The missing element of many portfolios

Andrew Lanoie is a best-selling author, investor, and podcaster at The Impatient Investor, as well as the co-founder of Four Peaks Partners.

Many who lost their jobs or found themselves in difficult or precarious financial situations as a result of the pandemic in 2020 woke up financially. Unprepared by Covid-19, many made reassessing and adjusting their financial plan — or lack thereof — a top priority. And the most important thing was how to protect themselves in the future from a sudden cessation of income or a sudden major financial loss.

Many asked this question: “What can I do to maintain my lifestyle and pay all my bills and expenses without sacrificing the future by diving into my savings or liquidating my assets?”

The answer? Passive income.

While many suffered from financial turmoil in 2020, part of the population went on with life financially. Of course, we were all affected by the social effects of Covid-19, but some people navigate the tumultuous financial waters better than others. “Wiping out the storm” wouldn’t even be an accurate description of what this sheltered segment of society — the rich — went through in 2020, because they were able to avoid the storm altogether. How? Passive income.

What is passive income?

Passive income is income that does not come from work or does not depend on the number of hours in a day. It is the income you earn whether you work or not, whether you are sick or healthy. It does not matter. Passive income investments don’t sleep. They work 24-7. That’s why people with passive income streams — especially streams that equaled or exceeded costs — were able to avoid much of the stress and anxiety about money that those without passive income streams experienced.

Passive income is often the difference between the rich and the middle class. It’s the difference between not worrying about an economic downturn and doing your best to plug holes in an unstable financial situation.

The rich have been covering recessions for years and fortifying their financial walls with passive income. Just look at the asset allocation of one such group of ultra-wealthy investors: Tiger 21. For those unfamiliar with Tiger 21, it’s an exclusive social investing club (minimum $50 million in investable assets to join) where the rich come together to share insights.

If you look at the latest asset allocation report for Tiger 21 members, one thing should become very clear. Unlike many in the middle class who follow the 60/40 asset allocation strategy – 60% stocks/40% bonds – those near or at the Tiger 21 level are heavily allocated to assets containing a mix of both passive and income as growth potential. Government stocks and bonds take a small slice of the pie.

Why the mix of passive income and growth?

Simply because the rich look beyond their own lives. They plan for future generations. Passive income meets current needs and can be reinvested to generate passive income forever. Underlying valuation provides another level of wealth that builds public equity and debt does not.

No more exchange time for money

Without passive income, you always trade time for money. In the words of Warren Buffett, “If you don’t find a way to make money while you sleep, you’ll work until you die.” Many in the middle class will trade time for money until retirement. In many cases, seniors who are financially unprepared for retirement will trade time for money long after their retirement age.

A simple formula to conceptualize the impact of passive income shows what can help achieve financial independence: Passive income > expenses = financial independence. You can achieve financial independence when your passive income exceeds your expenses. Why define financial freedom this way? Because unless you can quit your job and still maintain your lifestyle, you are not financially independent. It doesn’t matter how much you cut your expenses. Without passive income, you will eventually have to work to cover those costs.

Limits recessions and downturns

Passive income can help mitigate the potential economic effects of recessions and contingencies such as the Covid-19 pandemic. Investments in recession-proof assets are particularly attractive for mitigating economic disasters. In 2020, there were certain assets and market segments that did well during the downturn caused by the pandemic. Some assets even thrive in any economy. Passive income generated by these assets is ideal for mitigating a potential loss of income or lifestyle during a recession.

Live your best life

Passive income offers you a way to live your best life now. Most retirement plans are deferred gratification plans. It is now a matter of tightening your belt so as not to suffer later. Passive income allows you to stop trading time for money and buy back your time. It gives you a greater chance of freedom to walk away from your day job if you choose to and pursue other ventures and passions.

How to get started

There are multiple print and online educational resources on passive income – many of which focus on particular assets. These are valuable resources for the novice investors seeking passive income investments, but in my own experience I have found that the best source to learn about new investments is through investors who are already involved in them. Many of these investors can be found on LinkedIn and other social media investment circles and many are happy to share their experiences and knowledge. Invest in your passive investment education and take the time to seek out experienced investors to maximize your willingness and opportunities.

If you want to take a day off from work in the morning to play golf, have lunch with your partner in the afternoon, and play with your grandkids in the evening, passive income can make it happen.

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