Active income is much more enjoyable than passive income due to the positive feeling of purpose. We want to know our actions make a difference no matter how small the scale. But what is the ideal split between passive income and active income? Finding the right balance leads to a better life.
For those of you who fear retirement expediting your demise, don't worry. Every able bodied retiree will naturally gravitate towards doing something useful to keep themselves healthy.
Passive Income vs Active Income
When my total income was dominated by active income I was thrilled. However, I often felt there was NO WAY OUT. The only way to flourish was to work hard and constantly stress about being the best to continue getting paid and promoted.
I'm already quite disciplined, so to add high expectations from managers only compounded the one more year syndrome. It wasn't until my passive income hit about $3,000 a month in 2008 when I began to see the stars.
$3,000 a month wasn't enough to live comfortably in my house in San Francisco. But, it felt good knowing I could survive on my own if absolutely necessary.
Worst case scenario I'd sell my properties and rent a studio for $1,400 a month. With $700 a month left in disposable income after taxes, I'd wait it out until an opportunity came along.
Progress Is Happiness, Which Makes Active Income Attractive
Progress begets progress. Once I started thinking about my worst case scenario I became hooked on creating better worst case scenarios.
When I first wrote this post, I knew I couldn't easily send more than one kid to private school in SF if need be. But I found peace that my worst case scenario at the time was OK.
There are some great public schools in San Francisco, even though the lottery system is extremely stressful. And I also learned there are need-based scholarships at private schools for families who make less than $100,000 a year per child. So that's good! Fingers crossed my kids are studious and smart.
Related: Is Private Grade School K-12 Worth It?
The Ideal Passive And Active Income Split
Now I'd like to quantify a framework of happiness between passive income and active income as a percent of total income. The goal is to provide motivational goals for those seeking financial independence.
I'll share with you some of my thoughts along the way so you get a sense of how the journey feels. Essentially, for a more fulfilling life, you should embrace this philosophy: Earn Active Income For Wants, Use Passive Income For Needs. Not only will you feel a greater sense of purpose in retirement, you'll also strengthen your finances further.
90%+ Active Income As a Percent Of Total Income
When you have more than 90% of your total income as active income it's easy to feel like a slave to your job. Stop working and you starve, it's as simple as that.
Most people in America, if not the world are in this bucket where their job is their only source of income. The need for money and healthcare trumps one's dissatisfaction for work.
The trick is to increase your passive income to coincide with the decrease in the desire to work. It's the same idea as paying off your mortgage completely by the time you retire.
I was in this stage for eight years after college (1999-2007) and it was fine because I was full of energy until 2009. But the 2009 downturn really beat my motivation to a pulp.
If I was still trying to kill it during my 11th year of work without a reasonable passive income stream I'd be depressed because I would need to work another 10 years to get to financial freedom as a less enthusiastic worker bee.
60-89% Active Income, 11%-40% Passive Income
At this level you've begun to taste the sweetness of passive income. You aren't generating enough passive income to do whatever you want yet, but you know that if you stay the course for X amount more years, you'll get there.
To stay motivated, your passive income is earmarked to cover particular expenses such as vacation, food, clothing, or shelter. Once you find a purpose for your passive income, you gain more appreciation and motivation.
I was in this stage from 2008-20011, but instead of spending my passive income I just kept plowing the proceeds back into my investments. There was still a lot of anxiety because of the downturn so I felt the need to work as hard as ever.
One motivational thought I kept on thinking was that every $10,000 dollars saved was like giving myself a $400 a year raise so I kept on going.
40-59% Active Income, 41%-60% Passive Income
When you're at 40-59% active income you are now generating as much passive income as your active income. Thoughts are now dancing seriously in your head about whether you should quit your job and do everything your heart has been desiring all these years but couldn't.
Half of you take the leap of faith because you've been dreaming about this day ever since you started this passive income journey so many years ago. The other half of you stay at your job because suddenly, your job feels so much more fun without all the pressures to perform!
I probably would have continued working for another four years if it wasn't for the fact I was able to negotiate a severance package which allowed me to walk away with deferred compensation, severance, and health care. I was never able to get passive income to equal 41-60% of my total income largely because of my day job income amount.
20-39% Active Income, 61%-80% Passive Income
With the majority of your income coming from passive sources, you're only working because you find the job stimulating. You enjoy your co-workers and can't see yourself doing anything else with the majority part of your day.
You feel that your day job income is now bonus income because you can easily live off your passive income. The feeling of making “double money” is exhilarating. However, sooner or later your enthusiasm starts to fade. You begin to do some soul searching to find more purpose in life.
