Tag: investing

how a ‘regular person’ can make passive income


Wikipedia has a rather tortured entry on passive income. The entry begins by categorizing all income as either earned (wages), portfolio (income from market instruments such as shares) and passive (income from rental properties, royalties, etc.). I think a clearer definition might be to define all income as either earned or passive. Earned income is income arising from a continuing exchange of labor or time for money. Passive income is income arising from an exchange of money for the same unit of labor or time. That’s a confusing way of saying earned income is when you must continue the activity to keep getting money, and passive income is when you do the activity once and then keep getting money. So if I work for wages, I have to show up 8 hours a day to get paid 8 hours’ worth of wages. That is earned income. If I have passive income, I show up and do some work for 8 hours and then get paid that day, and the next day for the prior days’ work, and so on.

My definitions are fairly vague but the general idea is that earned income requires continuing work and passive doesn’t. If you buy a house, fix it up and rent it out, theoretically it could earn rent for the lifetime of the house, making it passive income. If you buy a house, fix it up and sell it, you are earning money for the time spent buying, fixing and reselling, so it’s earned income.

So why doesn’t everyone just forget earned income? Earned income is much easier to come by, for starters. I sell my time at a very specific rate to clients to perform consulting services, and in doing this I’m only doing the same thing 200 million other Americans do. If they have an 8 month project, they pay me my rate times 8 hours a day times 5 days a week times 4 weeks per month times 8 months. They don’t pay me any more after that. However, if I wrote a blog post, and someone comes to my page via a search engine and I get an ‘impression’ from Google Adsense, then the initial hour spent writing that post could potentially generate income for 8 months if people keep visiting the page. But it is hard to imagine that I could ever get to the point where the one hour spent writing a post might equal one hour spent doling out my consulting wisdom, earned through 15 years of experience and a master’s degree. That would be the goal, though.

I do have a fair amount of passive income which I have purchased with my earned income: stocks and mutual funds. Once I buy a stock, the dividends continue to come even though the earned income used to purchase that investment was capped out. If I worked enough hours to earn $100, then bought one share of a stock that earned me $1 per year in dividends, that passive income would (in theory) truly start after 100 years. Up until then it was just a deferral of my earned income in a sense.

I have given a good deal of thought as to what a ‘normal’ person like me, a wage earner, can do for passive income. I only come up with a few areas that are realistic:

  1. Owning dividend-paying stocks, interest-bearing cash accounts or other market-related investments.
  2. Owning and renting property.
  3. Creating original content (writing, art, music, etc.) and selling it.

The first two present the problem that you need at least some earned income to ‘kick off’ the passive income stream. You have to buy a stock or a house. Sure, there’s leverage, but still, some sort of earned income has to be there to initiate things. The third item is where the possibilities are.

This blog is original content. It may not be good original content, but it’s definitely my own work. Selling an original MP3 would be, too. If I can create good enough content, people will want to read/listen/acquire it, and they will pay for it, either passively through advertising or directly by paying me for it.

The goal, therefore, is probably to work on increasing your creativity, which is free of cost but can generate income. Of course the time spent in generating creative thoughts has to be retroactively paid for once the income comes in, but at some point - like the stock example above - you reach a break even point and move into true passive income territory. Once you have reached that point, the need for earned income decreases and you can stop selling your time for money.

This is nothing new to readers of Kiyosaki or Steve Pavlina or Lazy Man and Money or dozens of other blogs, who have covered the same ground in more depth and precision than I. But I think the challenge for many people is how exactly to recognize passive income generators. Owning and renting property and stocks is far and away the easiest way, but still require an initial payment of earned income (and again, many people would argue you can borrow money to generate that, but no-one will lend you money if you don’t have some sort of earned income ‘background’). Creative content, however, does not require an intitial payment of earned income, but a retroactive payment once it is created. So I continue to try to think of things to create, so I can generate more passive income and quit selling so much of my time (a limited commodity) to other people rather than using it myself.

things I learned from my grandparents about money, part 1

Most of my relatives have some very different ideas about money, and by relatives I am including the wide range from my wife to my parents to my in-laws, etc. I realized a long time ago that it is very easy to pick out the flaws in other people’s philosophies or actions while failing to recognize them in your own thoughts and actions. However, I still find it a fairly useful exercise to try and determine where people make good decisions and bad decisions. Even more important is trying to understand the ‘why’ behind those decisions.

