Passive Income Defined - Part 2 ! Effort

It was mentioned before that passive income means obtaining money repeatly while spending minimum effort.

What does minimum effort mean ? Can it be measured ?

Well, lets see. Effort can be classified into two;

1) qualitative - when you have a 'great' idea ! Brain power !

2) quantitative - when you work HARD for it !

Everyone has some good ideas at some point of time. When a good idea hits homerun, it flies like no one's business. It could bring to great wealth or great fame. Either way, this such good idea is hard to pre-determine and would only be known after the effects kick in. Hence your smartness is hard to be measured for planning purpose.

For some of those who have tasted success beofre, they would know that any great idea would also take some hard labour to turn it into a reality. It may be as simple as trying to convince someone on the smart idea itself. But nevertheless need to do something after idea conceiving stage.

Assuming all hard labours are similar by nature. Afterall, you are justing using your energy for something, without the brain. Hence, hard labour can be easily measured using time. For example, you may spend 30 minutes when opening a FD account, then perhaps using 5 minutes to monitor the monthly interest payment. So over a course of 5 years, you would have used 5 and a half hours in total.

Everyone has some worth in dollar sense. If you are working and your monthly salary is $3,000. And you actually work 40 hours a week resulting a monthly productive hours of 160. Then your productive worth would be $3,000 divided by 160 which is $18.75. Meaning if you spend one hour to do some productive work, your time cost is $18.75 per hour.

If we use 24 hours and 30 days a month, then your life worth would be $ 3,000 divided by 720 (24 x 30 ) = $4.17. For every hour you live, whether doing something or not, you have earned $4.17.

You may use either productive worth or life worth, its only a matter of philosophy.

If we use productive worth for the FD example earlier, 5.5 hours would imply 5.5 x 18.75 = $103.12 worth of effort spent over the 5 years; or an average of $20 a year. If the guy had save $10,000 with 2% FD rate, then he would get back $200 a year. $20 effort to earn $200 income is 10 times. The Effort Income ratio is said to be at 1:10

If you are a retiree, you probably do not have any productive worth. Lets say if you also have $3,000 income consistently from whatever source, then your life worth would be $4.17 as calculated above. With this your FD effort cost is only $23 over 5 years or barely $4.60 a year. In this case, effort income ratio is 1:43

With such a calculation, a few concepts have become more concrete;

1. The MORE money you save in FD, the more passive it becomes. If you only save $1,000 on above example, you probably cann't say you are earning passive income at all. Perhaps you may even be losing by spending too much effort monitoring it. On the other hand, if you were saving $100,000 instead of $10,000 then the young worker ratio may become 1:100 instead of just 1:10

When effort needed is the same,

increasing capital on passive income

will make it more passive.

Which is also the typical term people refer as "Money earns Money"

2. The period of consideration is important. For example in the FD example, if you only save for one year. then the effort income ratio is only 1:7 instead of 1:10 if you save for 5 years.

1.5 hour x $18.75/hour = $28.12. Earning $200 interest out of this 28.12 is 1:7.11

Likewise, if you leave your FD there for 10 years, the ratio will go up.

The longer you let the right finance vehicle runs by itself,

the more passive the income becomes.

3. The FD interest earned, although in same amount, but it is much more worth while for the old retiree to do it than the young worker. The young worker could have just work extra 2 hours to earn the same as FD's return in a year. The retiree on the other hand has not much to do anyway.

Not to mention some retirees do NOT have $3,000 income consistently, in that case the effort income ratio would even be much higher. In MalPF's world, any investment that can provide a 1:100 effort income ratio is considered a Passive Income.

Be reminded this is only refering to the 'minimum effort' portion. A true passive income has to happen repeatly. So winning jackpot in casino is not a passive income unless you actually have a way to win every month.

There may also be a few other not so direct implication on passive income after this exercise ;

1. Usually passive income starts with high effort in the beginning, then eventually the effort lowers to its supposed minimum level while the income starts to kick in. The more effort you put in the beginning, the higher chance to have a higher passive income in future. But it may also takes longer to reach there.

2. Passive income is a very personal thing. What works for you may not work for others. Its all about your current situation, your passion and what you do best. For example, if you are a talent in collecting rent, you may only need 5 minutes to do it. On the other hand, a shy landlord may need to make a few trips and a total of 4-5 hours a month to collect one payment.

