English Personal Finance

There‘s No Such Thing As Passive Income

To become independent of working for “the man” you need to find alternative sources of income.

A lot of people believe that you can only become financially independent if you receive a big inheritance or win the lottery. That’s not true, of course, but I think it says a lot about how little many of us think we are in control of our own financial destiny.

It’s either luck in the birth or the state lottery that could provide you with enough resources to live off, else you just (try to) stay employed till 67 (or whatever the official retirement age is in your country).

Creating passive income streams is a key component in the concept of financial independence. Here’s a spoiler alert, though: most ‘passive’ income streams are less passive in reality than they might appear in theory.

 

Getting rich quickly mostly doesn’t work

I don’t think that’s a problem, in fact I enjoy a reward more if I’ve made some effort to get it. But within the FI community you will sometimes come across people who make it sound as if making money from real estate, writing e-books, or offering online-marketing consulting services involves little work while yielding impressive income. Please take this with a grain of salt, especially if the same person wants to sell you how-to-courses.

Get-rich-quickly-and-with-minimum-work sounds too good to be true, and it is. You might hit on a brilliant idea that you can scale easily, and later run with minimum effort, the classical ‘muse’ Tim Ferriss writes about (no affiliate link). That’s super-cool and kudos to you if it happens.

 

Build up your own knowledge

But when you set out on your path to financial independence just treat quick and big success as potential icing on the cake. Start with a robust mid- to long term strategy of creating ‘passive’ income streams. And be aware that you have to build up your own knowledge in the areas that you choose to get engaged in. You can only really learn, and see what really works for you by your own experiences.

This is obviously not to say that you shouldn’t take advantage of getting insights from other people’s successes and failures – no use in taking the trouble to write this blog if I felt that way, right? But making sure to take responsibility for your own affairs is key. Otherwise, better be back to waiting for the inheritance or playing the lottery. Sorry, bad joke ;-).

 

Our ‘passive’ income streams

Okay, so to make it a bit more relatable: what ‘passive’ income streams are we building up? I will just give you a quick run-through and highlight some important issues while we go. Our overall-strategy and how these different types of income streams fit in will be the topic of a separate post.

 

INSURANCE-BASED PENSION PRODUCTS

CASH VALUE LIFE INSURANCE, PRIVATE PENSION INSURANCE

We still hold a long-running cash value life insurance my husband signed up for when he started working, and a fund-based pension-product I signed up for in 2000. Need I say that we would not choose these kinds of product again? Fortunately the cash value life insurance runs at a high guaranteed interest rate, and the monthly premiums for the pension product have been invested across both the millennial market crash and the big recession, so at least the average annual returns are not totally shabby after costs.

Truly passive income? Yes. 

 

COMPANY ‘PENSION’

DIRECT INSURANCE

Neither of us get a company pension. As in the US and the UK defined benefits pension schemes are the exception. Lucky you, if you still get one. Both of us had a direct insurance through our employers for some time, as that was the vehicle they chose to offer to comply with the law. (Employers in Germany have to offer one of a choice of vehicles for a defined contributions pension scheme. Up to a fairly small amount, the contributions will be paid from the gross income. This is NOT comparable in scope to 401ks in the US, and there has to be a guaranteed interest which lets you end up with insurance products rather than being able to build up a pension on the stock market.)

The direct insurance product on offer was a terrible choice, partially due to its construction. As the performance was so bad, we decided to stop contributing additional funds last year. On top of that, I had lost the benefit of paying from my gross salary 10 years ago when I changed companies, since the new employer subscribed to a different scheme.

Something to be learned here: We only started contributing because it was just before the deadline of a change in tax law where the lump sum paid out at the end would not be tax-free anymore. We didn’t stop contributing earlier although we were aware of the sub-par performance of the product, since the contributions only made up a very small amount of our overall investments.

Please don’t copy us. Trying to legally pay as little taxes as possible makes a lot of sense. You have to make sure though, that you don’t let tax relief trick you into an investment with high costs. Admittedly, not all costs were transparent when we signed up. But I think the overall point is still valid. And the second learning is to check performance in all your investments constantly. We could have stopped contributing much earlier, invested from our net without tax benefit, and still have achieved a better performance by simply buying ETFs.

PENSION FUND

I also hold a small pension from deferred compensation, i.e. out of the gross. I only contributed a short time, and pay-out will be okay, but quite a small monthly amount.

Truly passive income? Yes, but we were too passive BEFORE and AFTER signing up to get a good return.

 

STATUTORY PENSION SCHEME

My husband still is and I have been contributing to the German statutory pension system as this is required by law.

Truly passive income? Yes, indeed – but we worked for it, of course. No way to get out, so no need to get het up about missed performance opportunities.

 

REAL ESTATE

We have some rentals, already producing a certain cash-flow which is re-invested at this point.

Truly passive income? Nooo – I’m sure you guessed that one… 

 

STOCKS

While we have started investing in the stock market with some individual stocks in the dot-com-era (nope, unfortunately NOT Amazon, but terribly choices such as Intershop), We learned from our mistakes (?) and bought fund products, some doing better, some worse, but all too expensive cost-wise. This time, we really learned from our mistakes (!?), have pretty much sold all funds by now, and basically only invest in ETFs. Paid out dividends are re-invested at the moment.

Truly passive income? ETFs are definitely more passive than individual stock picking. But you still have to make informed choices. And you have to come up with a strategic approach that works for you.

 

So talking about strategic approaches – stay tuned for our overall strategy and how the different income streams are fitting in.

Financial Independence Rocks!

You Might Also Like

No Comments

    Leave a Reply