What is Passive Income?

Most sites refer to passive income (also known as residual income) without painting a vivid picture to explain the term. Here's a straightforward and detailed look at what makes passive income tick, and why you should pursue it.

Passive income is money earned, regardless of whether you are actively working or not.

Or, more accurately:

it is money earned, even when you aren't actively working toward generating it.

Now, it is rare, maybe impossible, for an income stream is 100% passive. The pump typically has to be primed before passive income can flow. However, like a primed pump, once the work is done at the beginning, the rewards flow bountifully.

See our continuum of passive income, below, for an illustration of how passive/active certain income streams can be!

There are 3 different types of income:

Earned income: Wage-based or salaried work.
Portfolio income: Interest and dividends derived from paper assets, such as stocks, bonds, and mutual funds.
Passive income

Both earned income and portfolio income are regarded as "active" income. The taxes are apparently highest on earned income, while passive income is the least taxed.

In the book "Secrets of the Millionaire Mind", the author points out that conditioning is the #1 reason why we find it difficult to generate passive income. Our education systems are actually designed to teach us how to make earned income only!

The book "Loopholes of the Rich" is another good one to read, to learn more about passive income.

Here are terms that help flesh out the concept of passive income more fully.

1. What is Leverage?

Q: How can 50 pounds of effort lift 1000 pounds of weight?

A: Only through leverage.

So rather than working non-stop on building your strength and endurance, so you can get to the point where you can bench press 1000 pounds... stop. and try to figure out how you can create leverage, that will enable your current 50 pounds of strength to move 1000 pounds of weight.

Earning passive income in a leveraged fashion involves generating income based on the efforts of others, as much as possible. Network marketing is a great example of this. So is affiliate marketing. And creating a franchise, also epitomizes leverage: How many burgers do you think Ray Kroc of McDonald's could have sold, if he hadn't created a franchise business model?

Like Robert Kiyosaki said: "A job is a short term solution to a long-term problem." (That problem being financial freedom). He's encouraging you to stop trading time for money, and instead to take some time out to figure out how you can generate passive income / create leverage / stop trading time for money.

2. Trading Time for Money:

This concept is best illustrated with hourly jobs. While a person on a salary still gets paid during holidays, vacations, and sick leave... a person paid an hourly wage only gets paid for the exact number of hours of work they perform.

Making this the ultimate trading of time for money.

People that work for hourly wages do some of the toughest, thankless, and often most undesirable jobs there are. They work harder than most of us do. But unfortunately, their financial reward is anemic. This is active income. This is the opposite of passive income. It may not seem fair, but it illustrates the importance of knowing how money works, so that instead of working for money, you make money work for you.

3. Making money work for you:

Robert Kiyosaki, in his book "Rich Dad, Poor Dad", stated that the #1 difference between rich people and the middle class, is that while the middle class works for money, the rich make money work for them.

This epitomizes passive income again, and is why the rich get richer. Picture it this way - as an individual, you can only work anywhere from 40-80 hours a week. But imagine if every dollar you had could ALSO work 40-80 hours a week? Imagine if every dollar you had could work 168 hours a week (that's 24/7)?

That's what happens with the rich. And we're not talking savings accounts, here. (The return on savings accounts is so ridiculously low, banks should be ashamed.) We're talking assets. While the middle class (most of us) rack up expenses and liabilities, the rich rack up income-generating assets. This is why the rich can work less than the middle class, and make MUCH, MUCH MORE. ASSETS.

4. Assets versus Liabilities:

So we've talked about making your money work for you. An asset is anything that puts money into your pocket. A liability is anything that takes money out of your pocket.

Most of what we buy are liabilities. Even our homes are liabilities, because they take money out of our pockets every month. (That topic can be elaborated on, later).

Assets are things like stocks that offer dividends, bonds, real estate rental property with positive cash flow every month, etc.

5. Financial Freedom

Financial freedom is a scenario in which your regular monthly passive income exceeds your regular monthly expenses. In other words, you earn enough passive income to not need a active income anymore!!

There are more people than you would think, living this way. The question is: When you arrive at this monumental point - what do you then do with your time?

Nice problem to have, isn't it?

Examples of Passive Income:

There are probably hundreds of different ways to generate passive income. Some examples include:

Real estate rental property
Network marketing
Affiliate marketing
Bonds
Tax leins
A vending machine business
Domain name parking
Royalties from items like original photography, or the authoring of a book or music album. Or even an invention.
Commissions from re-selling someone else's products
Licensing fees, from products originally created by you, and licensed for others to re-sell
On-line advertising revenue from your web content (content could be a blog, a video, a niche-focused web site, etc.)
etc. etc. etc.

To contrast, examples of portfolio income would include:

Savings account interest
Money market account interest
Stock dividends
IRAs - Independent Retirement Accounts (Traditional or ROTH)

The Internet has made the term passive income more prevalent in our everyday vocabulary. By its very nature, the Internet magnifies efforts by allowing you to have 1-to-many conversations with the same amount of effort that it would take to have a 1-to-1 conversation.

In turn, it makes the generation of passive income more efficient, because once you have a way to generate a dollar, you can multiply that method millions of times over. (The hard part is figuring out how to generate that first dollar).

Now, just as the Internet magnifies the effect of positive communication, it also does the same for negative communication. There are also a huge number of Get-Rich-Quick (GRQ) scams out there. Hence the need for solid, ongoing education, and the need for trusted providers that you can work with.

Continuum of passive income:

So here's a stab at comparing some income streams on a continuum of passive versus active. What's your take on it?

P a s s i v e -->				<-- A c t i v e
Royalties	Licensing fees	Affiliate marketing	Real estate rentals	Network marketing	Vending business	Salaried job	Hourly wages

Note: Passive income is sometimes referred to as residual income.

Which income vehicles should I choose?

Here's a way to objectively evaluate these income streams.

Learn more about Passive Income on Wikipedia.

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