My mother’s parents (my grandparents), for instance, have always been very frugal. They were both raised on farms in the 20s and 30s and suffered through the Depression. My grandfather left home to join the Army pre-World War II, serving in the horse cavalry (hard to believe the US still had a horse cavalry less than 70 years ago, isn’t it?)
Here are some of their views towards money that I think are interesting, both good and bad, and my take on them.

  • Investing, a good habit. My grandfather was an early fervent believer in investing. Coming from a rural background and suffering through the Great Depression you might expect him to be very wary of investing, but he was quite the opposite. He invested heavily in the market, and on a schoolteacher’s salary did very well over the years. He did this although he had a state pension and could have chosen to spend that money. From him I learned a very conservative study-buy-and-hold approach. Although I didn’t know it at the time I learned it from him, his approach was basically the same as Warren Buffet’s. While it didn’t make my grandfather a billionaire, it did make him a huge ‘extra’ retirement fund on top of his pension and my grandmother’s.
  • Never selling, ultimately a bad habit. My grandfather maintained an almost emotional attachment to some of his stocks and held them year after year, even in times of declining prices, shrinking dividends and their own advancing age and deteriorating health. They saved these stocks thinking they could pass them on, but as they have moved into more and more expensive housing (nursing homes are much more expensive than regular apartments, obviously) it has become obvious that all of that money will be gone soon, regardless. Had they moved it into a savings account paying 5% ten years ago they could have been earning steady income.
  • Never really spending, good and bad. Although they amassed such a gigantic fortune (relatively speaking) on retirement my grandparents never really spent much. They constantly talked of wanting to pass it on to my mother (an only child) and my brother and myself. They never traveled, although my grandfather dreamed of returning to see a peaceful Germany. They did ‘live large’ in some senses - they ate out almost ever day, they bought new cars for cash every few years while they could still drive and they were almost insanely generous to my parents and my brother and myself. They gave us stocks, cash and other gifts for years. However, it is hard for me to look back on their 20+ years of retirement and think that they never really did much after retiring. I know that part of that is my perception, since I love overseas travel, but I am not sure retirement was meant for watching TV and eating out. That’s a judgment each person has to make individually, I guess. But when my mom was younger and living at home they were very frugal, and even late in life my grandfather’s frugality could be amazing. A heavy, heavy smoker for his entire adult life, he quit cold turkey one day because he thought cigarette prices had finally gotten to high - and hasn’t smoked in 15+ years now. He never worried about the health aspect as far as I know, but paying $3 for a pack of cigarettes instead of $2 was apparently one dollar too much.
  • Avoiding debt, extremely good. My parents and grandparents gave me one gift that I realize is invaluable after I read many personal finance blogs: the fear of debt. I have been convinced since an early age that going into debt is practically a mortal sin, a stain on your character, a flaw. While I think it may have been overstated a bit, this philosophy has made me somewhat unique in a sense: I have never carried a balance on a credit card, EVER. I have had only two debts in my life: a car loan one time and a mortgage on my current house. Other than that, I have never bought anything I couldn’t pay for with my existing funds. So debt has never been a headache for me, which is a great gift.
  • Charity begins at home, mixed. I know this may run counter to many people’s beliefs, but another closely held belief of my grandparents was to take care of themselves and their own before others. This philosophy meant that there was no ‘automatic giving’ to charity until everyone in the family was taken care of. They gave (and still give) to their church every week, but I am sure without ever having seen it put to the test that had I been in need for some reason they would have given that money to me, instead. I know this is a somewhat selfish approach, but I think it’s right. Give when you are able. I do not subscribe to the Christian teaching that I should give ALL I own to the poor, and apparently from the number of Mercedes I see in church parking lots I’m not alone in rejecting that teaching. It doesn’t mean you can’t give to charity - I certainly give to several children’s charities - but take care of your family first.

