On this episode of The Passive Income Attorney, Seth discusses active vs passive income in a broad sense. Seth speaks about his investments and gives his advice on which type of income would suit your lifestyle, be it active or passive.

“The biggest advantage to passive investing is what I consider the most important thing out of all things. And that is time.”

HIGHLIGHTS:

0:00 – Intro
1:57 – Seth discusses active income
3:51 – Seth speaks about passive income
4:38 – Seth compares pros and cons for active vs passive investing
6:15 – Seth talks about the biggest advantage of passive investing
7:47 – Seth informs us about his personal investments, both active and passive
10:52 – Seth proposes that you ask yourself, what is the best way for me to achieve true financial freedom, and what level of activity am I willing to take on and still live the life that I choose to live?
11:14 – Seth mentions that in a future podcast he will take a deep dive into active vs passive investing in regards to real estate

FULL TRANSCRIPTION:

Welcome ladies and gentlemen. It’s another beautiful day and I am truly grateful that you have lended me your ear for the next 15 minutes or so, so that I can provide you with another stepping stone down the pathway to achieving the confidence and the freedom that comes along with creating multiple streams of passive income.

Today, I want to dive into a very important topic and that is defining passive versus active income. Previously, we went into a deep dive on, you know, passive income and how it can change your life. But really now I want you to be able to see the dichotomy between the two, between passive and active income and decide ultimately what’s right for you and what you have the time, effort, and capacity to do.

Now everyone is going to develop their own definition of what passive means and what active means. And in reality, it’s on a gradient scale. It’s not as if when you evaluate an income stream that it is either 100% active or 100% passive, but rather it’s more like comparing one investment to the other potential investments and evaluating how passive or active it is compared to those others. Now just so you know, I’ll be drawing some lines in the sand today between active and passive, but just keep in mind this comparative gradient scale approach.

So, let’s start with active income. For me, I define it active income as the money you earn as a direct result of the work or time you put in. So, this is the most common form of income and what most of us are used to and frequently earned by “trading time for money.” It’s, you know, it’s the income you’re getting right now from your W2 job. Think of it like a one for one tit for tat type of deal. I put in one unit of time of work, and I get one unit of value in return. That unit of value for many of you listening right now could be very high. You might be charging $300, $500, $1000 an hour. And if all goes well, and you’re competent, that number likely increases as you progress through your career.

For most people though, you know, active income comes from your W2 job and it’s their only stream of income. And really that’s an extremely risky position to be in. Don’t you think? Some of us may not have thought about this concept in this light, but some of us may have experienced it firsthand by getting laid off during an economic downturn or even a cyclical dip in our particular industry. We’ve seen that without our W2 active income, we have to pull from our savings to pay our bills, to pay for those nice cars, that nice house and that nice life that we’ve built for ourselves and our family. It’s stressful.

Switching gears on the other side of the spectrum is passive income. In a previous episode, I went into this in detail, but let’s quickly run through it in a different light. I like to define passive income in the same manner as active income. So comparatively passive income is money. You earn disproportionately to the work or time that you put in. I believe this is the most accurate way to define passive income because for all streams of income, you’ll need to put forth some sort of effort and therefore time into building that stream of income. But the more disproportionate the return in your favor, the more passive the income becomes. So, if I put in one unit of time or work, and instead of getting one unit of value or money in return, I get two units. Then this is more passive than a one for one investment. And if I put in one unit of time or work and I get three units of value in return, then this investment is even more passive.

Now let’s talk about the general pros and cons of active versus passive investing. For active investing, the biggest pro is likely control. If you’re investing actively, let’s say for instance, flipping a house or buying and running a business, then you have lots, if not complete and total control over the investment. Another advantage depending on the type of investment is taxes. Active investments are typically directly owned, and that direct ownership sometimes, but not always results in greater tax benefits. Now the biggest cons for active investing are obvious and that’s time and effort and the inability to exponentially scale. It takes time and effort to gather the skills and the knowledge to what essentially equates to running a business. You have to become a skilled expert in that particular investment type in order to be successful and meet your projected returns.