I wrote in 2013 that a part of me longed to go back to work in order to make “double income” now that the good times are back. I held off going back to work because I wanted to finish out the year with full dedication to entrepreneurship.
Now I can say I gave entrepreneurship everything I had in 2013 and look back with no regrets.
<20% Active Income, >80% Passive Income
At less than 20% active income there's really no need to work at all for a living. If you are working, you start feeling a little guilty about taking up a position that someone younger and hungrier would love to have.
Doing something for money feels off. As a result, everything you do that provides compensation adds some value to society.
Given I no longer have a job, it's much easier to have passive income dominate my total income stream. Based on reclassifying income in an online income contest, passive income was 80% of total income all throughout summer when I went traveling for six weeks. This income split provides for a high Return On Effort for a better lifestyle.
It felt great when I was distracted with travel, but once I returned home I longed to get active again. It doesn't feel great to not have something meaningful to do. Everybody needs a purpose, especially early retirees. I'm pretty confident that anybody in the 61%-100% passive income range will long to work again if they aren't already.
Ideal Active vs. Passive Income Split Chart
There's somewhat of an illusion that day job income is completely active income. One's day job income eventually starts feeling a little like passive income because we tend to take our job income for granted over time. Day job workers make money over the weekends, holidays, and when sick. We tend to always get used to everything we have. Passive income can also be classified as semi-passive.
Please don't confuse active income with passive income. For true financial independence, you want to have as much passive income as possible to live free. You can then supplement your passive income with active income by doing the things you love.
Strive For A Good Mix Of Passive And Active Income
Consider leaving a job you dislike when your passive income produces enough to take care of you and your dependents or when your passive income equals 30% or more of your total income.
Obviously the greater your total income, the less passive income percentage you will need to survive.
At 10% passive income as a percentage of total income, you've got your savings habits down pat, and you've also got room to grow your passive or semi-passive income streams if you dedicate your time.
When I left Corporate America in 2012, my passive income was roughly 25%-30% of total income. The figure is on the low end of my chart, but I had the courage to make the move because of the severance and deferred compensation, as well as having a clear idea of what I wanted to do.
If I were to go back to working in finance now I should be able to achieve a roughly 50/50 passive/active income split which I think would make me feel ecstatic coming into work every day.
Each paycheck would feel like winning a small lottery. But instead of going back to work in finance, I've decided to try my hand at something new!
Latest Passive Income Streams
Here are my latest passive income streams. If you're curious, I created a post ranking the best passive income investments. I share all the main ways you can start building passive income for financial freedom.
As you can see from the chart real estate is my main source of passive investment income. After owning four rental properties, I started aggressively investing in private real estate online through platforms like Fundrise.
Favorite Way To Generate Passive Income Today
Fundrise is my favorite private real estate platform that primarily invests in residential and industrial properties in the Sunbelt, where valuations are cheaper and yields tend to be higher.
I'm legging into real estate now given prices are down due to high mortgage rates. But with the Federal Reserve embarking on a multi-year interest rate cut cycle, I expect demand to surge higher again. Real estate has lagged stocks and provides better value.
I've personally invested $300,000 in Fundrise so far and Fundrise is a long-time sponsor of Financial Samurai.
Another private real estate platform to consider is CrowdStreet. Crowdstreet is a marketplace that mainly sources individual commercial real estate deals from various sponsors around the country. This way, you have more customization to build your own select private real estate portfolio.
Make sure you diversify your portfolio and do your due diligence on all the sponsors. Look up their track record, their management, and whether they have had any blowups before. Although CrowdStreet screens the deals, you have to do your screening as well.
Both platforms are sponsors of Financial Samurai and Financial Samurai is a six-figure investor in Fundrise funds.
More Recommendations For Building Wealth
The more passive income streams the more you have to keep track. I aggregate all 32 of my accounts with Empower so I can easily stay on top of my finances.
Not only is it free, Empower tracks my net worth automatically. It also allows me to manage my cash flow month-to-month. Plus, it has a fantastic Investment Checkup tool that highlights how much you are paying in portfolio fees and how you can optimize your investments.
They also have an amazing Retirement Planning Calculator. It pulls in your real data and produces realistic financial outcomes using Monte Carlo simulation. I’d definitely give it a try to see how you’re doing. It’s the best free financial tool on the web today.
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Fan of your vlog! You know what would be helpful.. could you post how much you have invested in each area, like you say $2,000 a month passive income in stocks but what is the amount in there and at what dividend yield, how much was put into the real estate down payments, etc. I think that would give some of us with less money to play with an idea of how you set it all up.
