Passive
Pronunciation: pa-siv
Function: adjective
Etymology: Middle English, from Latin passivus, from passus, past participle
Date: 14th century
Definition: of, relating to, or being business activity in which the investor does not actively participate in the generation of income
Lounging on the couch, watching TV, and logging into your bank account to see that more and more money is being wired into your checking account. Sound good? What if this was to go on for the rest of your life? Getting better, I know.
This may sound too good to be true, but this is life as a wealthy person, or an owner of income producing assets. If this situation does not describe you or anybody that you know, you will likely think that a situation like this is out of reach. Let us move on to describe what this can mean for you, no matter what your current income is.
Income Producing Assets? Ok, we all know what income producing means. Quite simply, it's something that puts money into your pocket. Asset is a commonly used term that is often misused. The easiest way to define an asset for our purposes is a vehicle that has the ability to produce income and/or grow in value. Examples of assets are Stocks, Bonds, Checking and Savings Accounts, Certificates of Deposit, Mutual Funds, Exchange Traded Funds, and of course what we specialize in here at the Commercial Investment Group, Real Estate.
Annual Returns on these different types of Assets can range from slightly over 0% to upwards of 100%. Generally speaking, less sophisticated investors receive slightly over 0% in vehicles such as Checking and Savings accounts, while seasoned investors will demand a minimum 8% return on most of their assets. A good rule of thumb is the higher the return of the asset, the higher the risk. For example, an interest bearing checking account at an FDIC insured bank (insures up to $250K per individual) that pays 0.5% is much less risky than a piece of property that pays 8%. Unsophisticated Investors generally shy away from risk and receive smaller returns, while Sophisticated Investors dedicate much of their time attempting to achieve the highest returns while taking the least amount of risk.
So how does this lead to money getting wired into your account without getting off of the couch? Let’s put this application into play by showing how much passive income that you could produce by putting $10,000 into two different assets – a checking account and a piece of real estate.
Scenario 1
Asset Description – Checking Account
Initial Investment – $10,000
Annual Return – 0.5%
Passive Income in Year 1 – $50
Scenario 2
Asset Description – Share of a Piece of Real Estate
Initial Investment – $10,000
Annual Return – 8%
Passive Income in Year 1 – $800
In Scenario 1, $10,000 is invested into an interest bearing checking account. This has little risk, but also only produces a small return. By doing nothing, you would essentially make $50 per year or about 13 cents per day.
In Scenario 2, $10,000 is invested into an interest in a piece of real estate. Let us just say that this is a $100,000 property in which you own a 10% interest. This has more risk, but also produces a larger return. By doing nothing, you would essentially make $800 per year or about $2.19 per day.
Agreeably, the Passive Income in these two scenarios is likely not enough money to change your life. Rather, it is used here as a tool to show the basic blueprint for the creation of Passive Income. In Scenario 2, you are essentially guaranteeing yourself a free Starbucks coffee every day for the rest of your life. If you were to invest $100,000 in Scenario 2, you would make about $21.92 per day without getting off of the couch. Free cell phone and gas money for the rest of your life... not bad.
Investing is a sport that lasts a lifetime. As you can see in these simple examples, the more that you invest and the more that you understand the risk, the more likely that you are to Complete one or many Perfect Pass-ive Investments in your investing career.
