Passive Income – What is Passive Income?

passive-income-residual-whatPassive Income are earnings generated by a business, property or financial assets in which the owner has very limited involvement.

These income streams are generated through a hands-off approach. Passive income provides the owner with a positive cash flow stream that requires little time and effort. All men, at every stage, should have at least one source of passive income.

This is the first step in become wealthier and making more money.

Passive Income streams are mainly tools of the rich in order to grow their wealth. The concept of having their money work for them, the rich, they are able to generate more cash flow on a monthly basis. Hence, the term the rich get richer.

The rich get richer because they understand how money works. Most middle class and low income earners work for their money, not have their work for them.

The concepts of having your money work for you and working for your money are two important ideals that must be differentiated.

Asset and Residual Income Definitions

There are two important definitions that you will learn in this post. What is the definition of an asset and what is the definition of residual income.

The definition of an asset refers to a tangible or intangible good that you own that generates a positive cash flow for you or your business. Many people are confused and consider a house or a car as an asset. Houses and cars, unless used to generate income through renting or Uber, are liabilities. They cost you money each month to maintain and do not generate cash flow.

The definition of residual income is the funds you have remaining on a monthly basis after your expenses, mortgage, and debt are paid. Wealthy people have multiple sources of residual income. Passive income streams are created to increase the amount of residual income you have at the end of each month.

Passive Income from Property

passive-property-incomeGeneration of income from a property is based on ownership of the property (asset) and giving someone else the use of it. The rights that are conveyed to the user of the property by the owner to generate income. These can range from the right to live on the property or the right to the natural resources on the property.

Rental of a property most commonly takes the form of building ownership. Income is created by renting out a room, apartment, unit or entire building to a tenant. The tenant is responsible to pay a monthly rent and this rent goes towards the cost of ownership of the building.

This passive income idea generates residual income when the cash received from the tenants is greater than the money paid out for a mortgage, insurances and taxes.

The rights to the natural resources of the property include the rights to the timber (trees), mining, oil or water. The owner of the property will grant access rights to an individual or company to enter their land. The company pays a fee or rent to begin tapping into those resources.

Lumber companies will want to access the timber (trees) in order to create lumber that you can use in home building. Mining companies will want to access the minerals, (ie. gold, diamonds, etc.) on your property similar to oil companies looking for oil. Water has become a significant natural resource and although fresh water is not a large money making venture, it can provide passive income to the site owner.

Properties generate passive income as the owner of the property has very little involvement. Through rental of the property, the owner collects monthly amounts and may have no involvement with the property whatsoever. Many rich people have an entire portfolio of properties they own that they rent out for different purposes. These properties range from parking spots to entire hotels.

Passive Income from Business

The opportunities for businesses that earn passive income are really limited to your imagination. Residual income from these passive income sources are earned from businesses in a variety of ways. These include fees, royalties, sales, or referrals. Passive income earned by business can be either from a tangible or intangible assets. The characteristics of these two types of assets are different.

Tangible assets are items that have a physical presence that you can touch. There is a limited direct involvement by the owner. The tangible asset could be a vending machine. The responsibilities of the owner are to maintain stock of the vending items, usually on a weekly basis. Although there is some involvement, that actual acceptance of monies from the patrons is done by the machine.

This passive income stream generates residual income when a patron purchases an item. When the value of the monies coming into the machine are greater than the value of goods that are being sold this will generate a positive cash flow.

Intangible assets are items that do not have a physical presence that you cannot touch. One example of intangible asset is a website. Although the website does not occupy any physical space, it can be utilized to generate an income for the website owner. Income can be generated through a variety of ways on the website but only if the website generates traffic. Starting a blog is one way many people make money online. Traffic being the number of people who visit your website.

This passive income idea generates residual income when the monies earned from the website are in excess of the costs of maintaining the website, generating a positive cash flow.

Passive Income from Financial Assets

passive-income-financial-assets-interest-dividendA financial asset is excess cash or cash equivalents that you have in your possession that earn ongoing income. Cash equivalents refer to holdings that can easily be sold (within 90 days) directly into cash. These can include stocks of companies trading on a public stock exchange, guaranteed investment certificates (GIC), treasury bills or bonds.

Financial assets are money that you are lending another institution, often referred to as investing. Investing is a term that sounds better. However what you are doing is giving up your money so that another institution can run their operations. These institutions, whether it be a business, government, or bank, require your money to maintain their current operations and will pay you a reward for giving your money to them.

Large publicly traded companies will often pay a dividend to you for owning their company’s stock. A dividend is based on the number of shares you own in the company. If you own 100 shares of a company and they declare a $0.10 per share dividend, you will be entitled to $10.00. Most companies that pay a dividend do so on a quarterly basis.

Banks will pay you interest based on the value of the money you hold with them. This interest could be earned through a savings account, GIC or bonds. The banks use this money that you have with them to loan out to other people at a higher rate. A bank will typically pay you between 0.1% and 1% on your investment. The banks will then turn around and loan it out at 3% through a mortgage or car loan. This is an effective way banks generate passive income for themselves.

Governments will pay you interest for loaning them money through treasury bills or bonds. From federal to state/provincial to cities, they have the requirement for excess funds at certain points to fund larger infrastructure projects. Examples of this include the funding of a new highway project or arena for sports. Bonds typically earn between 0.5% and 6% interest depending on how risky the investments. Investments with a AAA bond rating are considered very low risk and will carry a lower interest rate.

Passive Income is Positive Cash Flow

passive-income-positive-cash-flowOne of the caveats of passive income is that it must generate a positive cash flow or residual income. A positive cash flow refers to more money coming in then the money going out.

Many people refer to the fact that they have passive income assets. This is only true if the “assets” cost more to maintain or run then they are actually liabilities.

It is expected that rental or resource properties may have a negative cash flow (more money going out then coming in) in the first couple of years of operations. This is usually caused by improvements to the property. If these improvements will generate a higher income on a monthly basis going forward then these asset improvements are potentially worth it.

The key is to find properties that will bring wealth into your life without having to spend time running or maintaining them.

As mentioned earlier, many people consider their boat, cars, house to be an asset. This is wrong, as in most cases, does not generate an income for themselves. The luxuries that wealth can afford are nice but they can’t be considered assets as they do not generate a positive cash flow for you.

Passive income is a tool that the rich use to create even more wealth. They use the power of their own money to hold assets that generate even more money. The mindset of many in the middle and lower classes are that of working for money, this is wrong. To become truly wealthy your money has to work for you.

What is passive income is the first part of a multi-part series. The series focuses on having you earn extra money through passive income ideas which will generate residual income.

PS. If you enjoy making money without working long hours, then you might like the passive income ideas in part 2.

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