I really like this framework. My goal for Early Retirement is to just stop doing the temp work on top of my business. I’ll want to work 20 hours a week at my business and keep my other hours to myself, but still have enough to live well. If those 20 hours can generate 40% of what I need, then my passive income will need to equal 1800/m; this feels so much more attainable than 25 times my yearly spending.
@Andrew F – I am no expert, but save making sure you have your portfolio positions in the right buckets (RRSP, TSFA, Taxable) so as to minimize the taxes on dividends, income and capital gains, maybe doing some tax loss selling before the end of the year if there are any remnants of failed stock picks still in your taxable portfolio from your active stock picking days, or the extreme example of not having earned income (ie quit your job) and only having Canadian eligible dividend income so that you can take advantage of the $47K you can earn in such income (in Ontario – other provinces vary) without paying any tax (except for the $600 Ontario Health Premium) I don’t know of anything else you can do to minimize tax on your portfolio.
I think as soon as I’m approaching that 50-50 split I’ll start working on leaving my full time active duty job and transition to the Reserves. The Reserves offer a much easier lifestyle on the family, less frequent deployments (unless you want them), and less BS to deal with than the active duty side. I’ll still get a (reduced) paycheck and the opportunity to do what I love with a lot more flexibility. While my investments keep on producing passive income, we could live off of the active income from my day job at the Reserves. I think that could be a lot of fun. We should be there in less than 10 years.
Spencer, I think you’ll definitely have a lot of fun. The pension is going to be awesome, and you will find more fun things to do with your free time guaranteed. Good luck!
So I am with Anne who commented above. Sam you have also mentioned time and time again that the fun part is the journey towards FI…once you get there or damn close to it, your “job” becomes a little easier and more enjoyable. The little things (and people) no longer keep you from sleeping at night…you start to worry more about what truly makes you happy and focus your efforts there.
Yes, you definitely don’t sweat the little things as much anymore. You actually start joking with your significant other about how ridiculous some office situations get and point out the “I remember when I had to kiss butt to get ahead” type of moments. It’s definitely more fun!
I really love reading your blog. It’s really inspirational.
I had hoped that I had read it sooner. aka paid attention to my financials sooner.
Hence my request: I would like to get your take and advice for those who want to achieve financial freedom but have started realizing the realities of what it takes a little late in life. What’s you take for someone seeing the light bulb in his mid-30’s, 40’s etc. What should be done when the situation is made more challenging with the responsibilities of kids etc.
ZZ -Mid-30s, 40s is still pretty early imo as you’ve got 20-30 more years left of work if you want. Hence, there’s no time like the present and it all starts with being an aggressive saver, and figuring out the ways to mobilize your savings and make more money.
Good synopsis. As the % passive income increases, the need to work drops and you can really choose to do whatever you want in terms of productive labor. Part time, full time, freelance, profitable hobbies, or nothing at all. I used to think I would want to get to 100% active income and quit working or earning money completely. Now that I’m at that point, it is a little hard to not think about ways to bring in a little extra income.
Sam, I’ve never really thought of my portfolio in this way. Our index fund investments have gains but I’m hesitant to think of the growth as passive income in the accumulation phase. We do rent out a room in our house though, and that might be my favorite income of all. It feels like free money. It’s only about $550 a month when we include utilities, but that little bit represents over a fourth of our monthly living expenses.
I wonder if there might also be a correlation between the ratio of passive income to living expenses, in addition to the ratio to overall income.
Because my assumption is that 100% active income covers at least 100% of all expenses as we live within our means, I didn’t compare passive income to expenses. But I can and will when I get the time.
Sam,
I have a few comments about this post. First, by addressing this as a percentage of total income, some assumptions are made. Using 2008 Sam as an example, you were making 3k in passive income. If you decided to become a school teacher and earned 30k a year…all of a sudden, your passive income “percentage” jumps to over 50%. Wouldn’t it be more reasonable to compare passive and active income in relation to expenses and/or budget. That way, you’d be able to determine what amount of passive income gives you what feeling (i.e. elation when %150 of expenses are covered, comfort when 50% of expenses are covered).
Second, how are you defining passive income? With dividends, it’s pretty straight forward. However, people view rental properties in many different ways (and often get burned as a result). For instance, if you pay a $3,000 mortgage on an investment property but are collecting $4,000 in rent, is your passive income $1,000/mo. Do you factor in that $1,000 of your mortgage is going to principal…your net worth is thus increasing by $2,000/mo. Is the cost of deferred maintenance in the equation? What about recurring expenses of the property ($100/mo for the gardener, $75/mo for pest control, etc).
