There are many different ways to make money. Which ones are best for generating truly passive income, and which ones promise Passive income but aren’t? That’s what we’re going to discuss in today’s episode of Truly Passive Income.

Time Stamps

  • [00:00] Intro
  • [00:50] Understanding the difference between Passive Income and Residual Income
  • [03:16] The different ways people generate income, from W-2 employee, to self-employed, to business owner, to passive investor
  • [06:10] Explaining what we mean by “residual income” and why it’s not passive
  • [10:16] Even successful business owners (active investors) will eventually need to invest passively
  • [13:50] The era of the pension is gone! You need to build your own pension by investing in assets that produce truly passive income
  • [15:14] Thoughts on increasing your income if you are a W-2 employee
  • [17:51] Reducing your annual expenses with House Hacking
  • [20:36] Who should start a business? Who should invest passively?
  • [27:23] Wrap up

Key Take Aways

  • Defining Passive Income: Passive income is money earned with little to no ongoing effort on the part of the recipient. Understanding the difference between passive income and residual income from side hustles or businesses is crucial for making informed decisions about where to invest time and money.
  • Time and Effort Considerations: It is important to consider the time and effort required to generate income, especially for high-income earners. Pursuing truly passive income, such as real estate investments, can be more beneficial than starting a side hustle or business, which may require significant time and energy.
  • Evaluating Investment Strategies: Knowing the end goal of an investment strategy is essential. If the goal is to generate ongoing passive income, investing in assets like apartment buildings may be more advantageous than one-time deals, such as flipping a house.
  • The Value of Time: For high-income earners, it is crucial to understand the highest and best use of their time. Often, continuing to excel in their current career and investing the difference with professionals who can manage passive investments may be more profitable than dedicating time to side hustles or businesses.
  • Ambiguity and Education: If you’re unsure about the best path to take in generating passive income or side hustles, remember that ambiguity can be overcome through education. Accessing free resources and learning from others who have successfully navigated these paths can help you make more informed decisions.
  • Balancing Income and Expenses: To successfully generate passive income, it is essential to identify ways to reduce expenses or increase income and invest the difference in truly passive income-generating assets. This will help you achieve financial freedom without trading your time for money.

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  • Passive vs. Active Income: Understanding the Differences – There are many different ways to make money. Which ones are best for generating truly passive income, and which ones promise Passive income but aren’t? That’s what we’re going to discuss on the next episode of Truly Passive Income.
Transcript
Neil Henderson:

There are many different ways to make money. Which ones are best for generating truly passive income, and which ones promise Passive income but aren't. That's what we're going to discuss on today's episode of Truly Passive Income. But before we do that, a little reminder, if you are interested in pursuing truly passive income, you can sign up for our Passive Investor course absolutely free at trulypassiveincome.com/freecourse. Now let's talk about the definitions of income. Welcome to the Truly Passive Income Podcast. I'm your host Neil.

Clint Harris:

And I'm clint. Let's get started. So today, before we jump into talking about different ways to produce passive income, we wanna take the time to break up a little bit and define what is and what is not passive income. We talked a little bit about that before, but I think it's time that we get down to start splitting hairs a little bit and really understand the distinction between passive income versus residual income, which oftentimes can look very similar. usually the difference is that residual income looks passive to the outside observer without knowing how much effort and time went into upfront building the process or the machinery that kicks out the income and that's the end result. So when you just see the end result, it looks easy and it looks passive. But for us, the definitions are this. Passive income is the financial reward you get from the labor of others when all you need to do is invest your capital and trust the team to do the labor. So you're investing your money. they're using their time and experience to run the business and generate the income. The residual income, on the other hand, is the financial reward you get from your labor on a product or service you worked on, that continues to come in long after the bulk of the labor ended. A lot of times, again, that work was done behind the scenes. People don't get to see that. They just see you reaping the reward and it looks passive in reality you front loaded the work and then the system continues to operate.