3. If you have capital in the beginning you need less effort. Like wise if you have no capital, you will have to use a lot of effort in the beginning. Like most of the human networking programs ...

Have you run your own numbers yet ? Is your income really passive ? Or have you been worrying too much about it ?

Try read this article, it may help making your income more passive ... simply by NOT KNOWING about it once the right finance vehicle is setup.

Passive Income Defined - Part 1 !

Are there such thing as totally passive income ? As in you do absolutely Nothing and money comes to you ?

To earn fix deposit interest, you will actually have to walk right up to the bank, go through all those paper work, spend some time there to open an account. When you want to use the money you earn from the interest, you will have to go to the bank again to withdraw it. Not exactly as 'absolutely nothing'.

So many may argue there is no such thing as total passive income. But then again, that is only a matter of definition. Although it is a good thing to believe there is no Free lunch in this world, but the true definition of 'passive' is NOT "No effort" at all. It actually means 'with minimum effort'.

So Passive Income is a type of income you obtain repeatly with minimum effort.

In finance world ( NOT personal finance ), passive income is instinctively associated with rental income. This is the main reason why most people carry on the miss conception of property investment as a passive income vehicle into personal finance. This is another article but in short, rental may become a passive income but property investment is NOT.

So what does Minimum Effort actually mean ? Generally there are a few responds;

1. Do Once: Like the Fix Deposit example, you only do some work once and then enjoy the monthly interests without any more work needed. Hence the effort is minimum in long run.

2. On the way anyway: Collecting monthly rental income is relatively an easy task especially when you have a good tenant and the property is just next door. So you were just passing by anyway, collecting extra income while doing other things is really neglectable effort and therefore considered as minimum.

Minimum effort is when you FEEL like not doing much. Guess what, you will most likely feel like that when things are smooth and great going.

For example, when opening a fix deposit account the traditional way, you may actually feel cumbersome of all the paper work and may be frustrated that you have to repeatly mention the same information. Only when the account is finally opened and the interest starts to come in, you feel it was just all just minimum effort anyway.

So minimum effort has a Time factor.

The effort of collecting rental income may become not so minimum anymore when the tenant starts delaying payment; No one answer the door bell and you have to make a few more trips. Partial payment, broken items, wall repaint and other not-so-smooth-going experience may change your effort to not-so-minimum anymore.

If this so call 'minimum effort' or 'passiveness' is so subjective to experience and highly affected by the cycle of good-bad times.

No wonder when someone shout certain business can generate passive income, the other person will say no and yet both of them have very good points supporting their views. Its because they have different 'feeling' and may analyse the business at different time points.

Among all these uncertainty of feeling and potential changes over time, how can we reliably determine if an investment can provide passive income and if its worth it or not ?

Luckily in MalPF, there is a measurable way in defining 'Passive Income'.

... Read Part 2 ...

Index Fund or Malaysia Stock Indics ?

You may see in below graphs that in long run, FBM30 and Hijrah are the top 2 performing indexes from 2003 to 2008 ( 5 years ).

Top 10 stocks in Hijrah index ...

Top 10 in FBM100 ...

and this is the list of 30 Largest Listed Businesses in Malaysia

source : FTSE

Putting all these together, what can you get out of it ?

First of all, if halal investment performance is important to you then the TOP 3 business you can invest in are :

Sime Darby : SIME 4197 $7.10

IOI : IOICORP 1961 $4.70

Telekom : TM 4863 $2.94

else, your ranked choices are :

Public Bank : PBBANK 1295 $9.05

Bumi Commerce Bank : COMMERZ 1023 $9.10

MISC 3816 $8.60

As you may see, any of the stocks above is less than $10 each. 1 lot size in Malaysia stock market is 100 units. So each of your investment transaction amount can be as low as $1,000 each.

Minimum brokerage fee $8 would apply in this case. Adding other fees like stamp duty and clearing fee, it sums up to about 1% of total stock fee. This applies to both buy and sell transactions, totalling one complete trade to 1.84%.

Each stock price may have a different 'tick' size, below table shows their equivalent percentage. You may see the actual percent loss is different in each stock depends on the price you buy. However, we can use 0.5% as the average.