Those points are really just highlights. The important lesson to remember is that anything your family or your friends teach you about finance is valuable. Sometimes you may learn by avoiding their mistakes, sometimes you may learn by taking their advice to heart - but it’s all learning. From my maternal grandparents, I learned to save and to avoid debt but also that sometimes you need to spend money, too, because there ARE things and experiences in life worth the money. The truly important thing was never the money, it was the security the money bought, and being able to give back to their family, that mattered to them.

follow the Poor Dad sometimes

If you spend any time on personal finance sites, you’ll hear about Rich Dad, Poor Dad. Personally, I would credit it with a tremendous amount of influence on my life since I read it in late 2003. This book changed the way I think about money, about priorities and even about life in general. I plan to review it in the near future.An important distinction, however, is that not all of this change was good. One of the main tenants of Rich Dad is ‘maximizing cash flow’, or attempting to push expenditures as far into the future as possible. A very common way of maximizing cash flow would be to take a balloon mortgage, for example, where payments are low or interest-only for several years then escalate.

At the height of the housing boom we bought our current house. Fervently embracing the concept of maximizing our cash flow, we attempted to get an interest-only monthly floating rate mortgage, which would (at the time) have resulted in sub-$1000 per month payments on our half-million dollar home. After 5 years, the payments would shoot up, but we were convinced we could easily refinance or move or somehow avoid that situation.

Fortunately for us, the neighborhood we were moving into did not meet the lender’s criteria for “aggressive” mortgages. It was too new, and there was not enough payment history for the neighborhood for them to measure the risk of default. Our mortgage application was rejected, and we proceeded to obtain a 30 year mortgage at 5.6%. This meant our payments were almost double what we had hoped, and we were not happy.

Three and a half years after being turned down for the adjustable rate mortgage, we still have regular payments. With the increase in interest rates we would be paying almost the same amount on the ARM that we are paying on our traditional mortgage, but it would all be interest. The balloon payment would be looming, and our cash flow would be no better than it is now.

So in retrospect we were saved from ourselves. Despite the fact that we think we are fairly savvy people about finance (she has a degree in finance and I have an advanced degree in accounting) we lucked out by being turned down for the ARM. I doubt we would have done much with the ‘maximized cash flow’ since our first thought would probably have been to invest in more real estate, again using ARMs. Doing so would have compounded our error, and now we would be facing a mounting avalanche of debt.

I think the moral I take away from this is that even when you follow a particular philosophy or guru, you should always consider a worst-case scenario. Sure, the traditional mortgage has cut into my income and made it difficult to consider vacations and larger purchases. That pales in comparison to the ARM worst-case scenario: being forced out of the house.

As a postscript, I still think that Rich Dad, Poor Dad is a critical read for anyone who lives in America. Kiyosaki makes excellent points about working for income versus investing, and made clear to me for the first time that what I wanted to be able to buy was time, not things. Financial freedom is the goal, although I had never heard it put so plainly. So please don’t read this as an indictment of his book. I highly recommend it, but as with anything else in this life you have to be cautious and conservative when dealing with your home, your family or your health. Without these three things all of the cash in the world will be useless.

Other reading:

Rich Dad, Poor Dad:  What the Rich Teach Their Kids About Money-That the Poor and Middle Class Do Not!

teaching risk tolerance

Pay down debt or invest


There’s a debate you read often on personal finance blogs: if you have a large sum of money, should you use it to pay down debt or invest? The answer is usually dependent on the person’s risk tolerance, but I think it also depends on the nature of the debt.

