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By Dr. Jim Dahle, WCI Founder
Passive income is a wonderful thing. Who wouldn't want it? Money without work. It's like the Holy Grail and the pot at the end of the rainbow all wrapped up into one. While I have yet to actually live on passive income, the day will come eventually. Some forms of passive income are more passive than other forms, but you can learn more about all of them at Passive Income MD.
Today, I'm doing a Q&A with myself to talk about passive income, why it's important to me, and how much of it we've made.
Role of Passive Income
Q. Why is passive income important to you?
Honestly, passive income doesn't play much of a role in our lives. We mostly view it as part of our investment portfolio. Since we still have more active income than we spend—even including taxes and charity—the passive income we get at this point is all reinvested and simply raises our tax bill. We'd just as soon have an increase in the value of our investments rather than actually having the income, knowing that if we ever need the income later, we can just convert the investments into cash or into other investments that actually produce income. However, it is nice to know that stream of income is there. Perhaps somewhere subconsciously, that income has allowed us to take more risks with my career, our business, and our investments that we otherwise would not have taken.
Current Passive Income
Q. How much passive income do you have? Which of your income streams are you counting and which are you not counting as passive income?
I count regular real estate income from my passive real estate investments. On the equity investments, that's mostly rent sheltered by depreciation. Note that some of our investments (like Origin Fund III) don't make regular distributions. They send principal and earnings back in lump sums when properties are sold. I ignored all of those larger distributions in these calculations simply to make it easy to calculate, even though part of those distributions are considered taxable income. With the real estate debt investments, the income is just interest/ordinary dividends. I also count bank account interest and mutual fund dividends. I am not counting my clinical income (definitely earned), our WCI S Corp salaries (definitely earned), WCI S Corp distributions (maybe not so earned, but not particularly passive), or income from partner companies (again somewhat passive and somewhat earned). I am also not counting any capital gains.
In 2021, our passive income included the following:
- Taxable interest: $10,252
- Tax-free interest: $14,500
- Qualified dividends: $88,116
- Non-qualified dividends: $78,531
- Equity real estate income (rents): $36,841
- Income in retirement accounts and HSA: $93,828
Total: $322,068
Not counting taxes or charity, that's more than we spend. (We spent $207,000 in 2021.) If this were our only income, we could pay our taxes, maintain our lifestyle, and still give a good chunk away each year. We're not just financially independent based on wealth but also on income. Despite setting up our portfolio to maximize our risk-adjusted total return rather than to maximize income, there's still plenty of income there for our needs and wants. Since we're still working and investing, these income figures are only rising each year.
More information here:
How Our Private Real Estate Investments Performed in 2022
6 Ways Passive Income Beats Active Income
Spending Passive Income
Q. Do you actually spend any of your passive income, or is it all (at least after paying taxes) reinvested at this point?
Depends on how you look at it, I guess. Since our earned income is more than we spend, you could say we don't spend any of our passive income and reinvest it all. At the beginning of the month, however, we take all of our earned income and all of our passive income and lump it all together before determining how much is spent, paid in taxes, invested, and given away. From that perspective, we do spend some of it. If one defined our passive income more broadly to include S Corp and business partnership distributions, we certainly do spend a lot of that on taxes!
Misunderstanding Passive Income
Q. What do people most misunderstand about passive income?
Passive income is a bit of a continuum. There are some sources of income that are essentially completely passive, such as bank interest and mutual fund dividends. As you move into real estate, some income is far more passive than other income. Some additional work isn't necessarily a bad thing, as it often adds to your return, but it does mean that income is less passive. Other sources of “passive income”—such as blogs, books, and online courses—often require a lot of upfront work, and then the income comes passively after that. Even within the online entrepreneurship space, there is a continuum. An evergreen, automated course sold off a static website is much more passive than a cohorted, instructor-led course sold off of a blog. The first, I would argue, is mostly passive after the initial work. The second is not passive at all.
More information here:
How Did These Physicians Create Passive Income?
Independence Through Passive Income
Q. What do you think about doctors wanting to get some passive income so they can reduce their clinical work?
Early on in the COVID pandemic, many doctors saw decreased volumes and canceled procedures, which caused a large hit to their usual clinical physician income. As a result, they became MUCH more interested in diversifying their income streams, whether through active income streams or passive income streams. Even in more normal times, many doctors get to feeling pretty burned out and need to work less. The first thing I tell a burned-out doctor to do is to cut back to full-time!
Those docs just need to figure out whether they need to work less or whether they just need some different work. If you need to work less, you only have two choices. The first is to spend less money, and the second is passive income. Spending less money works really well because a penny saved is two pennies earned. Not reinvesting your passive income so you can spend it has the unfortunate nasty side effect of causing the portfolio (and, of course, future passive income) to grow more slowly. But it is relatively easy to shift a portfolio into assets that provide a larger percentage of the return as income. A growth stock mutual fund has a very low ratio of income to return (perhaps 0.1), but a debt real estate fund has a very high ratio (essentially 1).
If you just need different work and not less work, you have a third option: starting a side gig. Some side gigs will always be active, but many are more active up front and more passive on the back end. I think that's the route a lot of docs end up going. One of the most reliable entrepreneurial pursuits is direct real estate. You start out doing everything yourself and then gradually build systems and hire managers to follow your systems as you move along. Eventually, that income becomes very passive and may even replace your clinical income and/or fund the rest of your life.
All else being equal, more income is a good thing, and more passive income is a very good thing. I hope you found this peek into our passive income helpful. I wish you the best in building your own streams of income.
If you are interested in building passive income streams through private real estate investing, start your due diligence with those who support The White Coat Investor site. They just happen to be some of the best companies in the business.
Featured Real Estate Partners
DLP Capital
Type of Offering:
Fund
Primary Focus:
Multi-Family
Minimum Investment:
$100,000
Year Founded:
2008
Origin Investments
Type of Offering:
Fund
Primary Focus:
Multi-Family
Minimum Investment:
$50,000
Year Founded:
2007
37th Parallel
Type of Offering:
Fund / Syndication
Primary Focus:
Multi-Family
Minimum Investment:
$100,000
Year Founded:
2008
Southern Impression Homes
Type of Offering:
Turnkey
Primary Focus:
Single Family
Minimum Investment:
$60,000
Year Founded:
2017
Wellings Capital
Type of Offering:
Fund
Primary Focus:
Self-Storage / Mobile Homes
Minimum Investment:
$50,000
Year Founded:
2014
MLG Capital
Type of Offering:
Fund
Primary Focus:
Multi-Family
Minimum Investment:
$50,000
Year Founded:
1987
Mortar Group
Type of Offering:
Syndication
Primary Focus:
Multi-Family
Minimum Investment:
$50,000
Year Founded:
2001
AcreTrader
Type of Offering:
Platform
Primary Focus:
Farmland
Minimum Investment:
$15,000
Year Founded:
2017
* Please consider this an introduction to these companies and not a recommendation. You should do your own due diligence on any investment before investing. Most of these opportunities require accredited investor status.
What do you think? What role does passive income play in your life? How much passive income do you get in a year? What do you count as passive income and what as active income? Comment below!
The post The Effects of Passive Income appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.
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By: The White Coat Investor
Title: The Effects of Passive Income
Sourced From: www.whitecoatinvestor.com/effects-of-passive-income/
Published Date: Fri, 18 Aug 2023 06:30:04 +0000
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