Sum up the 1.84% fee and 0.53% gap loss rounds up to about 2.4%

So in comparison to investing on an index fund which charges 5.5% fee, one can also buy one of the largest business from the same index portfolio for only 2.4%. In both cases, Dollar Cost Averaging of putting $1,000 every month can be applied.

The biggest loop hole in this comparison ofcourse depends on which stock you ended up buying. The largest and best business at the moment may still under-perform as well as out-perform the index itself despite how big a portion this stock occupies the whole index portfolio. The beginning part of this article is an example of 'trying' to pick a business that can out perform the index it is in.

$8 is not always the minimum brokerage fee, other common numbers are $12 and $40. So the brokerage fee alone can be as high as 4%, in which case you shouldn't buy stock as a comparison to buying index fund with only $1,000 in each transaction.

However, in stock investment, you should also know what a MOTS (Minimum Optimized Trading Size) is. If the minimum brokerage fee is $8 or 0.1% then the MOTS is $8,000. So instead of $1,000 now we fix each of our investment amount at $8,000. That way, instead of the 1.84% stock fee, now it becomes 0.46%. This bring the total charges of buying an index stock to less than 1% !! In contrast to the 2.4% in the $1,000 example.

Summary

1. In addition to investing in an index fund, you may also buy one of the best stocks from that index portfolio. Espeically when you think you know which one will outperform the index itself. Doing so may help you save 50% of investment cost. ie. Apply Buy-Sell technique in this stock is better than doing so in the fund.

2. Investing in stock market would require a larger capital to optimize your strategy and investment positions.

Guest Post : Property as Passive Income

This is a guest post by Boon Ping. He is showing how one can turn property investment into long term passive income generator. This is actually a very common methods used in Australia, one of the world best property investment country. Altough recent down turn did affect Australia as well, but nevertheless still an area very active in this respect.

Do raise questions if you have any doubts in the comments area.

When we start in 2009, we put in $100K, buying an investment property at $500K with rental $25K per annum with loan amount $400K. Every year, we top up the loan based on its new market value to release equity(look at the Equity Released column on how much we get each year). We use the equity to cover any shorfall in mortgage repayment and also fund our income lifestyle. You see the equity balance keep increasing even though we keep spending.

You put in $100K, after 10 years you got $637K, 6x ROI. Remember this equity is tax free. What will you get after 10 years if you put in $100K into mutual fund? How much is left after tax?

Even we don't top up the loan each year, means the loan remain at $400K, the increase in rental is still sufficient to cover everything at the end, but this is not the strategy but just as worst case scenario.

This is with 1 property, what if you have 5, 10, etc.....

Basically the summary is in the excel file, noted that it's really a brief summary.

Assuming:
1) You start investing in a property worth $500K in 2009
2) Average annual capital growth = 10%
3) Average interest rate = 8.25%
4) Average inflation = 3%
5) Loan amount = 80% of market => Starting cost = $100K

Columns Definition:
Year => You know what it means
Value => Market value at that particular year
Original Loan => Loan amount when you first purchased the investment in 2009
Interest => Interest payable per annum based on ORIGINAL loan amount, ie loan amount x interest rate
Surplus => Rental - Interest - Maintenance
Equity => Different between current market value with ORIGINAL loan amount
New Loan => Loan amount based on 80% of the current market value
Equity Released => Different between current market value with NEW loan amount
Interest on New Loan = Interest payable per annum based on NEW loan amount
Maintenance => How much normally it need for maintenaning the property, eg council rates, management fee, repair, etc, 1% normally
Rental => Normally it's average 5% of the market value
Shortfall => How much you need to come out of own pocket money to pay for interest, maintenance after rental
Income => This is the passive income I am taking about, the income you need for living, spend, etc, increase each year
Total Spent Equity => How much equity that you spent
Equity Balance => Different between equity released and spent

I believe you sure got questions, feel free to fire back.

the Khong and Khong ... the future mutual fund service provider ...

Malaysia is a small developing country. Personal Finance is a very small topic here. There are some people selling insurances, less in mutual fund. Almost noone to talk purely on Personal Finance without touching on what products to sell.