Debt is a bad thing in most cases. Something you “own” like a house is actually not owned by you. The house is owned by a bank. The bank is just letting you use it. Why? Fail to pay for a month or two, depending on the mortgage terms, and the bank will take back the house. The bank can’t just take 1/360th of the house back for each month you miss, so they will repossess the whole thing and the law will be on their side. To me, this means the bank owns the house.

However, there are better kinds of debt; take a student loan. If you pay for your education with a loan, it can’t be taken away later. You will have that diploma and although you can have your credit rating wrecked or your wages garnisheed by failing to pay that debt, you’ll always have that education. That’s quite different from using debt to own things.

Now if you have credit card debt, pay it down before you spend a dime on almost anything else in your life except maybe health insurance. Any debt where you pay 18%+ in interest is bad debt.

In comparing debt to investing, no investment in anything, ever, is guaranteed. We could plunge into a 20-year depression in October of this year. Unlikely, but the US has a number of unfavorable situations that could cause this to happen, so it is not impossible. If that happens, all of my index funds and money markets won’t be worth much. Investing has no guaranteed rate of return, and in fact can have a negative rate of return quite easily. If you bought Enron stock, your net return was -100%. If you have a stock paying 2% dividends per year with a stagnant price per share, you are not doing as well as you could parking that money in a high-yield savings account.

However, if you can pay down debt you have a guaranteed rate of return. If I have a 5.6% mortgage (I do, lucky me), then every bit of principal paid early is a reduction in the amount of interest I’ll eventually owe. Once that payment’s in, that interest is gone. This makes wonderful sense for something you want to ‘own’, like a house. However, if you look at my student loan example, what’s the advantage of paying early? Nothing, really. I already fully “own” the asset (my knowledge and diploma).

To sum these examples up, what really matters is ownership. If you can pay down debt to own something, I think that will beat investing any day. Sure, the investment might return 11% per year for 15 years. However, it might not, and many, many students of the market have been burned trying to beat it – better students than I. So I think the goal is to look at whether paying down debt increases your “true” assets or just stifles your cash flow by hurrying up payments for something you already own.

So that’s my opinion in the debt vs. investing debate. It does depend on the individual, but I think I would rather be debt-free and investment-poor than highly leveraged with a huge portfolio. If that was a smart idea, people would be using their home equity loans to invest in the stock market, right?

15 things I’d say to high school BB

I read an interesting article at Lazy Man and Money this morning entitled “15 things..”. It got me thinking about what I would tell myself, aged 18 or so, if I could travel back in time and give some advice to myself. So here goes:

