Passive income: the not-so-secret secret to financial freedom


We’ve all heard the stories: people win the lottery and are broke five years later, famous athletes and musicians file for bankruptcy; and the concept of “high-income poor people.” The fact is, many middle-class Americans are woefully unprepared for their golden years, though they may lead a relatively well-off lifestyle.

When we begin our financial livelihood (usually as teenagers), we’re just trying to make a buck. Whether we’re saving for a car, trying to help our family with bills, or just looking for some extra spending cash, we quickly learn the concept of “cash in, cash out.” Unless it is forced on us by our parents, most of us don’t start a savings account of any kind, and even more rare is the idea of generating passive income.
Perhaps that explains why a majority of upper-middle class Americans are income rich but asset poor, continuing the cash-in, cash-out philosophy, but putting little thought into building a strong future for themselves or their children. Sure, we have a 401k, but as we can see in the chart below, most people’s financial assets (which includes retirement) are no higher than one year’s salary.
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How I explain money, cash flow, and finances to my kids

The thing about having kids is that it forces us to explain complex concepts in simple terms. In so doing, we also get a bit smarter – and maybe uncover an epiphany or two.
With my kids, I used an analogy of something they played with – a bucket full of water.
Now, let’s consider viewing our finances as a bucket of water. When we first get our bucket, it may have no water (money) in it yet, but it also has no holes. The bucket is still pristine.
When we get our first job, we are essentially pouring the first cup of water in. Each paycheck is a single cup, which we can use to slowly or rapidly fill our bucket.
Now enter the first hole. We buy a car. We get an apartment. We buy a concert ticket. Each purchase we make punches a hole in the bucket, and the water starts leaking out (I’ve actually punctured a pail or two from the dollar store to drive home my point).
This sets the stage for the kind of financial life we’ll lead, as we attempt to keep our bucket full of water. We can keep pouring cups of water in, one paycheck at a time, and we can attempt to keep more holes from appearing, but the first step is to plug up some of the holes we don’t really need.
I’ll have a post up on plugging cashflow holes shortly.
Cut expenses. Make more money. Pay off debt. That’s all fine on its own, but there is one more way of making sure your bucket remains full.

Fill the bucket passively

The key to keeping the bucket full is to work at plugging the expenses and maximizing your earning potential to build a steady stream of water, like a faucet drawing the good stuff from a reliable source.
That is what passive income is – a faucet that you build by busting your butt, and scrimping and saving. The water it delivers may only be a dribble at first, but the more you work at it, the more water will flow, and the easier it will become as time goes by.
With time and perseverance, instead of you working for your money, your money will work for you, which is essentially what passive income is.

As you go about the business of pouring cups in, this steady stream relieves some of the pressure of racing to fill holes, and allows you to focus on things that are more important – your family, friends, and your life goals.

There are several ways to generate passive income, including robo-investing services like betterment, becoming an investor with peer lending services like Prosper and Lending Club, and different kinds of real estate investments.
These can all be funded with a supporting vehicle like whole life insurance, which provides a way to:
  • grow your money even when it’s being used someplace else
  • arbitrage interest rates like the banks do, by borrowing low and lending high
  • financially protect your loved ones should anything permanently shitty happen to you – permanently.

Many financial experts aren’t telling us the whole story.

We are taught to get a job, invest in “high risk, high reward” models, or low-risk, slow reward vehicles such as a 401k. But there is another way.

If we adjust the way we think about our finances, work diligently to plug the holes and build passive income, we will eventually find that we’re going to need a much bigger bucket!

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