Tuesday 12 July 2016

Passive Income is a Myth

Many so-called passive incomes are not entirely passive. If you happen to see how most people invest, you will know where I am coming from. Most of them are not guaranteed returns and we shouldn't expect to receive it on a regular basis, nor the capital preservation. Here is the definition of Passive Income by Wikipedia: Passive income is an income received on a regular basis, with little effort required to maintain it.
Here are common "passive income" people talked about:
  1. Dividends
  2. Property rental
  3. Bank saving interest
  4. Bonds/fixed deposits
Dividends
I will not assume my dividends will come in on a regular basis. Dividends are declared by the company yearly and it is not guaranteed. There is no capital preservation too. I know, some hard nuts will say buying good companies is a natural process for dividends or/and capital growth. I love their convictions. We are just playing with probabilities. Watch your numbers.

Property Rental
Can you guarantee your investment property will be fully occupied 6 months down the road? How about the capital preservation? Many of the investors benefited from rocketing properties prices, decades after decades. Most people will think buying properties is a natural process to exponentially grow your wealth, especially with the leverage. Well, it has been really good, but there is still no guarantee. Again, we are just playing with probabilities. Watch your numbers, again.

Bank Saving Interest
Enough said? Bank saving interest will fluctuate (Anyway, most of the rates are quite pathetic already).

Bonds/fixed deposits
This type is definitely most passive and guarantee, unless the owners go burst. Just don't expect high yield. 3-4% per year is already considered good. There are negative rates in a few countries. You may lose out to inflation along the way.

So, all dreams shattered? Financial independence is nothing but a gimmick sold by the financial experts (at least the so-called experts)?

If you have enough money and cash flow, you have achieved financial independence. For example, if your household expenses is $30,000 per year and you have yearly income of more than $30,000, you are somehow there.
If you are solely depending on the so-called passive income, please put in some buffer. How much buffer? I wouldn't know. It is your comfort level. Maybe, 50% more? Expenses of $30,000 will need income of $45,000, in case of rate cut. If you still cannot sleep in peace, maybe living on passive income is not your cup of tea.

Another method will be using the capital draw-down style. Try calling Mr Bill Gates and ask whether he need passive income to be financially independent? If your capital is huge enough to last you a lifetime, there is no need for you to be so fixated at "passive income". For example, if you only need $1 million of cash, lifetime, you know that the $2 millions in your bank account is somehow sufficient.
If you coupled with the "passive income", it will work as your capital preservation, hoping you will never need to draw down the $2 millions by living on the interest earned. Again, who will eventually spent the $2 millions? Pass down generations by generations? Are you so sure that your descendants will be a better person with the inheritances? Will it deprives their survival instincts? Leave it to you to think about imparting the right values to your beneficiaries. Having inheritances are definitely a bonus, but values are more important. Maybe there are no correlation between the two. In my opinion, excessive wealth is useless. You may ask, Frugal Daddy, are you on your right mind?

Do remember to do personal hedging. In a more familiar term, it is called insurance. How much is enough? Only you will know. Maybe an amount that can last your family for >10 years, but a premium of <10% of your income will be a good estimate. Not all events can be covered by insurance, so you need more money for self hedging.

I am surprised by people chasing after money as if it is a life goal. Don't end up chasing after the moon in the river, after 50 years, realised you have wasted your life. If money can solve the problem, it is not a big problem. I know, if there is no money (it is a big problem!), we may not be able to focus on the essentials in life. However, It should never be the main focus, it is a commodity. If you crack your head harder, maybe, the money problem you think you have, need not be resolved by money. You may ask again, Frugal Daddy, are you on your right mind again?

Passive income is a good concept, it makes your money works for you, but it is not entirely passive for most instances. Make sure you strike a balance, because time is a more important resource that you have, and you can't have excessive time. I can guarantee you there are plenty of richer people out there hoping they can have more time than money, and they wish for a different youthfulness if there is a restart button.

There is no restart button, stop looking for it. Live your life now.



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