Finance
Breaking Free from Financial Constraints: The Power of Passive Income on Your Journey to Financial Independence
Passive income, the dream of earning money without constant effort, holds a unique allure. The idea of generating income while you sleep feels like discovering a treasure trove. While I haven’t fully transitioned to relying solely on passive income, that day is on the horizon. There are different levels of passivity within various income sources, but one thing is clear: passive income can significantly impact financial freedom.
Understanding the Role of Passive Income
Passive income doesn’t play a central role in our lives. We mainly view it as part of our investment strategy. As we continue to earn more active income than we spend, even accounting for taxes and charitable giving, the passive income we generate is reinvested, contributing to our tax bill. We prefer to see our investments grow in value rather than actively relying on the income. However, having a consistent stream of passive income offers reassurance. This income might subconsciously enable us to take calculated risks in our careers, business ventures, and investments that we might otherwise shy away from.
Our Current Passive Income Situation in Nigeria
Taking stock of our passive income in Nigeria allows us to have a better understanding of its effect on our financial position. For instance, I consider rental income on my real estate investments as part of my passive income, and this is usually sheltered by depreciation. However, I do not add the larger dividends from investments like Afrinvest Equity Fund, which are typically used to purchase another property. Additionally, I also include interests on bank accounts and dividends on stock mutual funds. Still, I do not count earnings from clinical work, salaries paid by my company, or income received from partner companies, all of which are treated as active income. Capital gains are also excluded.
As of 2021, our passive income comprises the following:
- Taxable interest: N3,960,404
- Tax-free interest: N5,584,156
- Qualified dividends: N34,002,456
- Non-qualified dividends: N30,071,038
- Real Estate income (rents): N13,928,174
- Income in retirement accounts and HSA: N35,858,464
Total: N123,404,692
If we exclude taxes and charity, our passive income exceeds our yearly expenses of N79,020,000. If we were to rely solely on passive income, we could comfortably cover our taxes and maintain our lifestyle while still allocating a substantial portion to savings and investments.
For example, let’s say that we invest N20,000,000 in real estate, and the earnings make up 50% of our passive income. With an average yield of 10%, we could expect to earn an additional N1,000,000 yearly passively. This example shows how building your passive income portfolio in Nigeria can be lucrative and a great way to achieve financial independence.
Using Passive Income Wisely
The question of whether we spend our passive income or reinvest it is nuanced. With our earned income exceeding expenses, one viewpoint is that we reinvest all of our passive income. Yet, we combine earned and passive income at the beginning of each month to determine our financial decisions. While it’s accurate to say we reinvest most of our passive income, we do allocate a portion for spending, taxes, investments, and giving. A broader definition of passive income, including S Corp and business partnership distributions, highlights significant tax spending.
Clarifying Misconceptions About Passive Income
Passive income exists on a spectrum. Some income sources are entirely passive, like bank interest and mutual fund dividends. As we delve into real estate, some forms of income require more involvement than others. A bit of extra work isn’t necessarily negative, as it often enhances returns, but it does decrease passivity. Other “passive income” sources, such as blogs, books, and online courses, demand upfront effort followed by passive income. Even within the realm of online entrepreneurship, degrees of passivity vary. An automated course sold from a static website is more passive than an instructor-led course sold from a blog.
Passive Income’s Role in Achieving Independence
During the pandemic, doctors faced reduced clinical incomes, sparking an interest in diversifying income streams. Even in normal circumstances, burnout pushes some doctors to seek alternatives. When doctors need to work less, two choices emerge: spend less or generate passive income. Spending less is effective, given that saving money is akin to earning more. However, not reinvesting passive income slows portfolio growth. Shifting towards assets with a higher income-to-return ratio balances this trade-off. For those seeking a change rather than reduced hours, starting a side gig offers an option. Some side gigs are initially active but transition to passive income. Direct real estate, for example, begins with active involvement and evolves into passive income that can replace clinical income or fund future endeavors.
In conclusion, passive income profoundly influences financial independence. As you build your own income streams, consider the diverse options available. Embrace the benefits of passive income, strategically balancing it with other sources to achieve your goals.
