passive income as "of, relating to,
or being business activity in which the investor does not have immediate control
over income". I don't think that tells the whole story. Passive income
is money that you receive over and over again without having to do much work
(notice I didn't say "any work"). It is different than earned
income in that you are not receiving money for your time (like you would a job).
But depending on the passive income stream that you choose, you may in fact have
immediate control over your income. But I'll get to that later.
Why would you want passive income? Well, like Robert Kiyosaki explains in his
book Rich Dad Poor Dad, that is the main difference between the rich and the
middle class. The rich invest their money in various passive income streams.
When their passive income exceeds their expenses, then they are financially free. "Financially
free" simply means that you do not have to have a day job to pay your expenses.
And you are "free" to then do whatever you want!
What Passive Income Isn't
Before I go into telling you what passive income is, let me first tell you want
it isn't. Passive income is not the same thing as "residual income".
Residual income is money that you receive on a regular basis after having done
work once. The best example would be TV sitcoms. Some actors get "residuals".
Actors get paid for filming the show. Afterwards, some actors get paid each time
the show repeats. Sales people that sell services, subscriptions, or renewable
products (like insurance) sell that item once and, providing the customer renews,
will get a commission off of each renewal. Royalties from the sale of books and
music are also residual.
Many say that multi-level-marketing or network marketing sales provide you with
passive income. Guess what? That's residual too.
If you have a small business or are self-employed, even if you are making a lot
of money, this is NOT passive income. If you receive a salary from your business,
that is earned income. There is a way to turn this into passive income, however -- so
stay tuned.
You know, I have to say that starting your own website cannot be passive income.
Whether you are selling a product (such as an eBook, seminar or other information)
or a service, you still have to market your website. You will have to do this
regardless of whether you are selling your OWN products or have the rights to
sell other's products. Marketing your website is work, simple as that.
But it's not a job. And once your marketing efforts start taking off, you
can make a lot of money with little additional effort. But that is residual in
my book, not passive.
What Passive Income IS
Passive income is a lot of things. The first thing that comes to mind, and also,
I believe, the most popular example is real estate. If you own investment property
and are getting a positive cash flow from a house, commercial property, or apartment,
that is passive income. If you rent rooms in your house, that's passive
income too. You only have to set this up once, and then the income comes in month
after month. Interest income from savings accounts, CDs, and money-market accounts
are passive -- the bank pays you for keeping your money in those accounts.
If you have a website with banner ads or Google Adsense ads, that can be called
passive as well.
If you invest in any business, but don't manage it, your profits are considered
passive income, exactly what Webster was thinking about when he wrote the definition.
What about business? Well, that depends on how you set it up. Rich people create
businesses and set up a system that the business follows. That way, if the owner
goes on vacation for a month to Fiji, the employees follow the system and the
owner still gets the profits. Any business will of course start out with a lot
of work, but if you take the time to set up a business so that it gets reproducible
results (exactly like a franchise), those profits become passive. And, according
to the IRS, any salary you get from your business is considered "earned" but
profits are considered "passive". It is vital when starting a business
to check with an accountant and an attorney to set up your business that financially
benefits you the best.
What else can be considered passive income? How about self-storage facilities,
parking garages/lots and dry cleaners! They all require some time to start up,
but once they are set up, you collect money over and over again.
Residual vs Passive Income
Residual and passive income are like siblings. They are both very similar and
most people really consider them synonyms. What does it matter, anyway? They
are both excellent ways to get money in your hands month after month after month
without trading your time or your freedom. How can it get better than that?
Reality Check
Beware of anyone that tells you that there is NO work involved in passive income.
Passive income does not mean no work! If you are going to invest in a business,
a stock, or a real estate property, you will have to do your research (this is
called "due diligence"). Research is work! You will also be required
to manage your investments, to check up on their progress and make changes as
necessary. That's work too!
The good news is that research and management is only a part-time endeavor. And
most of the time, that work can be done from almost anywhere, including on a
beach in Fiji.
Let us not forget the FUN factor. I'm sure there are some of you reading
this who like, even love their jobs (if you still have one). Some of you have
your own business-- and congrats to you! But most of us are in jobs just
because we need to feed our families and pay the bills. Looking into passive
income streams and investing your time and money can bring you many, many returns.
Researching for and implementing your passive income plans so that you can live
your dreams is FUN. Getting money every month, week, or even every day is FUN.
And trying out new strategies and managing your money -- when you have some
to manage -- is FUN.
I hope I've done my job and given you the passive income basics. If you
have any questions or thoughts, feel free to contact me through my website. I'd
love to hear from you!
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