The critical guide to passive income james puffin

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THECRITICALGUIDETO
PASSIVEINCOME
AThoroughExploration

By

JamesG.Puffin


TableofContent
Preface
Chapter1-WhatIsPassiveIncome?
Chapter2-SoWhatIsPassiveIncomeNot?
Chapter3-PropertyIncome
Chapter4-Royalties
Chapter5-Arbitrage

Chapter6-TheInternet
Chapter7-DigitalGoods
Chapter8-AlltheManyOtherWaysofMakingMoneyOnline
Chapter9-SummaryandAWordAboutOpportunityCosts
Chapter10-TheLongListofWaystoGeneratePassiveIncome



Preface
Passiveincomeisthepowerfulideathatyoucansetupwaystoearnyourselfmoneythat
willkeepearningyoumoneyevenafteryoustopworkingonthem-thisiswhatmakesit
passiveincome.SometimethetermSWISS-SalesWhileISleepSoundly-incomeis
usedtoemphasizethisalluringaspectofpassiveincome.
Inthisbookwetakeacriticallookatthemanydifferentwaysofgeneratingpassive
incomethatexist.Theworldisalreadylitteredwithoverlyoptimisticand,unfortunately,
oftenwildlyunrealistichow-toguidesforhowtogeneratepassiveincome.Ourgoalin
thisbookisthereforetoprovideasomberandcriticalguidetopassiveincome.
Thestartingpointforusiswhatispossibleforasingle,ordinaryperson.We
recommendformsofpassiveincomethatarepossibleforasingle,ordinarypersontohave
successwithandrecommendagainstformsofpassiveincomethatarenotviablefora
single,ordinaryperson.Forinstancewerecommendtryingretailarbitrageand
recommendagainsttryingarbitragebetting.Thisisnotbecausemoneycannotbemade
doingarbitragebetting-weevengoasfaraslistingresourcestousewhentryingarbitrage
betting-butbecauseasingle,ordinarypersonwillmorethanlikelybewastinghisorher
timeandmoneydoingarbitragebettingwithoutevergeneratinganykindofreal,lasting
income.
Thisisthereforenotanaivelyoptimisticbookthatpromisesitsreaderstheworldin
15easysteps.Therealityisthateasymoneyishardtogetby.Wedo,however,promise
ourreadersthatafterreadingthisbooktheywillbeabletogooutintotheworldandsetup
upsomeformofpassiveincomeforthemselves.Withenoughhardworkand-sometimes

-lucksomepeoplewillbeabletomakeaverycomfortablelivingforthemselvesusing
onlypassiveincome.Otherpeoplewillhavetosettleforasideincomefrompassive
income.
Inthisbookweusethefirst-person,pluralpersonalpronoun(we)becausethe
informationaboutthedifferentformsofpassiveincomewelookatanddescribewas
gatheredbymanydifferentpeoplewhospentatlotoftimetestingandlearninghowthings
worksinpractice.JamesG.Puffinismerelytheonewhohaswritteneverythingdownand
I(JamesG.Puffin)thankeveryonefortheirtime,hardwork,andpatience.



Chapter1
WhatIsPassiveIncome?
Thisbookisaboutpassiveincome.Whatitisandhowtoearnit.Quitesimplereally.Well
no.Notentirelysimple.Forstartersnodefinitedefinitionexistsofthetermpassive
income.Thisisobviouslyaproblemifyouwanttowriteabookonthesubject.Inthis
chapterwethereforestartbysettingouttofindadefinitionofthetermpassiveincome.
Afterwehavedefinedthetermwecompilealistoffivedifferentkindsofpassiveincome
thatwebelievecoverallformsofpassiveincome.Wealsobrieflyintroduceeachofthese
fivecategories.Weendthischapterwithapresentationofthestructureoftherestofthis
book.