  1. Save more. Echoing a comment by Lazy Man, I saved a lot but I could have saved a lot, lot more in my youth. There were a lot of gadget purchases and CDs and dinners out that I could have avoided that would probably pay for a year or two of my mortgage by now.
  2. Don’t stop exercising. The reasons for saying this should be obvious if you read some of my earlier posts on weight gain. I had a long slow period in the mid-to-late-90s where I never, ever exercised. The effects of that still haunt me today.
  3. Pay more attention to your tax courses. I have a master’s degree in accounting, but all of my specialization was in international accounting, audit and other ‘corporate’ areas. In taxes I whisked through a couple of courses simply because the university required it. I wish I had spent more time learning my taxes and building up my expertise in that area.
  4. Don’t move every year. From 1996 to 2000 I lived in 9 different apartments. Now part of that includes three brief stays of one or two months while “in transition” between cities, but I wasted a lot of time and money moving. While I was living in Moscow, it wasn’t so bad; I moved most of my stuff in one or two cars since I didn’t really own any furniture. In New York I wasted a lot of time and money moving, even though twice it was a somewhat involuntary move (Marriott bought my apartment building once, and 9/11 rendered another place I lived almost un-commutable).
  5. … and on a related note, buy a house when you start working and rent a couple of rooms out to roommates. I probably would be sitting on $300,000 of equity by now. And when you move to New York and think “who in their right mind would pay $600,000 for a two-bedroom in Manhattan?” the answer should be you. Some of that money wasted investing with priceline.com could have been spent on a down payment.
  6. Stay in touch with people. In the early 90s, it was tough to stay in touch with people. You had to call, or write a letter, or visit them. Then suddenly we got this neat little thing at work called ‘electronic mail’, or email for short. With a tiny bit of effort, I could have carried a little notebook with the email address of every colleague, acquaintance and friend of mine for the next ten years and dropped them a two-line email twice a year. I didn’t do this. I lost touch with a lot of good people – people I wish I still stayed in touch with for networking purposes, and some I just miss.
  7. Don’t work so much once you do get a job. I had a colleague in the got paid exactly the same as I did. Neither of us stayed with that firm, and as far as I know he went on to do just fine, as did I – but neither of us were making a future at that particular company. I had another colleague who smoked pot constantly and wouldn’t show up for days at a time. He didn’t get fired either. So I wasted a lot of time working very hard at a job I detested (I quit before I finished my three year contract). Who was the idiot?
  8. Don’t join a fraternity in college. Joining a fraternity seemed like a good idea, but other than making some very good friends it taught me nothing other than: (a) laziness, (b) racism, (c) sexism, (d) violence and (e) drunkenness. Sounds like a good deal, all for just a few hundred dollars a semester, huh? I basically spent three years surrounded by violence and ugly behavior that would make most people cringe. I wouldn’t wish that on anyone.
  9. Don’t worry about trivia. A major drama of my senior year involved a quiz for (supposedly) the smartest kids in school. I lost because of a difference of opinion over which battle of the Civil War was the “bloodiest”. I believe I answered Antietam, the single bloodiest day of the war; the correct answer was deemed to be Shiloh, the bloodiest battle of the war over the course of several days. Did losing the Brawl affect me in any way, shape or form? No. Don’t even enter the stupid contest, high school BB. Spend that learning Russian or just hanging out. It will be time better spent.
  10. Don’t waste a lot of time on TV. You will live in two of the world’s biggest cities, with a million possibilities for entertainment, the world’s best restaurants, cultural events and explosive nightlife, and you will often spend whole weekends watching football. You will even watch Notre Dame play, and you hate their team. Nice going.
  11. Buy a cell phone when you live overseas. I know $1000 for a mobile phone circa 1997 is a lot to pay, but it will be worth every dime not trying to coordinate your daily life from pay phones that never work. Your phone card cost $8 a minute, anyway.
  12. Be kinder to people, particularly women. I have never been cruel, I hope, but I spent a lot of careless years not worrying about how my actions might upset other people, particularly girls I dated or who liked me. I certainly ended quite a few relationships rudely and thoughtlessly, and probably created some real dislike if not downright hatred for myself. I was brutal in some of my work relationships both in my speech and actions. A little bit of compassion or even white lies to appear compassionate on my part probably would have made life better for everyone. I would have lost nothing by being kinder. I guess that’s just life, but I do look back and really regret some of the ways I lashed out at people where no lashing out was necessary. I particularly regret being cold and emotionless when I just could have faked a little bit of pleasantness.
  13. …and related, don’t worry too much about your relationships in the 90s and early 2000s. When you meet the right girl, things are going to be immediately and blindingly obvious. You may think you’ve met the right girl a few times in the late 90s, but when you actually do meet the right girl you’re going to realize that everyone up until her was definitely not the right girl.
  14. However, don’t do vodka shots with Russian mafiosos while out for a fancy dinner with your at-the-time-girlfriend and her friends. That will not end well on many, many levels. Oh, and make sure your visa paperwork is correct before you travel to remote Siberian cities. They don’t like it when foreigners show up with the wrong paperwork.
  15. Don’t work for the Big 4 or a corporation. This one is tough, because of course it has led me to the life I have today. But I do wish that when I was young and more or less free of responsibility that I had taken a few more chances. I wish I had gone to work at a smaller company, or a foreign company or even started a business. I spent a lot of my mid-20s – most of it, in fact – working horrible hours at decent but not exceptional salaries doing work I detested. I wish I had some of that time back, even if it meant I couldn’t afford a slightly fancier apartment or to eat out 5 nights a week. Working in the Big 4 gave me a lot of opportunities, but I always wonder what if…

That’s actually a good exercise. Feel free to leave a comment if there’s anything you’d tell your high school self.

