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Start up School Lesson #3: Sources of Passive Income

Sources of Passive Income

In lesson 2 in Start up School: taking control and gaining your financial freedom we described what it meant to do business the Tomato Way. We talked about generating residual (passive) income from your activities so that you can create a business that works without you.

In this post we are going to talk about the different types of passive income streams you can establish to fund your lifestyle. Some of these may be more suitable to you than others, Lesson 2 might give you some more ideas.

Here’s some sources of passive income, which one works for you?

Investing in the stock market

Firstly investing is which, by it’s nature is a passive process. Take for example Warren Buffet from Berkshire Hathaway, he rarely sells anything.  The idea is that you buy a stock or share and hold it. Over time you’ll get an income (dividend) and capital growth.

Whilst most people assume that you need a fair amount of knowledge to invest in the stock market, you  really need to focus on just  3 things : 1) Filtering investments, 2) when to buy and 3) when to sell. Although mastering these is no easy task.  But remember, investing, like life, comes with no guarantees and you should only invest after you’ve created your emergency fund.  What is more, the amount of passive income will be dependent on the amount of capital you have to invest.  Therefore, for most people the stock market will only form a small part of the passive income.

Property

For most people the largest asset they ever have at retirement is the equity in their own home.  But here we aren’t talking about your own home, we’re talking about renting property out to other people.  Unlike investing in the stock market you typically don’t fund the entire purchase of a property from your own money. You put an amount down, called the deposit and the rest is lent to you by the bank, known as a mortgage. You either have a repayment mortgage and pay it off over a fixed term, say 25 years, or you pay interest only and repay all the borrowings back at the end of the mortgage (usually by selling property).  Now you can more or less rent out any type of property but you need to do your homework choosing both your location and the property carefully.

Like an investment in the stock market income is generated in two ways. Firstly by the rent you receive from the tenant (less the costs of any repairs and the mortgage payment) and secondly through any capital growth.  Side note: professional property investors don’t invest for capital growth, they invest for the monthly cashflow i.e. the difference between the income from rent and the amounts paid out in expenses, capital growth is seen as a bonus.

A big differnence between investing in  the stock market and investing in property is that most people assume that the ‘gain’  or profit is simply the difference between the price you paid and the price you sell at. This is not the case. Because you borrow a fixed amount off of the bank, this is the amount that you will pay them. For example. Say you bought a house for $100,000 using $10,000 deposit and $90,000 mortgage from the bank.  At the end of the loan period (assuming an interest only mortgage) you’d still owe $90,000.

Let’s just say that you keep the house for 10 years and when you sell it you sell it $150,000. To most people that’s a $50k profit (ie a 50% return). However if you remember, you only put $10,000 of the purchase price of the property and the bank loaned you the rest.  The reason why many people like investing in property is this. You actually make $50k on a $10k investment ie a 500% return on your money…. but before you get carried away…

The downside of investing in property is that it takes a lot more effort than investing in the stock market and you also need some capital behind you in order to be able to fund the deposit. Plus you’ll need to have a good credit rating in these current times in order for the bank to lend you any money.

Network Marketing

Network marketing AKA Multi Level Marketing is where you act as a ‘distributor’ for a product or service, but instead of selling it through shops or online, you promote it via your network of friends. Think here Avon Cosmetics or Tupperware (sometimes called ‘party selling’).   Essentially it works like this, you demonstrate products to your friends and family and because they trust you, they buy the the products and you earn a commission.  The downside of a lot of these schemes is that once people have bought some things off of you they don’t need to buy them again, so you’re going to have to grow you business by either hiring more people to be distributors (and then you take a small commission off of what they sell) or you find more ‘friends’ (ideally you do both). These types of business tend to lend themselves to evenings and can be quite time consuming, often only generating relatively small amounts of commission.

A much better way of doing multi level marketing IMO is to sell or promote a product or service that people need to use all the time, you sell it once and they keep on buying it – it’s business on auto pilot. If you’re in the UK check out Utility Warehouse – who provide electricty, gas, phone and broadband internet. These are the sort of businesses that if you put in effort at the begining, they will reap rewards for you for years to come.

In some ways, Network Marketing is similar to franchising, but you don’t have a large up front cash investment, you can typically work from home and you can choose your own hours. Check my post Why Franchising Might Not Be Right For You.

Infopreneuring

Due to the popularity of the book The 4-Hour Workweek by Tim Ferriss this is the most common form of people looking to set up a passive income stream.  There are many routes to be an infopreneur. You could create videos, podcasts, membership sites or eBooks. Basically being an infopreneur is being a seller of information. What do you know or could easily find out knowledge which would be useful to others.

Perhaps you’re a runner and have run several marathons, you could provide a training guide or advice on how to get started running.   Maybe you’re a cook who is short of money and used to feeding your family on a few $’s a day.  Everyone knows something that will be useful to someone else. You just have to figure out what it is (more on that in the next lesson).

In the ‘old days’ ie before the internet an infopreneur would have sold their knowledge through the classified ads in local and national newspapers (some people still do) however, the most common way nowadays is via the internet, thanks to low cost distribution systems and large markets waiting to be satisfied and the communities that build around certain issues.

Affiliate marketing

Affiliate marketing is similar to being an infopreneur, but instead of marketing your own products you market those of other people. (Again we’ll be covering that in another lesson). Many people do this online – so called internet marketing or IM for short.  Essentially this involves either promoting the product from your blog or sales page or more commonly nowadays through your email list. We shall be covering all these items in future lessons!

Most people do not rely entirely on one passive income stream and neither should you. You should build multiple streams of passive income so that you aren’t overly reliant on one single source.

So, what about you, what do you think?