ADefinition
Forsomepassiveincomeistheideaofasecondaryincomestreamthatmightoneday
enablethemtoquittheirdayjobandretiretoabeachsomewhere.Forotherstheterm
denotesshadybusinesspracticesandconmenhawkingget-rich-right-this-minuteschemes
tohopefuldupes.Neitheroftheselooseunderstandingareveryusefulsinceweare
interestedinanobjectivedefinitionofthetermpassiveincomeandnotasubjective
opinion.
Wethereforeturntosomeoftheproposeddefinitionofthetermpassiveincome

floatingabout.Quiteafewexistandwearegoingtotakealookatthreeofthem.
Fortaxproposespassiveincomeisearningsderivedfromrentalproperty,limited
partnershiporothertradeorbusinessactivitiesinwhichyoudonotmateriallyparticipate.
Thisisagooddefinitioninsofarasitisprettyclear-cutandobjective.Butthedefinition
isalsoseverelylimitedanditdoesnotcoverwhatmostpeoplethinkofwhentheyhearthe
termpassiveincome.IncomefromactivitiesontheInternetifforinstancenotcovered.
Thisdefinitionisthereforenotusefulasatooltous.
PatFlynnfamedcreatoroftheblogSmartPassiveIncomedefinespassiveincomeas
“buildingonlinebusinessesthattakeadvantageofsystemsofautomationthatallow
transactions,cashflow,andgrowthtohappenwithoutrequiringareal-timepresence”.
Thisisamuchbroaderdefinitionofpassiveincomeandhintsatoneofthedesirable
aspectsofpassiveincome,namelyautomationandcashflow.Flynn’sdefinitionis,
nevertheless,alsolimited.Itfocusesnarrowlyononlinebusinesses,whichleavesout
offlineformsofpassiveincome.IncomefromrentalpropertyisinFlynn’sdefinitionnot
passiveincomesinceitisnotanonlinebusiness.WemustthereforealsodiscardFlynn’s
definition.
FinallytheWikipediaarticleonpassiveincomedefinesthetermpassiveincomeas
“incomereceivedonaregularbasis,withlittleeffortrequiredtomaintainit”(source:
en.wikipedia.org/wiki/Passive_income).Thisdefinitionisverybroad.Bothonline
businessesandofflinebusinessesarecover.Butthedefinitionisnotveryclear-cut.How
muchisalittleeffort?Canaverylaid-backjobbepassiveincome?Forthetermpassive


incometoretainanymeaningthatanswerhastobeno.ButunderWikipedia’sdefinitionit
isnotclearthattheanswertothatquestionis,infact,no.Wikipedia’sdefinitionalso
requiresregularityfrompassiveincome.Thepurposeofthispartofthedefinitionis
unclear.Alumpsumisstillincome.Wikipedia’sdefinitionisinthiswaybothtobroad
andatthesametimeoddlyconstricting.
Notsatisfiedwiththeexistingdefinitionswesetouttocoinourown.Weare
interestedinadefinitionthatisclear-cutlikeboththetaxdefinitionandFlynn’sdefinition

