Active income is the income you make from your job, profession, small business, or “investments” that you must personally manage. You can also call this “trading time for money”. It’s typically taxed at the highest rates. Most of those in the “Top 1%” that politicians talk about fall into this group. As a matter of fact the largest single profession in the “Top 1%” are physicians. These are the same professionals that I’ve spent nearly 15 years of my life working with. I can tell you that these individuals certainly don’t deserve to be vilified! Sure, there are some “bad actors” out there, but doctors on the whole are wonderful people who spend most of their lives helping to improve the health and well-being of others. Others that fall into the top 1% group are lawyers, executives, managers, sales professionals, professional athletes and accountants. If you get paid by the hour, this is active income. I would consider most small business income to be active as well. If you can’t walk away for a year and have your income continue to stream in, then it’s not passive. I always look around my business and life and ask “Is this scalable?”. It’s a concept from “The 4-Hour Workweek” by Tim Ferriss. In other words, can you get more out of the same or less effort? Active income is not scalable. Passive income is! 

What is “passive income”? According to Investopedia:  

Passive income is earnings derived from a rental property, limited partnership or other enterprise in which a person is not actively involved. As with non-passive income, passive income is usually taxable. However, it is often treated differently by the Internal Revenue Service (IRS). Portfolio income is considered passive income by some analysts, in which case dividends and interest would be considered passive. 

My goal was to get to a point where my passive income exceeded my basic monthly expenses: mortgage/rent, food, utilities, insurance. I would call this Financial Independence. This is when you can choose to live life on your own terms and it’s what I wanted! If you are a high income professional how can you replace your active income with passive income?  

Today I teach my young sons that investing is, “money working for you”. I tell them the steps to becoming rich are: 

1. Make money (have a high income profession or business) 

2. Keep money (live below your means, follow an efficient tax strategy) 

3. Invest money (become Accredited and structure your portfolio for income and appreciation) 

 Obviously you want to get to step 3 as rapidly as possible. You need to think like an Investor. One of my favorite expressions is “act as if”. Act like you already are a successful investor! If you see yourself as such, the next step is to structure your accounts and portfolio so that you can automatically flow money into investments that grow year after year. Ramit Sethi does a good job of showing how to make your saving automatic with his “12-Minute Guide to Automating Your Finances”.  

I like to structure my finances in buckets. As one fills up it then starts to flow into the next:

1. Emergency Savings Bucket (3-12 month’s worth of expenses) 

2. Insurance (Life, disability, liability, health insurance) 

3. Qualified plans (401k, SEP IRAs, etc.) 

4. Opportunity Fund (cash, life insurance, brokerage accounts, etc.) 

 If you are making a lot of money and you consistently save each month, eventually your excess income will flow into the 4th bucket. This can grow rapidly. Once you have a significant amount in this bucket it is time to put it to work. 

 What are your options? 

In his succinct book “Automatic Wealth: The Six Steps to Financial Independence” Michael Masterson outlines his thoughts on the 5 places where he thinks you should put your money: 

1. Stocks and index funds: about 20% 

2. Fixed-income: 40%-50% 

3. Managed real estate: 20%-40% 

4. Emergency cash and gold: 5% + 3 months cash 

5. “Play” money 

It’s a short read and is from someone who has actually become a multi-millionaire, not someone who got a degree or a certification. As someone who has an M.B.A. in Finance and has been investing for more than 2 decades, I respect his advice.  Richard Wilson of The Family Office Club, which works with family offices worth $100M or more, states that these families typically devote 20%-30% of their portfolios to income-producing real estate. 

The formula is then simple: invest enough in cash flow investments to replace your active income. What are your options? You can learn more by going to our website and applying to join the Next-Level Income Club.