Passive Investing Vs. Passive Income

Passive Investing Vs. Passive Income

Let’s talk about passive investing vs. passive income. If you pick up almost any book on investing, 95% of them will talk to you about how to be a passive investor. Passive investing meaning you don’t intend to put a lot of due diligence into what you’re investing in. You’d rather pay some expert to manage your portfolio and your investments. You want to go back to everyday life, and come back later to a nice retirement.

Passive Investing Vs. Passive Income

Traditional Investment Advice

Here are some of the common themes you’ll hear when listening to traditional investment advice….

1. Diversify based on your tolerance to risk– although many factors come into play when assessing tolerance to risk. age tends to be the biggest factor. The older you get, the less it’s about growing your money, and the more it’s about preserving it. The reason being is that taking more risk is something you can recover from if you’re young, and something you can’t recover from when you’re older. So a young investor’s portfolio will be heavily invested in the stock market, while an older investor will begin to allocate more heavily towards bonds, CDs, and cash.

2. Dollar cost average to get a better deal– most financial advisers won’t advise their clients to time the market. They actually follow a theory that  it’s almost impossible to do so. So instead, they advise their clients to allocate  fixed sums of capital into the market periodically. The idea is that if the market is “overpriced” your money will buy less shares. If the market is under priced, you’ll buy more shares with the same amount of money. This can create an overall better average price per share, and increase your overall returns.

3. Buy and hold– the same theory that tells them it’s foolish to try and time the market for buying, also tells them it’s just as foolish to try and time the market for selling. So they advise most people to buy and hold for the long term. After all, the U.S. Stock Market has been steadily increasing for the past century. (Although it certainly crashes periodically)

Active Investing

This might be hard for some people to understand, but passive investing is not the most effective way to generate passive income (In our opinion). In fact, I would argue that passive investors will probably have to work harder and longer building up their money for their passive investing to even work for them.

Let’s say you want to turn over all the decision making to your so-called expert fund manager. First of all, he’s going to charge you a fee which comes out of your retirement. Secondly, he makes money by collecting hundreds of millions or even billions of dollars into one giant fund. Since the more he manages, the more he makes, he doesn’t care that the fund size has now become too large and clumsy to invest effectively. The fund is now so large that as it’s buying and selling, it’s driving the market against itself. It forces them to buy higher and higher on the way up, and sell lower and lower on the way down. There’s a reason that only about 4% of mutual funds ever beat the market over the long-term.

Let’s say after all is said and done, you average about 5% annual. What that means is that in order for you to live on a $50,000.00 a year income, you’ll need a nest egg of about $1,000,000.00. Do you know how unlikely it is that somebody who can only scratch up a couple hundred dollars a month will reach $1,000,000.00? Almost impossible when your average performance is only 5%.

Now let’s say you pay the slightest bit of attention to what you want to invest in with your own money. Let’s say you care enough to only buy businesses with strong earnings, steady growth, little debt, and a consistent market demand for their product. It isn’t hard to find companies like them. And let’s say that as a result of your marginal due diligence, you now average 10%. Part of why you average 10% is because you aren’t paying a fund manager.

You’ll only need a $500,000.00 nest egg to live on the same $50,000.00 a year income. And you’ll get there WAY quicker since you’ll be compounding your money faster. Now imagine if you could kick it up to 12% or even 15%.

Active Investing = Passive Income

In our opinion, there are many effective ways to get much higher returns than your standard mutual funds. And in our opinion, they aren’t any riskier. (In fact we think they’re less risky.). Active investing is simply about putting together an All-Star Team of investments, rather than picking ones at random. Warren Buffet does it. He’ll spend years waiting for a good company at an attractive price rather than trying to spread his bets out among a hundred different stocks. That’s why while mutual funds average only 5% to 7% after fees, Warren has averaged over 25% over his very long and steady career.

Who do you think is actually more ‘active’ in their pursuit of money? Warren chooses to do a little work up front, he no longer has to worry about showing up to a job for a paycheck. Meanwhile passive investor baby boomers are still working into their 60’s and 70’s. So ask yourself this. “Do I want to be a passive investor? Or do I want to start making passive income as quickly as possible?”

We’re probably the laziest investors you’ll ever meet. We believe an ounce of prevention is more valuable than a pound of cure. We are willing to be a little smarter up to be way lazier on the back end. Take a look to see one of the ways we accomplish this here.

 

 

About The Author

herbertkoehler

I am a college drop out who found my passion as an investor. I love the many facets of finance, investing, and business. But even more than that, I love sharing what I learn with others.

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