Random thoughts on investing

I have a lot of thoughts on money, which in my case center not so much around how to spend it as how to save it. I rely heavily on my own prejudices, which are heavily influenced by my cynicism as an auditor who sees crooked finance and operations people every day at big multinational oligarchic companies. And I was heavily influenced by Rich Dad, Poor Dad (although some of my earlier infatuation with Kiyosaki has lessened as I thought more about his advice – more on that later).

Saying there is nothing urgent about saving money for the future is, to put it mildly, famous last words. Better to deal with things when you can do it in a calm and relaxed manner rather than needing to scramble when you’re 65.

…

I am a believer in the US market primarily because there is no real alternative for a corporate employee who has to put most of his savings in a tax-advantaged 401(k) that only really allows cash (money market-type holdings), bond funds and mutual funds as investments.

I have held individual stocks for most of my investing life, but no more. Why? Here’s an example. I was holding Wal-Mart stock. I got it when it was selling at 6. It split 4 or 5 times, went up to 50, and then stagnated for years, paying an awful 3% in dividends which were reinvested.

I took a look at Cigna, a major holding of my very elderly grandparents, recently. I personally think it is utterly crazy for retirees in their eighties to have so much money in a single stock. Cigna right now has a .04/share yield, which considering the $163/share price is effectively $0 yield per year: therefore they are losing 5.25% on 100,000 per year, or 5250. So if there was a capital gains tax hit of 15%, it would take 3 years to get in the black (and that’s simplified since I’m not considering taxes on interest). From a risk perspective, I think an insured money market would be far safer and significantly more liquid. The instant liquidity of cash principal may be important soon, and if they were forced to sell Cigna when it WASN’T selling at near its 52-week high, they could take a huge (imaginary, since it never really existed as a “gain”, only on paper) loss. Cash will not go down (except via inflation, blah blah blah, but that can be effectively hedged with a TIP or a money market, since inflation is not running at 17% – yet). CDs, barring some economic meltdown, are safe and insured.

However, it will take 3-4 years to be in “profit” mode selling off a huge stock holding like that, so it might not be worth it from that perspective. But in the long run at 5-6% in a CD/online savings account they could squeeze out another $5000 or so of cash a year.

The general fragility of the US economic system is a big bugaboo for Bubelah (my wife, at least what I’ll call her on this blog) and me. We have spent some time trying to figure out how to legally open a Euro bank account to start shifting our money out of the US. People put a great deal of reliance, for example, on the Chinese not calling their 500 billion in loans to the US. And I got really spooked by our stock-concentrated savings a couple of years ago - actually maybe a year and a half ago - watching a documentary about Enron. They were issuing “buy” recommendations on that while unbeknownst to the analysts, regulators, etc. Jeff Skilling was dancing around drunk telling his staff to make up fake invoices inflating sales. Is any other company out there as bad as Enron? Beats me. Could be. Maybe not. Maybe so. Probably so, in fact – human nature being what it is there’s always a guy out there who thinks he can game the system.

My thinking with finances has therefore been that rather than trying to think I can outsmart the thieves, the traders, the investment banks with their Crays making 8.2 million trades per second, better to plow everything into high-return cash and mutual funds that mimic the market, and then forget about it. If the US crashes, we’re in a bad spot, but if 5 of the Fortune 500 turned into Enrons tomorrow it would only be 1% of our portfolio. If someone holds a half dozen stocks, it’s 15% of theirs.

It’s tricky. Obviously I’m not retired and living off my investment income in Bermuda so it’s not like I know it all.

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