Passive Income is King
When it comes to early retirement, everyone tends to focus on net worth. Seriously, net worth is king. I track mine every month, and there are plenty of others who do it as well. Many of the personal finance blogs on Rockstar Finance also track their net worth. But is this the right metric to track? Should we spend all of this time meticulously counting every quarter to determine “the number?” Probably not. We should focus on passive income.
Net Worth Stinks
Okay, net worth doesn’t really stink. But a bunch of people track it. What is net worth anyway? It’s actually pretty simple: take all of your assets, and subtract your liabilities. The result is your net worth! For example, let’s say that you have $50,000 in the bank, own a $300,000 home, and owe $100,000 on your mortgage, your net worth would be: $50,000 + $300,000 – $100,000 = $250,000.
Net worth is a great way to track your financial progress. You can see how much you are both saving and investing. It’s also pretty addicting. We’re in a very long bull market, and our net worth keeps jumping up, even if we don’t add any more money to our portfolios. But net worth doesn’t tell the whole picture, not by a long shot. The reason is that not every element of your net worth is created equally.
Certain components of your net worth, such as investments, may increase in value and even pay dividends. This is extremely good because you have money that makes you money! But what about other assets, like a home? Let’s say that you have a $300,000 home. You live in that home which is great, you might not even owe a mortgage. But other than providing shelter, what does that home provide for you?
Not much to be honest. You’ll count the $300,000 towards your net worth, but you can’t quickly sell it. You owe taxes on it ever year, and things break all the time. Buying a new HVAC system is expensive.
What is Passive Income?
Passive income is awesome. Passive income is the best income. Passive income is when you make money by doing nothing, by being passive. The best example is when you invest money. Let’s say that have $100,000 invested in a mutual fund. That mutual fund will pay dividends each year. Let’s say that the dividends are 2%. This means that every year, you will get paid $2,000 simply for owning shares of that mutual fund! You can also have passive income from other investments, such as rental properties.
Passive income is the best type of income because you don’t need to work for it. When you receive your paycheck, you traded your time for money. A modest trade. But you receive passive income regardless of what you’re doing, even while sleeping. The more you save and invest, the more your passive income grows. At some point, you might earn more passive income than your day job. You might even earn more than you spend. When this happens, you have reached financial independence.
I recently asked the Twitter community how much passive income is enough to reach financial independence, and then retire early. I got a large set of answers, and the results were surprising.
What is your Financial Independence / Retire Early passive income goal?
— Zero Day Finance (@zerodayfinance) July 19, 2017
So, I may have messed up the poll. Oops. Option 3 should be $60,000 – $100,000. The main takeaway is that “lean FIRE,” retiring on less than $30,000 per year, isn’t desired by most people. Sure there are people who do it like the folks at early retirement extreme advocate for it, bust most people don’t want to.
We also see that it’s a pretty even split between $30,000 to $100,000 per year in desired passive income. Creating this level of passive income isn’t easy. In fact, it takes decades of determined investing. But what type of net worth do you need to create this passive income? Does net worth even come into the equation?
You could have a $1 million+ stock portfolio and a $500,000 mortgage that would generate $40,000 in passive income per year on your $500,000 net worth. But you could also have a $250,000 stock portfolio and a $250,000 paid off home, and you would barely generate $10,000 in passive income on your $500,000 net worth.
While net worth sort of indicates your total passive income, it doesn’t provide a lot of precision. Most Americans buy homes instead of investing. There are plenty of Americans who have a $500,000+ net worth and $0 passive income because they haven’t invested.
Passive Income is the Goal
When it comes to early retirement, your net worth means nothing. Seriously, don’t focus on your net worth. You need to pay attention to your passive income. You are making many investments, how are they paying off? Is your stock portfolio providing you with a nice dividend check every month? Do you invest in property and collect rent checks?
Whatever your strategy, it doesn’t matter. You must build passive income so you can retire early. Without it, your net worth is a fairly meaningless number, and you won’t be able to comfortably retire.