Saturday, May 9, 2015

Active Versus Passive: A Dollar Isn’t A Dollar

I’ve discovered something really interesting over the years.
When I first started out in the auto industry, I was so excited just to make some money. I still remember crossing $30,000 in one year and thinking how “rich” I was.
Now, don’t get me wrong, $30,000 is a lot of money, even for an entire year of work. For perspective, that puts you in the top 1.23% in the world in terms of annual income.
So that’s just a lot of money to earn in one year. I worked incredibly hard for that money, pulling down many 50-hour workweeks. I remember working until 9:00 at night on Mondays – after starting the workday at 7:30 a.m. Nothing like getting home at 9:45 or so, eating a quick bite, taking a shower, and going to bed. Ahh, the American Dream.
While I was appreciative of the income, I also knew there was no way I wanted to keep doing that for decades on end.
And that kind of brings me to what this article is all about.

Work Smarter, Not Harder

There’s a major difference between active income and passive income: effort.
We already know what passive income is. It’s any income you don’t actively work for. Dividend income is of course my favorite flavor, but income you earn from a bank account, credit card rewards, royalties, licensing, and fixed income is all passive income. Rental income could even be included as well, though I’d argue that involves a bit more hands-on work than the rest.
Passive income doesn’t care how hard of a worker you are. It just flows your way, like a river to the sea. Now, you have to work hard – incredibly hard – to build up a passive income stream in the first place, but once that stream is flowing, it’ll likely continue to flow. Basically, you do the work once and potentially collect for the rest of your life.
That’s very different from active income.
If you have a job of any sort, you’re earning active income.
Active income is great. It provides the cash that you can turn into cash flow – converting active income into passive income, slowly but surely. But you have to work for it. Constantly. If you stop showing up to work, guess what else stops showing up?
You guessed it: your paycheck. Your active income.
Working hard is admirable. But make sure you turn that hard work into smart work. Turn those active dollars into passive dollars.


You’d think that you’d somehow get punished for making “easy” money like dividend income. Like there would be this major drawback to just sitting on your butt and collecting money. But our economic system actually favors the investor class over the working class. As such, favorable taxation is just one more reason to work smarter, not harder.
I’ve discussed it before, but it bears repeating every once in a while. Qualified dividend income is wonderfulfrom a tax perspective. If you’re within the 15% tax bracket or lower, qualified dividends are taxed at 0%.
Using tax year 2015’s tax bracket, you’re in the 15% tax bracket up to $37,450. So if you’re, say, a single filer, you can claim the standard deduction of $6,200, the personal exemption of $3,950, and earn up to $47,600 in qualified dividend income and still pay a big fat zero come tax time.
Compare that to your paycheck and I think you’ll find yourself quite disappointed. Not only is the income notso favorable from a federal income tax perspective, but you’re also most likely going to be responsible for Social Security and Medicare taxes as well. So just go ahead and wipe out another 7.65% (assuming you’re not a doctor or lawyer) of your taxable income right there.
Active income or passive income? Hmm, tough choice.

A Dollar Isn’t A Dollar

I mentioned at the outset of the article that I’ve realized something over the years. And that something is that a dollar isn’t always a dollar.
My long-term goal for dividend income is $18,000 per year. So I hope to earn $18k in passive income by the time I’m 40 years old. That’s approximately what I think I’ll be spending at that point in time, but it’s obviously impossible to know for sure what I’ll be spending eight years from now. Nonetheless, that’s my target.
Now, some people might scoff at that. After all, it doesn’t sound like a lot of money. Let’s forget for a moment about all we’ve learned about happiness and how it just doesn’t take that much money to be happy. Let’s also forget that would put me in the top 5% of the world in terms of global annual income.
But $18,000 in passive income is a lot more than it sounds like.
And it’s certainly worth much more than its equivalent in active income.
First, we have the math to prove it. $18,000 in active income worth about $2,000 less than passive dividend income after you’re done with taxes (assuming you’re single).
Second, there’s no associated costs with the passive income. No lunches with co-workers, no uniforms, no dry cleaning, and no transportation costs to and from work.
Third, financial independence grants you geographical independence as well. You’re no longer tied to one particular spot. How much would you pay your employer (or give up) to work from home? To work from Spain? To work from the mountains in the summer and the beaches in the winter? To work from… anywhere? What’s the value in that?
Fourth, and more importantly, you don’t have to work for passive income anymore once it’s flowing. The$941.85 in dividend income that hit my brokerage account last month came my way without one second of work on my part. I just woke up and – poof! – it was sitting there, waiting for me. It’s like the best magic trick of all. I feel like Houdini sometimes. Abracadabra. Money!
I continue to work, save, and invest so that I can keep adding to that river of passive cash flow, but the river’s already flowing. No stopping it now. Even if I stop investing right now, it’ll continue to flow and eventually render me financially independent one day anyway. You can see that via my recent dividend growth update. Financial independence is coming whether I like it or not (I like it).
Think of it this way. If someone gave the choice of working at a jobby job for $30,000 per year in exchange for about 2,250 hours of your life annually or they promised you $18,000 in passive income that would increase at least in line with inflation for the rest of your life, which would you choose?
A dollar is not always a dollar.
And that’s because our time is the most valuable commodity of all.


I hope this article perhaps offers some perspective when it comes to your different income sources. Passive dividend income is truly more than it seems at first glance. There’s no objective and quantitative number that can be given, so it’s up to you to decide how you value your passive income. But I can tell you that I personally value every $1 in passive dividend income on par with at least $3 in active income. I can tell you for sure that I’d rather collect a buck for just waking up and being me than three dollars for busting my hump at pretty much any job a vocational counselor could come up with.
What do you think? Is a dollar not always a dollar? How do you value your dividend income? 
Thanks for reading.

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