Neil Henderson:

Hundred percent. And I, it's something we're gonna harp on constantly because we did name this podcast the Truly Passive Income podcast, and we. Where, Clint and I have both benefited from, things that people would describe as quote unquote passive income, we're real estate investors, we've both, done Airbnb investing. Clint's built an entire business on that and it certainly looks so passive now, but I think it's very important because there's an entire industry that's developed around pitching "passive income", and I think for our purposes it's very important to, make a clear distinction between what we believe are the two, types of income when it comes to that.

Clint Harris:

Yeah, absolutely. and really what it comes down to is first of all understanding what is and what is not passive, and then looking at each different type of strategy that people have of producing income. and see in the long run how that plays out and what that looks like in terms of the way that you have to invest your time into it. Because at the center core of what we're trying to get out of what our focus is truly passive income. it's. It's a lot trickier than you would think. There's a lot things out there, that are not passive. and in order to get down to what that is, we need to talk about the way that people live their lives and the employment that they have on a day-to-day basis to get there.

Neil Henderson:

Great. Great segue. So let's talk about the different ways that people earn money in their life. and this first definition is for probably 90 percent of the world, which is you're an employee, you've got a job, you work, you get paid. If you stop working, you stop getting paid. and unless you're paid hourly and you're working for overtime, the harder you work. You're not going to make more money. if you are a bartender or service, a cocktail waitress, somebody who's earning money like that, the harder you work, yeah, you will make more money. but the problem is that. Ultimately, there's a limit to the number of hours that you can work in a day, and there's a limit to the amount of energy that you can put forward. Time is our only non-renewable resource. You cannot make more time. it's very difficult to save your way to retirement in this way unless you are making, an obscene amount of money. So the other way is self-employed. And in that case, you own a job. you create a product or service and people pay you for it. if you're providing a service, you're like a masseuse, a real estate agent, a graphic designer, a portrait photographer. If you stop providing that service, you stop making money. the good news, bad news is the harder you work, chances are the more money you will make. the bad news is, that the harder you work, the more money you'll make and that can get addictive. And there again, there is a limit to the amount of time that you can work.

Clint Harris:

Let me jump in there for just a second. Okay, go. Second. Second. So one of the things that I think is important, a distinguishable difference between employee versus self-employed is that when you're any type of employee, just like you said, you're trading your time for money. That's a finite resource. If you're an athletic trainer or whatever it is, there's only so many hours of the day that you can work, and when you're trading time for money, there is a ceiling on what you can hit and the physical capabilities of how much you can do when you're self-employed. It puts you in a position where you can get to the point of other people are trading their time for money, and so it's more scalable because you start out. Owner operator in a business. And then as you try to take on employees, they're trading their time and you can re benefits off of that as well. So it allows you to scale, but if the ideas that becomes more passive as you do that, it's absolutely not the case. Okay. you're building a house of cards. It's significantly more difficult over time. And again, there is a limit. When you hit the limit of your ability to manage a large group of people to provide a service or build a product, that's the limit of the income that you can. All right.

Neil Henderson:

What you're talking about is if you're a service-based, self-employed individual, There is no way that you're ever going to stop trading your time for money. Okay. I mean, cuz it is service-based. You are providing a service for someone that depends on you being there. you can also produce a product and you can sell it and there's a good chance you will earn continued income. What people often refer to as "passive income", what we have redefined as "residual income" and there's nothing passive about it You said. You put in the work to produce and deliver and market the product, and you continue to earn income from that labor long after it's ceased. But it, as you described, it takes an enormous amount of energy, to that took the front loading of that labor to produce that product that then continues to produce that income. And I've often described it as it's like you're making a little piece of charcoal that you're then able to place into a furnace. Then heats a little steam engine. And as long as you're able to continue to produce that charcoal that then goes into the furnace, it will keep running that engine. But eventually you're gonna run outta charcoal.