butthatunlikethosedefinitionscapturesthefulluniverseoftypesofincomesthatare
logicallysimilar,e.g.bothonlineandofflineactivities.Tothisendweproposethe
followingdefinition:
Passiveincomeisincomedecoupledfromthenumber
ofhoursworkedtogenerateit.
Passiveincomeherebybecomestheoppositeofsalariedworkwherethereisaverydirect
(thoughnotalwaysperfect)couplingbetweentheamountoftimeworkedandtheincome
earned.Thisfitsnicelywithhowpassiveincomeissometimesequatedwithunearned
income-forbetterorforworse.ItalsosubsumesboththetaxdefinitionandFlynn’s
definitions.
Sotherewehaveouranswer.Passiveincomeisincomedecoupledfromthenumber
ofhoursworkedtogenerateit.Notehowpassiveincomeinthisdefinitionisnot
inherentlybetter-orworse-thansalariedwork.Thatincomeisdecoupledfromthe
numberofhoursworkedsimplymeansthatthereisnorelationship.Youcangetluckyand
earnahugeincomeonverylittleworkoryoucanbeunluckyandnotearnadimeafter
havingputinahugeamountofwork.
Thisdownsideoftryingtogeneratepassiveincomeissomethingmostpeople
overlookintheireagernesstoearnlotsofmoney(orselllotsofpassiveincomeproducts).
Butitplainlyexists.Insalariedworkyoucanneverearnmorethanitsaysinyour
contract,sayforastraybonusortwo,butyoucanalsonevermakeless.Ifyouwork,you
arecontractuallyguaranteedpaid.
Toputitanotherway;passiveincomeoperatesonabroaderspectrumwithamuch
largerupsidebutalsoamuchlargerdownsidethansalariedwork.Thisiswhymostpeople
havesalariedwork.Itisasaferbetandbettersuitedtotheriskaverse,whichthelarge
majorityofthepopulationis.
Anotherthingtonotewiththisdefinitionofpassiveincomeisthatadecouplingof
incomeandworkdoesnotmeanthatworkisoptionalwhentryingtoearnpassiveincome.
Generatingmostkindsofpassiveincome,infact,requiresasubstantialamountofwork,
andthekindsofpassiveincomethatrequireslittletonoworkwillmostoftenrequirea
substantialamountofcapital.Whatismore,theinvestment-beitworkorcapital-is

requiredupfront.Youhavetoputinyourworkand/oryourmoneybeforeyouseeany
kindofreturnoninvestment.Thisseemscommonsensicalatfirstglance.Butthe
decouplingwhichbydefinitionisthenatureofpassiveincomemeansthatnothingis
guaranteed.Youmighthititbigoryoumightnot.Eitherwayyourtimeand/oryour
moneyisalreadyspent.Thismightdiscouragesomepeopleanditshould!
Easymoneyisoneofthehardestthingstocomeby.


5Categories
Havingnowdefinedpassiveincome,wecanuseournewlyminteddefinitiontocompilea
listofdifferentcategoriesofpassiveincome.Wearriveatfivecategorieswebelievecover
theuniverseofallkindstypesofpassiveincomesatisfactorily.Inthefollowingchapterschapters3through7-wewilldiveintothespecificsofeachcategoriesandexplorethe
differentformsofpassiveincomethatfallineachcategory.Wewillalsoprovideexamples
ofpotentialbusinessesineachofthefivecategories.
Belowisabriefintroductionofeachofthefivecategories.
1.PropertyIncome
Propertyincomecomesinthreevarieties;rent,interestandprofit.Rentcomesfromthe
ownershipofpropertythatisrentedout.Thiscanbehouses,officebuildingsoreven
naturalresourcessuchasshalegas.Interestcomesfromtheownershipoffinancialassets.
Thiscanbedividendsandinterestfromowningsecuritiessuchasstocksandbonds-this
issometimesalsolabeledportfolioincome.Finallyprofitcomesfromtheownershipof
capitalequipment.Thiscanbeassimpleasowningyourowncarorascomplicatedas
owninganentirefactory.
Commontopropertyincomeisthatitrequirescapital.Ifyoudon’thaveahouseto
rentout,youneedtobuyonebeforeyoucanstartrentingitout.Sometimesitalsorequires
work.Runningarentalserviceforexamplerequiresalotofwork.Owningstocknotso
much.
2.Royalties
Aroyaltyisausage-basedpaymentfromthelicenseetothelicensor.Thelicenseepaysthe
licensorfortherighttouseanasset-oftenanintellectualasset.Royaltiescanworkin

