KEY POINTS:
Passive income is the catchcry of property investors everywhere. It's income which flows into the bank without having to work for it, and it is, ultimately what brings financial freedom, says Robert Kiyosaki, author of Rich Dad Poor Dad.
In Kiyosaki's terms the rich use their money to
buy real assets, which generate a positive cashflow, and reinvest until their capital increases to a point where their passive income overtakes their expenses.
Of course there are very few real passive income opportunities. An investor who has his or her properties or business managed still has taxes to complete and accounts to review.
Even so, too few people understand the concept of passive income, says business coach Martin Jimmink of Action International. He recommends clients read The Richest Man in Babylon.
Passive income itself can be broken down into two basic types: residual income and leveraged income.
Residual passive income is income that continues to be generated after the initial effort has been expended. Examples of this include everything from insurance agents earning annual renewal commissions on policies to an author or playwright receiving ongoing royalties. The insurance agent sold the policy once, but continues to get an income, while the author spent many months or years writing but then, if the work is a success, receives cheques for their rest of his or her life.
A classic example of residual passive income is Speeches.com developed by Aucklander David Slack. Anytime anyone in the English-speaking world uses his build-your-own speech website, ker-ching another deposit of US$19.95 wings its way into his coffers, any time of the day or night whether Slack is awake or not.
The other type of passive income is leveraged income, where you use the work of others to earn income. Examples of this are business owners who earn income off the efforts of their employees, people selling products of any sort through a network of affiliates, contractors who outsource work to subcontractors, and franchisors who get a cut of sales from their franchisees. The key is that you're earning money from other people's labours, not yours.
There are examples of passive income where you are actively involved, such as running a seminar where the more people who come, the more money you make. Although you're involved, your earning potential increases the more people who come, rather than being paid on an hourly rate.
When it comes to passive income from investments, the formula for how much capital you need is quite simple, says financial planner Lisa Dudson of Acumen. That is take whatever annual passive income you want and multiply it by 20.
"Too many people say, 'I have a $1.2 million house'," says Dudson. "Whoopty doo, you're not going to eat off that." The capital needs to be over and above any lifestyle assets such as house, bach, boat and cars and these assets also need to be paid off.
Dudson says she meets many people who underestimate the work and risk involved in building up passive income fast. While the minority of property investors, for example, achieve it, those that do take on considerable risk are "completely consumed" by what they do.
Dudson compares it to dieting. On one hand, serious dieters such as body builders will live on egg white, chicken breast and broccoli for a month and achieve their target of losing fat. For the majority, she says, simply consuming one less beer and hamburger in a day is all they can achieve.
"People think it is a lot easier than it is," says Dudson. "I had one couple visit me last week who wanted to create a passive income out of property. They had a $1 million gap between where they are now and where they wanted to be in two years' time and they had a very conservative risk profile. Is that achievable? Highly unlikely."
Just being in business doesn't guarantee a passive income. It's only when you employ people, or sell through a network of associates or other businesses that passive income is produced.
Nor does buying a business, says Clyth McLeod, owner of Business Appraisals Ltd. Unless you've got a cool $5 million or more to spend on a business it's likely you'll have to work in it and work very hard for the first few years. Only after then will you be able to step back and live off some of the passive income.
Assuming your business is a success, that income should be well in excess of a managerial income in the same industry. McLeod cites two retail business owners he met recently who worked two days each a week in their business, which generated net annual profits of $350,000.
McCleod is keen to point out that business on average returns 27.4 per cent, far higher than stock or property market investments over time. And if you're not entrepreneurial, says McCleod, there is always the opportunity of investing in a medium-sized business using brokers such as himself to identify potential investments.
"The banks are still fairly bloody minded about lending to small to medium-sized enterprises and if the investor also has skills that could be complementary to the owner it is a win-win situation."
Another way that people without obvious business acumen get into business is through multi-level or network marketing, which is increasingly popular.
Names such as Tupperware and Avon have been around for years. Newer kids on the block include USANA and other health supplement companies.
Typically someone starts by being a consultant and selling the product itself. But the ultimate aim is to recruit more salespeople and take a percentage of their sales. The greater number of layers of salespeople you get below you, the more times you can click the ticket for sales you haven't personally made.
Network marketing is an industry that requires a lot of caution on the part of potential salespeople. Some companies require a considerable upfront investment to buy samples of the product. More dubious ones require the salespeople to commit to spending so much a month on the product themselves before they're allowed to sell it.
Another example is couples, where one partner is able to dedicate time to building up passive income while the other continues to earn a a fixed income.
Passive income rhymes with massive income and it's not surprising that the concept attracts rip-off merchants by the dozen.
Google the words "passive income" and a series of sponsored links appear that tell the story: "Earn $1000-$6000 a week", "Millionaire Methods", "I can make anyone a fortune online, proven system", "3 wks financial freedom". Pull the other leg.
What's more, says Dudson, just look at the vast numbers of seminars on offer promising the secrets of passive income.
Some such as those from property investor associations will be genuinely educational, others will simply be selling another overpriced product, creating passive income for the seminar presenter, not you.