Clint Harris:

Yep, absolutely. And eventually, it's, the whole thing's gonna slow down and stop unless you built a system in place to where it works without you being there. if you still have any kind of input at all into it to get the outcome, eventually when you stop putting that in, the whole thing slows down and stops. So from there on the step forward from there, and the evolution to get it to a point where it can become passive, although I would argue that for most people, It doesn't ever get over the final hurdle, but has potential to is if you're a business owner and you own a system. This is something that, that happened to me out of necessity to get to a point of it being passive and that's something we'll talk about in a future episode, but essentially on level one of being a business owner, you start a business, you build a system, it provides a product or a service and produces income for you. If you're good enough at building systems and at hiring people, you have a chance to reach the next level, which is a level two. Instead of being a business owner slash owner operator and running the business yourself, you can try to make the junk to where you're working. On the business instead of in the business. And you have people and employees or partners that are working in the business, that are putting the coal into the fire to generate the steam. And you're working on the business, creating a system so that the coal keeps coming, right? And if you reach the level two of being a business owner, that's the most passive business owner. It's essentially. You get to the point that it's basically automatic. You may still have to manage the managers. You look at the end of year reports, you get owners distributions and things like that. But at that level, it has taken you an enormous amount of time, money, energy, experience to successfully build and implement that system. On top of that, you've got a lot of people involved, so you have to be good at managing people, good at hiring people, the right systems in place, and then even after that, it still needs to be monitored. So, even when you hit level two and it's the most passive that you can be as a business owner, and from the outside looking in, it looks great. What people don't know is that it may have taken you months, years, or decades to build a system in place and put the people in place that you trust and make sure everybody's having their own personal goals and needs met, that it becomes passive or looks passive. And that's why you and I make the distinction. That's not passive at all. It's residual and it's great and it can get you to the point where you can level up and eventually start taking that residual income and investing into passive investments that don't you to require you to start over by investing large amounts of your time into something else. So a business owner by itself, that is very much not passive. If you are successful in implementing a system streamlined, automating, put people in place and understand their motivations, you can become a level two business owner, which looks passive. It's not because you front loaded all the work, but it certainly looks that way. And I would also argue that the lessons you learned along the way in getting to that level are gonna help you with your real estate investing career from there on. But at that point, you basically are looking to make the jump from being a business. To the next step, which doesn't require you trade your time for money.

Neil Henderson:

A hundred percent. We've come up against this a couple times as well, when we've had people who are business owners who are, making outsized amounts of money, an outsized return on investment, versus the labor they're putting in, they're actively, generating large amounts of income with their labor. They're a business owner. But again, a business owner still has the same problem, which is time is a limited resource and energy time ultimately is energy. And, people have different levels. you've got people who, you've got Elon Musk, that sleeps four to six hours a night, and has just seems to have, endless amounts of energy. But the average person isn't like that. eventually people need to sleep, the average person needs to sleep, and eventually people run out of time. And at that point You need to start investing, and that's where you become an investor. You're a silent partner in owning a business, either indirectly, like owning stocks or mutual funds, or directly, like investing in a friend's business, or, buying into something like a real estate syndication. The only labor that's required of you is to do your due diligence, making sure that this is an investment you want to be involved with. And a team you want to be involved with. And then it just takes you wiring your funds trusting in that team and cashing the checks that they hopefully send you. So for me and for Clint, I, this is truly what we view as truly passive income. all of the others, I honestly are, have their benefits and they have their place, but they're all pretenders.

Clint Harris:

That's right. and again, the, a lot of the times, the ones that are residual look passive, but in the true sense of the word of if you're taking on a new investment and you have something to invest in it, the best way to do that and remain passive. Is to invest your capital and to somebody else's time and experience. And I think that this is something truly passive income by investing in other people's businesses, stocks, mutual funds, real estate. and groups of people like a syndication, which is a group of people that takes their money to invest together into something that's the sum is, whole is greater than the sum of its parts, essentially, is that you're investing into a project that nobody could take on their own. So you have a small group of people that invest in something big that's been around forever. It's been around for a long. The difference is the opportunity that we have to access that because of the way that the world has changed in the last 10 or 15 years. especially, and the ability for people to connect and network and things like that. But also because of the way that the world is changing in our ability to network the world is also changing in things like, What the value of the dollar is doing. I also think that in the past it was reasonable for our parents' generation and certainly our grandparents' generation to save their way to retirement. They could do that in the same way that there are more opportunities being presented to potential investors these days. There are other things that have been taken away. And that ability to earn and save your way to retirement is one of the things that has been taken away sadly. And so in order to understand that, I think it's important for us to have a very frank and open conversation about income, where we are as a country and in order to have a very open and honest conversation about that, I think that we just need to be very frank about where we are as a country in terms of the opportunities that we have and what income looks like along our population segment. And depending on how much you make, where the highest and best use is for you to invest those dollars to get you to a point where you're no longer trading time for money.

