Advantages of the "passive" income compared with the traditional salary
What is "passive income" and why we speak about additional passive income? Very simple because you could create additional stream of income only if it doesn't eat up more of your time. You have only 24 hours and I know this with absolute certainty. You can't generate additional income trading more of your time for money unless you start a second job. Some people this type of income active income because you actively must be there and working in order to get paid. It requires your time, energy and efforts. In the case of the passive income this is not the case. They don't require your time and effort on a recurring basis especially after the investment is already working. It needs your energy at the initial stage only.
To understand the main differences between both income types let's first try to define the meaning of "passive income". Many people imagine that this is like the interest from a CD in the bank – you are lying on the beach and the money is automatically wired to your bank account. The interest on a CD may also be considered a passive income but the assumption here is that you are already rich and have a lot of money in the bank. The idea of this web site and this article is to discuss the other types of passive income which could be described as passive income. We could count as passive the income from property rent, intellectual property, network marketing, dividends from business ownership etc. This type of income has its own category because it has some specifics that we will discuss in this article.
1. The main characteristics of this income type is my eyes are their cumulative ability. I mean that they accumulate with the time. This is the case because for the generation of this type of income you must do a certain effort (purchase, rehab and renting out of property or you must write a book), but after that this effort is bringing you income very long period of time without additional effort from your site. In contrast if you don't go to your working place each day, you will not receive a paycheck at the end of the week or at the end of the month. If you have been especially successful one month this will not bring you benefits for the next months or the coming years. In the case of the passive income the situation is different. They often related to some kind of product creation which bring rents, dividends or royalties for a long time.
If you continue with your product creation efforts you will add additional income to the previous one and in that way, you will start building your passive income stream. If you have a job your salary will remain the same and you show up again each month if you want to receive it further. Don't get me wrong here. I don't say there is something wrong working for a salary. On the contrary. This is actually very good starting position which you should keep until you have prepared for a new type of earning money. It is nevertheless important to understand the various types of income and their advantages and disadvantages.
2. The passive income is in the most cases a recurring source of income, which means that you may pay your bills with it. Some people understand as investment the purchase low and selling high type of transactions. This is the purchase of gold for instance. It will protect you from the inflation but it will not pay your bills on a monthly basis. You will have to sell part of your gold in order to cover your monthly expenses. It is different with the income from renting a property or royalties from intellectual rights or even network marketing. In the latter cases you may build up your income gradually without the necessity to destroy your investment to pay your bills.
3. The income from a salary is unfortunately with the highest tax burden. First of all the tax for a labor is calculated based on the nominal amount of the income. This means no deductions from the taxable income are allowed. This is different with the other income types where you are allowed to deduct your expenses first or at least a certain percentage is recognized as expense and is tax deductible. The taxable income is then only the difference between the nominal income and the expenses. This reduces significantly the tax burden. If you have decided to invest in real estate you may deduct the interest on your mortgage loan from the taxable income. It is actually your largest expense in this type of investments. The second significant disadvantage of the taxation of a salary income is the fact that the tax is paid immediately and it is paid by the employer directly. It doesn't even depend on the employee and he/she can't even touch this money. He/she sees the amount on his monthly paycheck as deduction and that's it.
When you obtain rent income or royalties this is different. This income is taxable once a year at the beginning of the next year. In my country the tax authorities decided in 2016 that the property rent income must be taxed quarterly. This is still much better than to have an immediate deduction of the income.
4. The passive income is the proper income source for your retirement as well. Once in place you may enjoy the income for a long period of time that will allow you to retire on it. On top of it this income source of income is not regulated by the state. When you become 65 years old nobody will force you to retire and to take a pension instead of your salary. This is your income for life. The salary is a regulated income source because it is coming from the strong regulated labor market.
5. If you think a bit longer on the above point you may logically come to the biggest advantage of the so-called passive income types. Even if you have a brilliant career and have very high position in your organization, after you retire you can't leave it as heritage to your children so that they continue what you have started. This is a labor market as mentioned and the rules are different. As you may already guess you will be able to leave your investments to your successors if you wish. And the related income for sure. Said in other words when you work for this type of income you may have completely different time horizon.
6. One feature of the passive income that is often underestimated is the higher degree of control that you have compared with the salary. This is income that you create and multiply. Everything depends on your creativity and proactiveness. It is not necessary to wait for years for a salary increase and to beg your chef for one. In the same time is a constant income that nobody can take you away. There is no job uncertainty here. As employee you have no control over the market strategy of your company. If the management decides to close your department or the plant you are working in you don't have many options. Your job simply disappears. Quickly and smoothly.
7. Very often the passive income is inflation protected. In this case we consider the point of view of the private person who is looking for an additional income. In the majority of the cases the private persons are investing in residential real estate and blue chips of major corporations because they are more accessible and easier to understand. In the rent contracts for residential properties there is normally no inflation indexation clause but nothing prevents the landlord to update the rent on a regular basis if there an inflationary environment. Your salary will not be updated so regularly and at least this doesn't depend on you but much more on your boss. However, if you are experienced investor who invest in commercial real estate you will be in the position to embed the inflation indexation directly in your rent contracts. This is a common praxis on this market.
8. The ultimate purpose most people pursue when they are striving for passive income is the higher degree of free time and flexibility they have for themselves and their families. The accumulation of additional passive income that doesn't depend on you showing up in the office or not, could one very pleasant additional effect. Namely you may retire much younger than 65 old. Indeed, the passive income could provide you with this flexibility of the working time and despite of the fact the you must put some efforts to maintain them you may choose your working hours.
9. The end stage of the flexible working time is of course the financial freedom when you will be in the position to allow yourself to work several hours a week and to have enough income despite of this. Saying this I have to clarify that I personally don't believe in this scenario. The reason is that a person who is enough active to create the passive income stream in the first place doesn't dream on early retirement and never-ending vacations. I don't think that anyone is doing this actually. But this is expressed in this way to illustrate the freedom you will gain gradually if you choose to go in this direction. Imagine that you want to change your profession entirely! Or to write a book just for pleasure, to create a new business from scratch. You may do alone the wooden chair for your beautiful garden of your home that you wanted always to do but had never the time. And of course, many other examples.
10.The last major advantage of the passive income that we will discuss here is the option to use the resources of the other people. This is valid in particular for the investments in real estate. You may also refer to my other article about the advantages of the real estates. For these investments is smart and advisable to use leverage or simply said financing. The latter if done properly could dramatically increase the return on your equity or ROE. You may also use the knowledge and the time of other experts to help you to finish your investment. You will probably agree with me that as employee you may not pay someone else to do your job. Your options in this case are limited. This is often overseen but very important advantage of the real estate as an investment asset class. Your additional stream of income could be literally be created by other people whom you pay to do so. This is one of the reasons why everybody is claiming that the knowledge is the ultimate investment. For a modest price you may use the knowledge and the experience of your teacher or mentor who might have spent many years and a lot of money to obtain it.
Now you may ask yourself "How can I benefit from the fact that the real estate market is so slow?". Good question actually. Imagine you could predict what will happen on the market in the next several years. Would it be beneficial to you to have enough time to prepare? I guess so. But we don't have a crystal ball, right?
Did you know actually that you could predict the real estate market because it moves in predictable cycle with equal length? Wow. I have surprised you I guess. I have created a whole online course about the topic and you may have it at a discount price if you click here. You will learn a lot about the real estate market and how it functions.