So in a land of not many choices, it is NOT easy to find talent or people with genuine interest. If by chance we meet some, it is our duties to share and spread despite any personal differences.

Taxsaya and Wangtool were mentioned before in software arena but today's story is the Khongs.

Khong and Khong ( not their real business name, just the way I call them here ), is a Father and Son team. Father Tony has been in Mutual Fund industry since the beginning of mutual fund in Malaysia. His experience, contacts and network is unspeakable influential. Son Jason is a handsome young man dedicated to doing what he loves.

What caught my interest is the chemistry within this team. Although older with experience, Tony is not stubborn when it comes to implementation where Jason has the competitive edge. And although young and energitic, Jason is able to iron out some impractical fancy ideas while setting the right priority on what to do first. Truly a scenario where legacy experience is re-maximized and applied in today's web solution for everybody's benefits.

Within a short 15 minutes random chats, Tony was able to pick out some very small ideas that could be useful for his project, shared it with Jason and thats it ! Another idea to expand market has just been initiated!

Because of Tony's experience, most of the Khongs services are provided in relation to mutual funds. They have ;

1. fundprice.my : a widget site to show the most recent fund prices from all companies by popularity. There is also a small graph next to the price showing the latest trend of the price movement, which I find rather interesting. You can also use their service for FREE and put this widget on your own web site. The Best Rate widget created by MalPF is inspired by fundprice.my

2. If you are one of those who have been buying many mutual funds from different companies, you will appreciate SingalInvest.com. Very often agents from one company always over emphasize their own fund performance while even discredit other companies with the hope you will put more money with them. All these bias talks actually make you very hard to compare the funds performance from one company to another. This is where SignalInvest.com comes to handy. You can track all funds from all companies yourself.

3. The most successful venture for Khongs does not come from above two. Remember Father Tony was an agency manager himself before ? He had to manage so many investors until it is almost impossible to do it manually. So Jason built a solution for him. After being tested in real life for real business for many many years, the solution is now also available to all other agency managers too.

invest.com.my is a solution for agent who has a large pool of investors to manage. Unlike solution provided by the fund manager's company which only track its own funds, invest.com.my can track ALL funds. Its an added advantage for agent to help his client to track all the client's funds, walk the extra miles so to speak.

Actually I haven't used any of these systems in depth yet. As mentioned in the beginning of this article, I am not here to promote their services. I am just sharing that I met someones who are genuine to provide useful services to mutual fund industry.

Not all of what they have is useful to you now but if you have something in mind please do share with them, I am quite sure they will value your input. And if anyone can help implement a solution for you, its this team !

I truly believe they can go far looking at their experience, passion and genuine interest to help.

What Michael Jackson has contributed to MalPF ?

The concepts that MalPF preaches which were influenced greatly by Michael Jackson ...

Income is NOT a part of personal finance

Richness has NOTHING to do with Financial Freedom

The ONLY thing MalPF wants you to do

Money earns Money is NOT be the only passive way

In the past 27 years, MJ has earned 120 billions. At the time he passed away, he left 12 billions while carrying a 14 billions debt. Resulting a net of owing 2 billions debt.

If even 120 billions is not enough to let one person simply spend as he wishes, do you still think getting rich is the key solution to TRUE financial freedom ?

But wait, guess what saves Michael's finance status ?

The change of his living status ultimately update his royalty tax status as well. Just the past few days alone may have already gathered more than 2 billions, not to mentioned an estimated collection of 100 billions in time to come.

Can you see the differences between active and passive income yet ?

source : 988 Radio

Mutual Fund, Buy-Sell or Buy-Keep ?

There are mainly 2 different schools in mutual fund believers.

1. Apply Dollar Cost Averaging, (DCA) put in money consistently for a long long time. Never take it out until you die, retire or you initially planned to. Lets call this Buy-Keep technique.

2. Buy Low Sell High, when market is bad, buy more, when market is good, sell them to take profit then buy again when market is low again. This way you maximize your return, the more you roll the bigger you get. Lets call this Buy-Sell technique.

There may be some simple answers : (a) Its really a personal preference; (b) If you know DCA you use DCA, if you know the market, you use Buy-Sell techniques. But at the end of this article, there may be a distinctive answer NO MATTER if you have a preference or understand anything on DCA and the market.