Neil Henderson:

A hundred percent. we. It's very important to realize that our parents' generation grew up in, a time where there were pensions. you could be a, a postman or a, a factory worker earning $50,000 a year, and live very comfortably, and then have a pension in retirement and, and also be saving a little bit of money and live a very comfortable retirement. pensions are mostly gone now. You're in charge of creating your own and the truth is that most people are not very good at it. I believe, and this is, this possibly a controversial opinion that in the average city in America, if you're not earning more than $240,000 a year, then chances are you're not really living a great life and getting ahead. That's a sad fact. I think it's of course very dependent on the cost of living, and your ability to live frugally, I'm sorry, Mr. Money mustache would be probably, grabbing me by the collar right now and slapping me up inside, down the face. but I, this is what I believe is that you, if you aren't a hyper frugal person and you live in a median cost of living place, I think your target income should be $240,000 a year. not, I'm not saying your retirement income, but in your peak earning years, that should be your target income. To me, that is like, you're living comfortably. You're able to travel and you're able to save an amount that is going to allow you to be set up for a comfortable retirement. Now, if you're an employee who currently earns less than a hundred thousand dollars a year, and I realize that we're talking to a lot of our audience that is in this position. The first problem is that, That's not gonna be our main focus on this podcast. and you're probably, there, there are plenty of resources out there. I'm not saying don't listen to us, cuz I think you'll learn an enormous amount. But some of the things you should, you should be looking for side hustles. you should look for the website. Go to the website. Have you ever heard of this? Grow with Google?

Clint Harris:

I have not.

Neil Henderson:

Google. Huge tech company is always in need of different kinds of tech people from, online marketers to data analysts to coders and grow with google is a website that allows you to go and learn the skills that Google needs that are marketable, the tech industry needs that are marketable, that allows you to then earn a better living anyway, that's not the purpose of this podcast. Just a little sidebar. So your options, if you earn less than a hundred thousand dollars a year, are to find a way to increase your marketable skills to a point that you can demand a higher wage, what I just described, to decrease your expenses drastically enough that you are then able to save an outsized amount of your income towards retirement, towards passive income. It's not 10%. 10% was the savings rate that your parents could get away with back, 20, 30 years ago when there were still pensions. That is not a savings rate that's going to get you to a comfortable retirement now. You can do things like house hacking and Clint, we're gonna talk about this at a later date, cuz Clint and I have both been very successful with house hacking, ways to basically eliminate your biggest expenses. And it's not eliminating lattes from your daily commute at Starbucks, that's not going to do it. It's gotta be much bigger. Typically, it's car payment, it's housing payment and student loan payment. Unfortunately,

Clint Harris:

you were right when you said this could be potentially controversial. there's some heavy information here and I wanna go back and revisit some of the things that you said that essentially, I would agree with you that I think that the number that the average person needs to be earning to get ahead is probably a lot higher than many of us are willing to admit to, especially if you talk about the quality of life and things like that, that we all want to have. and it, I'm hearing you, when you say, if you're talking about an employee who earns less than a hundred thousand dollars a year, that's gonna have some caps on what they can make, whether they're salary or hourly, and trading their time for money, ultimately there's a finite amount of income that they can hit there. So what I'm hearing you say is your options are to either find a way to increase the amount of money that you make or find a way to decrease the amount of expenses you have, which is not rocket science. And there's very creative ways to do that. And specifically, like you said, House hacking is something that's very near and dear to my heart and yours cuz I've done it twice. Once with traditional multifamily, long-term rent as a young man, and then once with a multifamily Airbnb property just in the last few years, that paid for the next house. And there's creative ways to do that and I'm looking forward to the episode where we dive deep into that and I think people have more ability now for side hustles and things like that, Than we've ever had before. Keeping in mind that the vast majority of those are not passive at all. And the issue can become that if that takes away from your main job or the highest and best use of your time, and the highest and best use of your time might be at a job that makes $70,000 a year or 80 or a hundred or 40, whatever it may be. I certainly hope not, we all should be looking for ways to get ahead. But yeah, the short and quick version. Your options are to either increase your your income to cover your expenses, or decrease the expenses themselves, which is sometimes easier said than done. Sometimes that can be things like relocating, working remotely, house hacking, changing transportation models and things like that. But I ultimately agree with the latte concept. You're not gonna get there with a small change. this is gonna take some actionable steps. And also when you talk about people cutting, their fixed overhead and things like that, a lot of that depends on where you are in your stage of life. It's gonna be a lot easier for a 25 year old to do that versus a 45 or a 65 year old

Neil Henderson:

or somebody with kids.

Clint Harris:

Absolutely do. You've got dependence and that can change, in the blink of an eye and things like that where your fixed overhead may not be the thing that you can change. And especially with dependents and kids things like that. If you don't have time to dedicate to a side hustle, it can be really hard to increase that income as well. There are creative solutions to that. I think you and I have lived through some of those, some of them with great effect, and some of them we probably could have done better at and I'm looking forward to talking about that and laying that out there. But at the end of the day, you're right, those are your options, but any of those side hustles are all gonna be tied to the amount of time that you can put. Eventually our goal is to get you from that person to the investor that is making the amount of income where they can save and take that money and put that money to work for them. Because essentially, if you get up, you spend your time and energy to make a certain amount of income per year. If you can get over to the hump where you can save a certain amount of that income and put that income to work, it becomes a second or sometimes third income for your household coming in that's working passively even while you're asleep.

Neil Henderson:

If you are somebody who is earning a substantial wage, 150,000, $250,000 a year from your employer, from your W2 earned income job, do you think it is advisable to, in order to save more money, to start a side hustle or to start a business,

Clint Harris:

I would say probably not. Unless it is, unless it's very clearly aligned with what you're already doing and you've got all the pieces and it's literally just turning on a switch. Then maybe, and I'm not gonna oversimplify, but I have this conversation yesterday. My wife is a real estate agent here on the island where we live. And we were looking at a property and ended up putting an offer in on investment property with some very high earning husband and wife. Couple that, that are both doing very well for themselves and they're like, oh, well maybe we, we want to flip a house. We want to do this, we want to do that. And my question was, okay, what's the goal? What's the end goal? If the end goal was to generate some additional revenue, but ultimately it was an investment strategy where they were trading their time and energy and they were gonna get paid once, it was not residual income from buying a small apartment building or something like that. It was a one-time deal. And in that situation, if you just lay it out there on a piece of paper and you run the numbers, the highest and best use of their time and energy is to just keep doing what they're doing. And then they have the ability to save money and then give it to somebody else that can earn a higher return than if they went and use a certain amount of their time, energy, and things like that to take on a project that they were gonna get paid for once. Also, the market's tumultuous right now, what happens if the market corrects 10 to 15% in the next year and they're in the middle of a nine month renovation project? There's a lot of ups and downs, right? And again, that comes to relying on time and experience and timing the market for those people. No, they don't need a side hustle. They need to keep doing what they're doing. There's probably ways, if they have a clearly defined financial goal that they can cut some of their expenses if they want to, but they really don't need to. They just need to keep doing what they're doing. A lot of the people that I worked with in my former medical sales career, these are white coat professionals and what happens is they get in their jobs, some of 'em don't like it, or over time they're looking for an exit. and so they get to the point that they wanna start earning some additional income as well. For that individual, most of the time, a side hustle, a side gig, a single family rental investments and things like that is a bad idea cuz it's taking them away from what's the highest and best use of what they're doing. If you take that physician's career and you break it down to what they make per hour and then the amount of time and energy that they're going to be spending, finding a deal, managing the renovation, the construction setting up, whether it's a short term rental or a flip or whatever it may be, at the end of the day, no amount of money that they are going to make is going to equal what they make per hour, just doing their normal job. So for those people, the highest and best use of their time is to continue doing what they're doing, live in a way that allows them to save, invest the difference with somebody else who can spend their time and energy doing that. So it, it depends on who you're talking to and if it's somebody that's making $40,000 a year and has hit the ceiling with what they're currently doing, you probably need to be looking at investing in yourself in terms of education or finding a new job, or if you love what you do, find a way to increase your skillset or take on, whether it's managing Airbnb properties for somebody else, if you have time, or, cleaning houses or whatever it may be. Any kind of side hustle with a clearly defined goal of raising X amount of capital to invest, to get you to a point where eventually you're not trading your time for money.

