Friday, July 3, 2009

Passive Income Defined - Part 2 ! 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.

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