Good points. I can certainly create another chart in this post or a new post comparing passive income and expenses.
I think I didn’t because we know that if passive income covers all expenses you can do whatever you want, including working as a teacher for 50k a year in your example. The feeling of different stages is the same, and the rest is just math eg 50/50 split means passive income = to active income.
For your property example, the passive income is net of all expenses. If not, that’s called passive revenue.
Sam,
I’ve never thought of passive income in this way, but it makes sense. I’m still in the 90%, but I have a low stress job that pays very well. No more than 40 hours required and I work some from home. I think the magic number for me would also be the $3000/month. Not a comfortable number in the DC area, but that would give me some real options. Not sure how long that will take me from here, but I’m working on it.
-RBD
This is much closer to the way I look at the world. I’m all about cash flows.
If your passive income exceeds your normal expenses then you are financially independent. You can choose to work, or not. You can choose to work at something you enjoy. Etc.
I see this as far more important than the net worth number. Net worth isn’t always a useful metric. Especially if people include so many illiquid items in that number.
I do think that psychologically, work is good for people. Work provides a structural balance in a person’s life and the opportunity to engage outside of ones normal social environment. It also provides the challenge of learning new things.
In my opinion, if your passive income exceeds your expenses, and you have a comfortable family life, then you are rich! Even if you live in Cleveland.
Great article ! In 2007 i was very unhappy with my job and all i wanted to do was to retire early, which prompted me to have a goal to retire in 10 years time and i think by the end of this year i would achieve my goal. But the closer to the goal i am, the more i enjoy what i do now ( maybe it is the feeling of me having a choice whether or not i work) and lately although i am very excited about reaching my goal, i often wonder whether or not i still want to retire in a few years or not. Instead, i have been thinking about keep working, not sure whether it is greed or it is the uncertainty about the future or maybe because of my extremely poor upbringing that i don’t want to stop working, also because i earn a decent wage. If i was in a low level paying job, maybe the decision to give up would be easier, i don’t know, still searching for the answer and what to do. Your article really resonates with me well. I agree we need to feel a sense of purpose. Keep up the good work Sam!
I’m with RB40. 50‰ is my sweet spot.
If you’re able to live off half your income, once you hit 50‰ passive income you know you can survive on just that and are saving all your active income.
My passive income is still low, but I’m greatly anticipating hitting that hallway point.
Sam,
Interesting concept. I don’t know if this applies to all people in a broad sense, however. Some people find purpose and passion in work, and some just do not. I fall in the latter camp.
For example, my best friend and I talk about money and FI all the time. He’s become inspired by what I’m doing and I’m trying my best to steer him in the right direction. However, he’s made it clear that he has no interested in ever not working, but rather just wants to be flexible and secure. I, on the other hand, am completely driven by not having to “work” ever again – at least, in the traditional sense of the word. Once my dividends cover my expenses completely I’ll never have a 9-5 again. I’d love to continue writing and inspiring people, but I view blogging and typing stuff into a computer as a hobby that I make a little side money off of. And it’s good to know that I don’t have to do it. However, I never want to be in a position where I buy myself a job, and if at any time writing becomes a drag I’ll just stop.
Best wishes!
DM,
Not liking work and not wanting to work is great motivation to achieve FI! I got my butt kicked so hard my first two years on Wall St. that I HAD to save all I could b/c I knew I wouldn’t last.
I think you’ll find work more fun once you don’t need the money. You’ll search for a job you’ll really enjoy.
Cheers
Not to date myself too much, but I used something like this in the late 70’s! I started investing in rental properties to generate (semi passive& tax sheltered) additional income. Leverage and aggressive investing allowed me to grow it into a business. The key to rental property investing is finding larger buildings because of economy of scale. My next step was diversifying income with cash generating businesses. Now I am in a different stage of life where I want more passive income of the stock market. In retirement, I want a different mix of steady income of Social Security and a pension (COLA adjustments) which I can use for my needs and my investments for my wants.
My theory was building assets to a point where it would yield income at some future date. I still use that same theory with my investments because now is a great time for growth and income can be reinvested for more growth.
I’ve been working on building my passive income streams. I sat on cash for too long without doing anything with it and I realize now how foolish I was.