Neil Henderson:

You, you said something, that made me think about the calculation that you need to do. Which is, somebody who's earning, you're a high income earner, you're earning $250 an hour. If you decide to do a side hustle or start a business sitting down and figuring out the amount of hours you're going to have to, to put in order pro, to produce, a similar income. Now that calculation to me is very different from somebody who's earning $15 an hour or $25 an hour versus somebody earning $250 an hour. Chances are, you can produce, A higher income, than $25 an hour with some sort of side hustle. But again, time is a finite resource. And you need to sit down and do that calculation of how many hours total from the very beginning am I gonna have to put in order to earn an income that is more than I'm earning with my, my active labors.

Clint Harris:

That's right. And I think if you do the math and you're honest with a lot of times how. Effort and time it would take to build out that business. If you are a high income earner and you look at the amount of money that you make per hour at your job, the amount of hours it's going to take to invest, to build that business where you wanted it to be, you'll probably find that you could just go out, take the same amount of money. And buy a business that's already up and running. And then the question is, do you really wanna be in that business? Because now you've just created another job for yourself. And if you get it to the point, you go from that stage one business owner to the level two business owner where it's mostly running on its own, to make that transition, you usually have to give up some of the profit margin to pay other people to be in there, to run it, to operate it and things like that. And if you're making $15 an hour, What do you have to lose? Right? and if you, if the question is, how much money do I need to make? if someone's asking themselves that, how much do I need to make to turn around and invest and be happy? And if the answer is, I don't know, that's okay. and what do I need to do? What could I do as a side hustle? And the answer is, I don't know. That's all right. That implies ambiguity. Ambiguity is just a lack of knowledge. Lack of knowledge is a lack of education and education is free, and that's one of the things we're a free resource to try to help with that, just the same way that you and I came along on our journey by utilizing those free resources from other places. So I think right now the big distinction is understanding where you are on the pay scale. But ultimately having the goal of what's it gonna take to get me to the point I either have extra capital right now that can be invested into truly passive income. Or if I'm in a position where I'm trading time for money, I need to identify opportunities and look for ways to either reduce my expenses or increase my capital. And take that value delta, the difference between what you're making and what you're spending and invest it, but invest it in something that, in the long run is gonna create truly passive income.

Neil Henderson:

Great. Alright, so we've talked today about, our definitions are our sticklers for being definitions about what is and isn't truly passive income. we've talked about the various ways that. People earn their income through employee, self-employed, business owner, and then ultimately investor. and we've talked about what, types of income is probably best for you based on your specific life situation and how much money you're currently earning. Next week we're gonna get into a little bit of our backgrounds and our journey, to explain why we believe, what we believe, and why we think, truly passive income is what people should be aiming for. Thank you so much for listening to this episode of the Truly Passive Income Podcast. If you liked the show, if you think it would be useful for someone else the greatest compliment you could give us would be to share the episode with a friend and leave us an honest review wherever you listen to podcasts. If you have any questions, please don't hesitate to let us know on Twitter @TrulyPassive and remember, with truly passive income comes Freedom of Time, place, and the freedom to pursue your higher purpose.