Introduction to the Passive Income Journey

Active Passive Additional Income Pyramid

We like to write about the importance of building passive income streams and the journey to financial independence. For some the journey starts early in life, saving pocket money or money from a part-time job to go towards a car purchase, for education or even to put towards an investment such as a share or managed fund portfolio, an investment property or even cryptocurrency.

In most cases the earlier you start investing in quality assets (using compounding interest to your advantage) the quicker your path to financial independence will occur (anyone reading this who has young children start teaching them about investing and entrepreneurship now!).

If you are a little late to the investing party, all is not lost. As the Chinese proverb states “The best time to plant a tree was 20 years ago. The second best time is now.” So to help you begin your passive income journey, let’s determine where you currently are at financially.

What is your current financial situation like?

We are going to assume that you are on top of your finances and are ready to take your investing to the next level. Should you need help setting financial goals then have a look at this article or if you would like further information automating your finances then have a read of this article. Essentially you want to be on top of your bills, have budgeted for your monthly lifestyle expenses and with your current levels of income have sufficient surplus income to go towards your savings and investments.

If this isn’t the case, have you reviewed your expenses recently? Are there ways you can increase your household income either with a pay rise, new job or setting up a side hustle? If you haven’t got a handle on your expenses it’s going to be hard to plan out your investments

Review your expenses and look for ways to reduce these, get a handle on your monthly lifestyle budget, review your income and look for ways to increase and once you’ve started building a regular surplus that is going towards your dedicated savings account now it’s time to look towards investing, ideally passive income investments.

Active income versus passive income

Most people are introduced to their first form of an income via pocket money. Perform chores around the house and you are rewarded with some pocket money from mum and dad or another relative.

As you get older you are likely to take up a casual or part time job in high school or college or a full time job straight out of high school or after you finish your university or tertiary qualifications. This form of income is known as active income, where you are trade your active labour for an income. No some jobs are more laborious than others i.e. blue collar v white collar however the concept is the same, trade your labour for income.   

Passive income (as the name would suggest) is a form of income that you receive passively or with little to no labour needed by yourself. This would include dividends paid to you from listed shares that you own, income from an investment property that you own or dividends from a business that you own and get others to run for you.

So which is best, active income or passive income?

Firstly, any income is great and the more of it the better for your finances. Ideally though you would prefer to have the passive income more than the active income as the more passive income you earn (in theory) the less time you are spending working for that income.

The big catch with passive income is that it usually takes a while to build up an investment or business to generate sufficient levels of passive income to allow you to replace your personal exertion income or to buy a passive income investment providing a sufficient level of income will usually cost you a significant amount of money.

Now that we can see that passive is the preferable income option, how can we transition from active to passive income?

Let’s assume that your current levels of income are enough to pay for a modest lifestyle with a small amount of savings per month. In this example you are looking for ways to earn additional money to build up your savings and investment potential as you wish to move to eventual financial independence.

Let’s look at the types of additional income one can earn.

Introducing the active/passive income pyramid

Active Passive Additional Income Pyramid

Above we have a diagram of what we call the active/passive additional income pyramid. It highlights the levels of additional income to your household and whether they fit into the active or passive levels of income. These levels are:

Level 5 Additional Income Unskilled

For most people the easiest way to increase the income levels coming into their household is to either get a pay rise/new job or to take on a 2nd job or establishing a “side hustle”. This can take the form of either additional unskilled labour income or additional skilled income.

An example of additional unskilled labour would income delivering food or packages, driving people for money, performing odd jobs for people such as cleaning or basic gardening.  This is reflected with the purple tier of the active/passive additional income pyramid.  

Level 4 Additional Income Skilled

Moving up to the next tier of the pyramid we get to the additional skilled income. This form of income is derived from a skill that you have or have learnt. This could include income derived from teaching someone a musical instrument, tutoring someone in a certain topic or taking on a freelancing gig in your chosen field of employment. This is reflected by the blue tier in the pyramid.

Level 3 Passive Income Basic Tier

Moving up to the next tier of the pyramid we get to the first passive income level. This is the introduction level passive income tier, an entry level position where you don’t have a lot of money to invest in a ready made passive income investment that will allow you to replace your current income so you are either buying a cheap income stream (small share portfolio) or a fairly cheap online business or building a passive income stream with your labour (so not so passive in the beginning).  An example of this could be you teaching someone or a group of people a certain skill or topic that you are looking to build into a passive income business. Another example is spending a lot of your time researching quality shares or purchasing a very cheap fixer upper investment property. This is reflected by the green tier in the pyramid.

Level 2 Passive Income Intermediate Tier

Moving up to the next tier of the pyramid we get to the second passive income level. This is the level where the passive income is significant but not sufficient enough to replace your regular job income. This could be purchasing a typical residential property (or two), a significant business that you will need to put in time with or an online business that will need significant time input to maintain its current income level. This is represented by the yellow tier of the pyramid.

Level 1 Passive Income Top Tier

The grand daddy of them all! This is the highest level, the level in which the passive income is enough to replace your current work income. The only drawback at this level is that the price to play in this field is very high. This could be an industrial or commercial investment property earning 6 figures net per annum. Or the real world or online business that provides a 6 figure net dividend with the day to day running handled by employees or a share/managed fund investment portfolio providing over 6 figures per annum in dividends. This is represented by the orange tier of the pyramid.

Obviously the orange level is the aim, how do we get there? Keep building up your household income levels through additional income or starting your own passive income business/investments through your labour. Keep reinvesting your surplus income and additional savings in these investments/businesses and watch these grow and grow and hopefully you will be up to the orange level one tier, in total control of your financial independence, managing your own calendar and living life on your terms!