Insightful that the ideal is, in fact, a split – I recently came to this realization myself. For a while I was investing primarily in income-producing assets (real estate, high yield debt, P2P loans, etc) in the interest of achieving financial independence as soon as possible. Of late, though, I’m asking myself the question, “then what?” What will I do when I get there? Certainly I’d keep working in some capacity and would continue to earn some kind of active income. This has helped me realize that “FI ASAP” is less critical than living well at the present and building a well-rounded financial picture – FI is a great byproduct of prudent saving and investing, but it’s not the end-all-be-all. This realization has led to an interesting practical result: whereas previously I was solely interested in acquiring income producing assets, now I’m more focused on growing overall net worth. I’m investing in growth equities and real estate with appreciation head room as opposed to high yield bond funds and real estate with better current yield but less long-term upside.
I’m not sure of how to quantify the ideal ratio between the two, but your post is a considerate perspective and I suppose the ranges you identify and sentiments associated with those ranges are probably pretty accurate for most of us. Good stuff!
“Then what?” is a huge question that we discussed about in a previous guest post. Check it out.
I’ll tell you this… once you get to FI where all your passive income covers all your expenses comfortably, the world of possibilities opens up tremendously. I’ve got this new advisory gig now I’ll discuss in an upcoming post I’m really excited about.
Growing net worth + having all expenses paid is a great combo goal.
Love the article. Being able to classify where your passive and active income ratio is can be a great tool for planning and decision making.
This article got me thinking about is the relationship between income and spending, relative to these active/passive ratio categories. I almost want to see a few columns in your table for “% of income saved”.
If I’m in the 50/50 active/passive category, my saving/spending ratio will play a big role in how I look at my need to work.
Of course, that’s re-scoping the article a bit. The active/passive income ratio by itself is definitely a great metric to be aware of.
The good thing is, by default, to generate passive income one must figure out a way to save, and save aggressively at that. Otherwise there’s no way to ever invest in passive income vehicles.
Check out, “How Much Savings Should I Have By Age.“
Thanks for the breakdown of passive vs. active income levels. I’m only beginning my passive income journey so I’m aggressively trying to grow that stream – right now it is mainly made up of income stocks that are automatically reinvested, but I’m looking to move into real estate in the near future as another semi-passive income stream, as well as other possibilities. Right now I’m only at about 2.5% passive vs. active, but I look for that to grow as I become more focused.
2.5% is better than a poke in the eye! It’s a long, but rewarding journey. Keep at it!
I’ve never really considered the ideal split between passive & active income. I’m still in that 90% group, so my only goal is to focus on creating as much passive income as possible without having a “goal” in sight.
My short term goals are to create enough passive income where losing my job isn’t a devastating event. But I can see myself moving the goal posts as my ratio of active/passive increases.
Glad you mentioned the fear of losing your job. I think we’ve become kind of complacent with our job security with the huge rebound in the stock markets and economy.
If we have prolonged weakness in both, people will start worrying about job security again. Passive income will definitely alleviate this fear, along with unemployment benefits!
Passive income is tough for regular people. Right now, we’re only at about 15% passive income. Our rentals are just not pulling their weights. I guess I need to give them a few more years. Anyway, I think 40-50% passive income would be ideal as long as that is enough to pay living expense. That way, you can save all your active income.
Ever consider buying more rental property?
I love thinking about my journey towards FI and passive income! I am currently at the 25% passive income level, but it actually feels like a bit more because I definitely don’t NEED the full income I make to survive. I live on a fraction of my income, so perhaps I need even less to light out on my own.
That said, I don’t have diversified passive income. If the stock market goes in the toilet for a year or two, I would be squeezed without my active income. I need to build other sources to help stabilize that a bit.
I am like you though, all my passive income right now goes back into my investments.
I hope the stock market doesn’t go in the toilet, but as we’ve seen with todays (1/24) dump of -315 in the Dow, it very well could be!
25% is great, and also an excellent point that it feels like more b/c you don’t need 100% of your active income to live. Given you’ve been able to develop passive income, it’s likely you are saving 20%+++!
Great points about passive income. That is why I love rental properties and I am trying to buy as many as I can. I have 8 now and a 9th under contract. I also run a business and do my best to delegate tasks so I am not the one doing all the work. I went on vacation in November and worked maybe two hours the entire time! As a real estate agent that is unheard of. lol
I think there are two paths to passive income. Cash flowing assets and running a business that can survive without you.
Have you ever considered moving to an area with a lower cost of living. At $3,000 per month, you could easily live in a lot of others areas around the country. I wouldn’t be satisfied with that, but to me is would be a better worse case scenario.
I definitely have. In fact, I’ve been thinking about moving back to Honolulu since the financial crisis because there’s a paid off house there waiting to be fully occupied.
Hawaii is my next step if I ever move away from SF. I wrote about it in, “If You Can Make It In Hawaii You Can Make It Anywhere.”