And of course this takes time, time away from your career, your family, and from yourself on the other side of the table for passive investing, the cons are the lack of control and sometimes the lack of liquidity, depending on, depending on the type of asset. It is likely that if the investment is passive, you are giving up some sort of decision-making control to others. And depending on the asset, lack of liquidity could also become part of the equation. However, this is not always the case.

The biggest advantage to passive investing is what I consider the most important thing out of all things. And that is time. You may need to put some time and effort in upfront, but after that, the effort is spent by others to maintain and operate the underlying asset. The other big pro for passive investing, which sometimes is forgotten, is the opportunity to rely on experts in their specific fields to produce optimal results. We’re all experts in something, but if it’s not in developing a commercial real estate project or building or operating a tech company and building it from the ground up, then perhaps we should focus on picking a winning horse instead and letting them do all the work so that they can take us to the victory circle.

In summary today, we discuss active investing versus passive investing in a very broad and general sense. You just need to take an honest and hard look at your situation and decide which one is best for you. If you have some extra time, or if you have a really hard time letting go of control, then taking an active approach might be the best approach for you. But if you are strapped for time or care to spend your time on other activities, then taking a passive approach could be a better fit for your lifestyle and goals.

Me personally, I won’t say I’ve done it all, but I have certainly collected a wealth of experience investing both actively and passively, and I continue to do so. On the active side, I’ve sponsored large commercial real estate projects. I’ve flipped, wholesaled, rehabbed, and rented houses and multi-family properties. I bought a fitness franchise, started numerous small businesses, traded stocks just to name a few. On the passive side, I’ve invested in and continued to invest in commercial real estate syndications. I’ve been a private lender. I’ve invested in a restaurant and startups and I’ve invested in 401ks and index funds.

While I was working at a big law firm, active investments, certainly put a strain on my career because there just wasn’t enough time in the day to do all that. Once I discovered passive investing, I was able to buy back my time and eventually go out on my own where I now have more time and more freedom to take a more active role in my investments, which I love, but it’s not necessarily for everyone. Not everyone wants to quit their job. A lot of us enjoy our careers. We get satisfaction and pleasure in, you know, growing professionally. And I get that same feeling, but I’m just more of an entrepreneur and I needed to be out on my own. So I needed to figure out a way to buy back my time, which I did, but for those of us that want to stay in our career and stay you know, high performing big law firm attorneys or continue saving lives in the emergency room or climbing and scaling the corporate ladder. That’s awesome. But just know that there is a flip side of that coin, where if you’re able to generate and build passive income streams outside of that primary W2, it just gives you an indescribable confidence that if there’s an economic downturn or you get laid off or you get fired, or your industry takes a dip or technology somehow, you know, makes you dispensable. You’ll just know that no matter what, you’re still going to be able to provide for yourself and for your family and not just provide but prosper. If you’ve properly allocated your funds that you earned from an active income to building passive income streams, then you better believe it. You’re going to be just fine.

Now, as far as actually buying back your time and eventually taking a more active role in, you know, let’s say real estate projects or running a business or something like that, then that’s great as well. And I love it, but it’s not for everyone. And at some point, I completely intend on becoming 100% passive. You just need to ask yourself what is the best way for me to achieve true financial freedom. And then what level of activity am I willing to take on and still live the life that I choose to live. And that makes me happy.

Alright, well, because I’m a big proponent of real estate. In a later episode, I’ll take a deep dive into active versus passive investing again, but in the purview of real estate only. If you want to learn more about passive income through private equity, real estate or other alternative vehicles, go check out my website at www.passiveincomeattorney.com and grab my free passive income guide, which will only be available for the next few weeks. If you enjoyed the show, please leave a five-star rating and a positive review. Until next time guys enjoy the journey.