Monday, January 22, 2007

Thinking about $2M's passive income

On January 16th, my friend, $2m, posting a summary of his 2006 passive earnings.
The totaled:
  • $1,830 from dividends
  • $1,426 from interest
  • $1,810.36 from real estate

His total was $ 5,066.95. Very impressive when you think about it - actually, it's excluding his blog income - which can't be too shabby with all the big media references he gets.

His networth is $317,504 as of 12/31/2006. Since this figure excludes interest and dividends in his retirement accounts, you can't calculate his return on assets with simple division, rather you need to back out his retirement assets from his networth.

Here's a quick and dirty analysis:

$119k in cash and non-retirement brokerage accounts (excluding employer spp, retirement, etc...) plus $43k in rental house equity. That's $162k in assets, which yields a 3% passive income return on assets - it's important to consider that this does not include unrealized capital gains. Really, it's not that bad.

Here's the rub, $2M admits that he wouldn't feel financially independent with only $5.1k in passive income. He would need at least 10 times that amount. Makes sense to me. Personally, I would need about 24 times that amount.

But are 10 and even 24 times accurate estimates. I don't think so. Here's why:

Historically, much of long term stock market gains is actually derived from reinvestment of dividends. Without reinvesting dividends, the long term performance drops quite a bit. Read Bernstein's 4 Pillars for a good discussion of the topic. If I still had my copy, I'd quote you the percentage.

The important fact is that you investments would grow (appreciate) very slowly if you did not reinvest the dividends. Unless they've reached a point where you no longer need them to grow, but rather, grow a little bit more than inflation, it will be very hard to live off of dividends.

But what about the 4% approach. Can't I live off 4% of my assets each year? You can - and you're not likely to run out of assets - but the better question is 4% enough for you to live on? The Trinity study had a very important assumption - that 4% of assets from the time someone retired - the critical presupposition is that they would not retire until 4% was enough to meet their daily needs.

So how much passive income do we need to be financially independent? That all depends upon where you are? If you're like $2m or myself (being in my late 30s), we are at the asset accumulation stage and can't rest on our laurels for a very long time - at least until we could comfortably live off of 4% of our assets - that would be about $2k/month for me - once sixth of what I need.

Regards, makingourway


Anonymous said...

Speaking of $2mil's blog income - how much do you think it is? MM at PFBlog said a couple months ago that he'd made his $100,000th dollar on his blog. However, he's virtually ceased blogging. FMF put his take in the range of $30k/yr, which he allegedly donates to charity (?!?!). On the other end, James and Miel at DINKS (who have worthless content) have pulled in $600 the past year.

I've been talking about starting a blog now for over a year, and I wish I would've taken the stab and gotten myself out there. If I could make $5k or $10k a year blogging about my only hobby, I would be in heaven.

Anonymous said...

Hehe - mine is not yet at the level of many others - it was roughly $3k in 2006.

Anonymous said...

2million - that's awesome. (This post and the first one are from the CPA1298 poster who has posted on your site quite a bit). I would love to have an extra $200 to $300 coming in every month. I'm still thinking about doing it. I'm pretty spastic abouting monitoring my finances; I keep them in Quickbooks. I read PF blogs every night (if my wife lets me). What do you think?

makingourway said...


A few hundred dollars extra each month are certainly nice - though I'd balance the cost in personal time that it takes to acquire that money. How much is your time with wife and children worth?

I recently put up a post discussing the big lie in PF blogging - that PF Blogs themselves are a means to escape the rat race.

The bottom line is that $2m is pretty successful as a blogger - I initially read about him in businessweek.

The space is so crowded now it will be very hard to stand out and garner the needed publicity to really pull in high profit advertising - or even $300 per month.

Also, there's a steep learning curve.

If you do jump in, do it for the right reasons, that pf blogging will help you maintain a disciplined personal finance plan.

Regards, makingourway