How Much Passive Income Do You Need?

Most people I speak to, when they want to measure someone’s wealth, measure wealth by referring to how many houses they have. For example, “John owns 14 houses. He is rich.” However, someone may own 14 houses, but each house may only be worth $200k, which gives total assets of $2.8 million. However, what if he also had $2.7 million worth of debt? His net worth would be $100k whereas someone who owns one house worth $1 million that is fully paid off would be 10 times wealthier even though he owns 14 times fewer houses. This example clearly demonstrates how misleading a count of houses is. A more sensible approach is to calculate net worth.

However, net worth can be misleading as well. For example, suppose you inherited a house from your parents that was worth $500k and you live in this house. Suppose suddenly this house went up in value to $1 million. Are you better off? Your net worth has increased by $500k, but because the extra wealth is within the house, you cannot unlock it unless you sell the house. If you sell the house, you’d still need a place to live, so you’d buy another place. The problem is that if you buy another place, that home will have risen in value as well, so the net effect is that you have paid taxes, real estate agent fees, conveyancing fees, etc but there is no difference in your living standards. You are worse off. If you downsize and buy a cheaper place, you’d be able to unlock your extra wealth, but then your living standards drop (e.g. extra commute time).

This point highlights that net worth, although better than a count of houses, has its flaws. An alternative metric, in my opinion, is passive income. Passive income (e.g. from dividend income but also from rent, interest, etc) is income you receive by not working. Passive income should subtract any debt as debt is negative passive income. Debt is the opposite of passive income because you must work to pay off debt. This applies if you hold debt as a liability. If you hold debt as an asset (e.g. you own bonds) then this is passive income. The bonds generate interest for you that you can live off without any work.

Passive income is more useful because it directly measures your standard of living. If your net worth goes up by $500k, that may have zero impact on your standard of living. However, if your passive income goes up by e.g. $1000 per month, that is actual cash in your hands. It directly impacts how much you spend and directly impacts your standard of living.

So how much passive income is enough? It all depends on the person. Everyone is different. It also depends on the city you live in. Some cities are expensive while others are cheap.

However, using Melbourne, Australia for this example, in my opinion, to cover the basic necessities of life, passive income of about A$2000 per month (US$1500 per month) at a minimum is needed, in my opinion.

Currently I work, and I do like my job at the moment, but loving my job is a recent experience. For a long time I have hated my job mainly because I have had bad managers. Something I have learned is that things change all the time at work, so you need to have an exit plan at all times. Too many people get a job, expect they will always love the job and always make good money, so they go into debt to get a mortage, have children, inflate their lifestyle, etc and then suddenly they find they hate their job, but by then they are trapped. I made this realization early on in my career because, when I started working, I went through a restructure in the organisation. I learned quickly how risky it was to have debt and obligations, and I realised the value of structuring your life so that you have the ability to walk away from anything, not just your job but from any person or any organisation. There is great power in being able to disappear at the drop of a hat, and this is achieved with passive income coupled with minimum or no obligation (including financial obligation i.e. debt).

Don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.

~ Neil McCauley

Even if there were a restructure at work or a tyrannical manager took over and started legally abusing staff, with passive income of $2000 per month, it is easy to stop work and live an urban hermit lifestyle e.g. renting a one-bedroom unit on the outskirts of the city (e.g. this place in Frankston), living off Aussielent, and surfing the internet all day. The only costs are rent ($1000 per month), Aussielent ($320 per month), wifi ($50 per month), electricity ($100 per month), and water ($100 per month), which comes to a total of $1570 per month. I round that up to $2k per month just to give a little buffer. Nevertheless, this is quite a spartan minimalist lifestyle. Doubling it makes $4k per month passive income, which I feel is enough to really enjoy a comfortable and luxurious lifestyle e.g. travelling, living in the city, eating out, etc. Nevertheless, $2000 to $4000 per month in passive income is a good range to aim for.

Converting Human and Erotic Capital into Cash

There is a lot of talk about passive income. Passive income is income that you receive (e.g. from shares or bonds) that require no work. Active income is income that requires you to do something e.g. when you get a job and work. While there is much attention on passive income vs active income, there is little discussion or focus on the capital upon which this income is derived. Passive income comes from what I call passive capital whereas active capital includes capital that requires you to work in order to derive an income from it, and these types of capital can appreciate (e.g. human capital if you build your skills) or depreciate (e.g. erotic capital if you let yourself age).

In spite of what people say about the rise of socialism, I believe that capitalism still rules the world. Government workers simply work for those who own capital. Capital is the “means of production.” It is whatever makes money. We are all born with human capital i.e. our skills and ability to work and earn a salary from it. In addition to human capital there are also those men and women who have “erotic capital” (also known as sexual capital) that allows them to charm others. When we humans enter life, we are faced with the challenge of working so that we can convert human capital and erotic capital into cash.

Human capital and erotic capital is different from other types of capital e.g. financial capital (e.g. stocks, bonds, or ETFs) in that work is required to convert the human or erotic capital into cash. Financial capital is different because e.g. you can own stocks and bonds, do nothing, and receive income from it. However, to derive income from human capital (e.g. skills), you must work. To derive income from erotic capital (your good looks, charm, people skills, etc), you must also work (although it comes naturally to some).

Because passive capital requires no work whereas active capital requires work, I believe that this is where overeducation or oversexualization can become a problem. There are many people who seek to build their human or erotic capital. For example, many people stop working and dedicate large amounts of money and time into degrees and qualifications. Their human capital grows significantly but it is a challenge for them because human capital cannot be spend. You need to work first to convert that human capital into financial capital. The same can be said of erotic capital. Many people are obsessed with networking, looking good, etc, and this may pay off, but like education there is a significant degree of uncertainty, and a lot of work is needed to convert that erotic capital into financial capital.

The old saying that you should “invest in yourself” should then be scrutinized. It makes sense to invest in yourself, but there are downsides.