5 Figure Passive Income

Ok, so 5 figures is not some rock star amount of money, but hey, you have to start somewhere! That is at least over $10,000/year in passive income. In this article we will explain how we built five figure passive income machines so far.

Why passive income?

Passive income is loosely defined as income generating from owned assets that do not require you to commute every day and sit in a cubicle. Passive income gives someone something more valuable than money, it gives a person more time. Our modern perception of time as people is pretty straightforward. Our lives feel like an hour glass that starts with a full load of sand, but as we get older the sand slowly flows down and diminishes (at least that is our perception, which could be inaccurate, I am not Stephen Hawking!) Some cultures see time as more a wheel or perhaps it is even incomprehensible to us simple humans? But for the sake of money management, time appears linear. Time is something we all have a certain amount of when we are born in this life. Some more than others, but many of us will get an average of 80-90 years.

Make the best of it

Passive income is important because it gives us back some of our time!

Passive income strengthens the value and freedom of some of that sand in the top of our hourglass. It offers a person greater flexibility and creativity in terms of choosing a profession. It also allows greater opportunities to travel and perhaps experience another culture. Passive income is also closely tied to wealth building because it typically flows from an owned asset that holds value to other humans. When I buy a stock, I own a small sliver of that businesses future profits and value.

Here is an overview of current passive income:

  1. Dividends: $2,000/year
  2. Index Funds (Vanguard, Fidelity, SPDR): 3% rule, withdraw $3,000/year off $100k
  3. Rental property: $400/month cashflow, $4,800/year
  4. Blog income: $1,000/year

Bottomline:

$11,000/year passive income (Not a bad start!)  

1. DIVIDEND STOCKS

One of our favorite passive income machines are dividends from high quality stocks and index funds. Here are some of the criteria we look at to identify long term dividend stocks:

Does Warren Buffett/Berkshire own it?

Sometimes nice guys do finish on top. Buffett did not inherit a bunch of money. He made it and earned it over decades of thoughtful and meticulous investing. He analyzed, valued and acquired strong American companies with wide moats. So, we are taking some of our investing cues from him and why not? He has the track record! 99% of us are not good at picking stocks. There is one guy we know that is pretty darn good at it: Warren Buffett and his holding company Berkshire Hathaway. This is one reason we call Berkshire stock (BRK-B) a forever stock to hold. But the only complaint I have about Berkshire stock is that they do not share their dividends. So we look for companies that Berkshire invests in but ones where we can directly collect the dividends. These are companies like the following examples: Coca Cola (KO) & Others Apple REITs like STORE Capital

Buffett’s criteria

Buffett’s secret sauce is somewhat of a secret, but we have a sense of the fundamentals when Berkshire is choosing a business to invest in.
  • Demonstrated consistent earnings. In other words a long track record of being a profitable business.
  • The business earns a good return on investment while limiting the amount of debt.
  • Has good management in place.
  • Straightforward business model. No fancy businesses of technology that is hard to understand.
  • Large businesses that can weather economic storms.
  • Wide moats. A business that is somewhat hard to get into for the average company. Otherwise competition will eat away at the company.

To boil this down even more, Mr. Buffett has expressed the following principles:

  • A business he understands
  • Long term favorable prospects
  • Operated by trustworthy people
  • Available at an attractive price or value

Other factors one could use to analyze a stock investment

Price/Earnings Ratio: The P/E ratio simply helps an investor determine whether a stock is over or under valued. Like all indicators and measures, this one is not perfect. This compares the current stock price to earnings per share. The S&P 500 has an average P/E of around 15. So a company with a current P/E of 25, above the S&P average, trades at 25 times earnings. The high multiple indicates that investors expect higher growth from the company compared to the overall market. A high P/E doesn’t necessarily mean a stock is overvalued. Any P/E ratio needs to be considered against the backdrop of the P/Es for the company’s industry. Too high of a P/E ratio can mean the stock is overvalued. In other words, look for a moderate P/E value to indicate you are not buying the stock at the top! Earnings per share, EP/share: This is the total earnings divided by the number of outstanding shares of stock. This is important because you will want to know if the company turns a healthy profit and would then be able to return either dividends and/or value back to shareholders. Dividend Aristocrat or King: Numerous studies have shown that dividends make up a big percentage of total stock returns. Estimates suggest that stocks returned about 9.4% annually between 1900 and 2010 and that dividends made up 4.4 percentage points of this return. If a company has returned a dividend for 25 or more years, they are a Dividend Aristocrat. If they have paid a dividend for over 50 years they are a Dividend King. A good example is Johnson & Johnson with 53 years of dividend increases. Most returns from the stock market over the long run come from a relatively short list of stocks. These are the types of companies that have stood the test of time and have weathered many recessions and conditions. They do fall at times, but if properly managed and continually making strategic maneuvers, these companies know how to deliver. Dividend yield:The dividend yield is calculated by dividing the annual dividend by the share price. The average S&P 500 yield is around 2.5%-3%. I like a nice healthy 3% or maybe a bit more. The only problem if you get too high is that the company may not be able to sustain it. So beware of sky high yields, it may be short lived. Companies have to balance sharing profits with shareholders with investing back into the business for new equipment, space, marketing, etc. to continue to grow the company.  

2. INDEX FUNDS INCOME (Vanguard, Fidelity, SPDR): 3-4% rule, withdraw $3,000/year off $100k

So we are being a little more conservative here than the traditional 4% rule. The 4% rule says a person can withdrawal 4% of their investment nest egg each year, and therefore run a low risk of drawing down the account too fast. So for example, on $100k invested, a person could theoretically withdraw $4,000 per year in income and preserve the $100K in invested capital.

Do not cut down the fruit tree

This is what we call “not cutting down the tree, just harvest the fruit.” Or the classic analogy is the goose and the golden egg. If something produces golden eggs, do not cut it down!  

3. RENTAL PROPERTY: $400/month cashflow, $4,800/year

We write a lot about real estate investing. I have many years of experience in this realm. One thing is for certain, it is not easy and not a “get rich quick” method in my opionion. Yes, over several decades real estate investing can be a very lucrative endeavor and investment vehicle, but in the short run it can be full of headaches and expenses.  

4. BLOG INCOME: $1,000/year

We started doling out financial tips and tricks about a year ago and we are having a blast. For legal purposes we must say our site is for entertainment purposes only, if you have questions about your own personal fi situation, go see a professional. We are self-trained, self-educated guys from the school of hard knocks and experience when it comes to investing. Creating a blog is a ton of work and a practice of passion and interest. Therefore it can be a stretch to call creating a blog “passive income” because it takes a lot of time to research, develop, create and share. Jerry and I are enjoying the community, the learning and the creating. Creating a blog about something you are interested in and want to learn more about is awesome in my opinion. As we continue to refine and create quality content, we are seeing some of our revenue grow. Above all, this is something we are doing to learn and have fun, but a little extra play money never hurt for putting together some good work.    

3 thoughts on “5 Figure Passive Income

  1. Five figures may not seem like much, but my high school and college self 1-1.5 decades was only clearing about $13k a year. This is like having that old self working for you in addition to your current self.

    Are you actually using a 3% SWR on your 100k or is that just projected if you were to start taking withdrawals? I assume the later.

    1. Thank you for the comments and funny point about high school/college income. I forget that after being out of college for 20 years! I am using the 3% in this example as an illustration, not drawing on it yet and plan to wait as long as possible. Just to illustrate the concept so people have an idea of how much they can take out of their investments to generate passive income.

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