DCA is boring. All it says is you save a FIX amount of money PERIODICALLY. It doesn't tell you when you can take profit, when to withdraw. It doesn't care what the market is doing now. It just say save, save save ...

The good thing about DCA is it is simple. You just need to know (1) the amount and (2) the period. And both of these parameters are 100% under your control. You decide the amount and you decide the period. Another good thing about DCA is it is usually 'cheaper' - as low as $50 or $100 for each transaction.

The good side of DCA's simplicity can also be viewed as its disadvantage. Simple may also be viewed as lack of abundance, or in this case, ignorant. Admit it, its kind of stupid to think that if I want to earn money, all I need to do is to decide the amount and period !? Having said that, DCA is not really easy to implement neither. Simple concept is NOT always Easy to execute persistently. Unfortunately This has been statistically proven.

The good stuff about Buy-Sell technique is its exciting. You may read news, find info, analyse finance data or even play with charts in order to know the up down of the market. You may even be very well verse in some particular industries that you have secretive insider knowledge. Either ways, it is exciting. You may be able to gain big profit when your decisions are right.

The unhappy moments of Buy-Sell technique is when your intrepretation of the market is wrong. Or may be you are still right, just that the market goes the other way. It could be big guys play you out, natural disaster or simply that you thought you knew but actually you didn't. On this method, you will need to spend some effort to analyse the 'timing'. You need to know when to buy and you need to know when to sell. If you spend too much time on the timing, it may be disqualified as a passive income generator afterall.

If you are reading sequentialy, there may not be any apparent answer yet. It still seems like a preference issue.

Lets look at the risk-reward of both techniques. In long run, DCA seems like to be able to cushion the risk, but it would also provide lower return. So relatively, it seems like a lower risk lower return. Buy-Sell on the other hand is very investor dependant and therefore high risk high return.

Athough a weird dude run some numbers and said that in DCA, when you lose, you lose less and when you win, you win more. But in this context, Buy-Sell technique would still provide higher return than DCA while carrying more risk. Buy-Sell technique can also claims that the longer one practise it, the more experience one will gain and therefore, the longer it is the higher chance one may win. ( hardly a truth neither )

Ok, by now can you see any distinctive answer yet ? If not, then we will have to run some numbers again ...

Says you use DCA method and put in $1,000 a month for 5 years. You would have put in $60,000 in total. If you are paying 5% charges, the total fee you have paid is $3,000 through out the 5 years period.

On the other technique, lets say you buy-sell twice a year, that would be 10 times in 5 years. Assuming the average of each transaction amount is the same as your initial capital, $60,000. The total fee you have paid would be $15,000. Equivalent to 25% of your initial capital. Comparing to 5% from DCA method, this method is disadvantage by 20%, not in practice, but in strategy.

So if out of the 10 times you buy and sell, your total lost-win ratio is 50-50, then you would most probably ended up with performing 20% lower than DCA method ( not really, read on ). In other words, in order to eliminate this potential strategy short fall, your lost-win ratio should be at least 40-60 in order to break even. ( Conceptually, not exact by numbers because other parameters are needed for full calculation ).

Another way to put it, if you earn the SAME return in both techniques and you have a net profit of $1 in DCA, Buy-Sell technique would have given you $0.80 only.

If we go back to the fundamental in mutual fund is that we pay HIGH fee for professional services. If after paying them such a HIGH fee, you turn around making your own calls. It would be equivalent to wasting all the HIGH fee you pay them at the first place, wouldn't it be ?

No doubt Buy-Sell technique is a good method but why would you ever want to pay 5-6% fee comparing to other tools that charges less than 1% and yet allow you to buy sell much easier ?

So no matter if you have a preference between Buy-Sell vs Buy-Keep, no matter if you really understand DCA, no matter if you know the market, you should NEVER apply Buy-Sell techniques in mutual fund.

If you still insist to Buy-Sell mutual fund, then please understand this formula ....

The only scenario where Buy-Sell mutual fund is NOT strategically disadvantage is when you found a particular fund that already has a large number of stocks that you planned to invest into anyway. In that case, there is a chance that the 5-6% high fee is average down by the number of stocks until it is even LOWER than the stock invetment fees.