manywaysbutaretypicallyapercentageofgrossornetrevenuesderivedbythelicensee
throughtheuseoftheasset.Anauthorearnsroyaltiesbylicensingouthisbooktoa
publishinghouse.Similarlyapharmaceuticalcompanycanearnroyaltiesbylicensingout
apatentforadrug.
Royaltyincomeoftenrequireslittlecapitalbutlotsofwork.Thinkofthestarving
NewYorkauthor.Butitcanalsorequirelotsofcapitalifthegoalforinstanceisanew
drug.
3.Arbitrage
Arbitrageisputsimplyaboutbuyinglowandsellinghigh.Usuallyitinvolvestaking
advantageofapricedifferencesbetweentwomarkets.Arbitrageisusuallythoughtofas
thedomainoflargefinancialinstitutionsthattradebillionsofdollarsinsplitseconds.Itis,
however,alsothedomainofthelowlyeBaysellerthathasfiguredouthowtobuy
somethingcheapandsellitwithamarkup.
Arbitrageinitspureformrequiresnocapital,asitisarisk-freeinstantaneoustrade.
Inpractice,though,itusuallyrequiresatleastsomecapital.Italsorequiresalotof


legworktofigureoutwheretherearearbitrageopportunities.
4.TheInternet
ThegreatwhitewhaleoftheInternetispassiveincome.Manyhuntforit.Fewcaptureit.
TherearegenerallythreeroutestoearningpassiveincomeontheInternet;advertisements,
affiliatemarketingandsubscriptionservices.Advertisement,i.e.sellingeyeballs,isthe
mostcommonformofincomeontheInternet.Everybloggerhopesthatonedayhisorher
blogisgoingtotakeoffandthead-moneyisgoingtostartrollingin.Itseldomhappens
andthecompetitionisfierce.Affiliatemarketingissomethingthatmostlyhappensinthe
seedyunderbellyoftheInternet.Theideaofaffiliatemarketingisthatabusinessrewards
affiliatesforacquiringcustomersforthem.Itcanbehighlylucrativebutitisoftenhighly
difficult.Finallysubscriptionservicesinvolvegettinganaudiencethatiswillingtopayto
read/listentowhatyouhavetosayorforaccesstoacommunityyouhavebuild.
ThebarriertoentryontheInternetisverylowandanybodycanstartbuildingan

audienceinaslittleasafewminutes.Butpatience,hardwork,andluckarerequiredto
succeed.
5.Digitalgoods
Digitalgoodsunlikephysicalgoodshavepracticallyzeromarginalcost.Thismeansthat
producinganextraunitofadigitalproductcostsnothing-oratleastpracticallynothing.
Digitalgoodsalsohaveverylowdistributioncosts.Togetherthesetwoaspectsofdigital
goodsmeanthatthesaleofdigitalgoodsisfertilegroundsforgeneratingpassiveincome.
Digitalgoodsincludethingssuchase-books,software,downloadablemusic,graphics,
audiobooksetc.Thelistislongandgrowing.Whatisimportanttonoteconcerningdigital
goodsisthatmostcreatorsofdigitalgoodsdonotselltheirdigitalgoodsthemselves.
Insteadtheylicense(andgetroyalties)thesaleofthegoodtoadigitalstore.Thinkofan
authorindependentlypublishingthroughAmazon.Thatauthorisnotsellinganythingto
anybody.InsteadtheauthorhaslicensedhisorherbooktoAmazonwhoinreturnpaysout
royaltiesforeverysaleAmazonmakes.Whentryingtogeneratepassiveincomewith
digitalgoodsthemaingoalshouldthereforenotbetocreatebuttosell.
Sellingdigitalgoodsrequiresbothhardworkandasmallamountofcapitaltosetup
astore.Italsorequiressomewaytolurecustomerstoyourparticulardigitalstore.This
canincludeadvertising,anaffiliateprogramofyourown,havingexclusivecontent,or
presentingcustomerswithanopportunitytosavemoneyorfantasticcustomersupport.

TheStructureoftheRestoftheBook
Sotherewehaveit-fivecategoriesofpassiveincome.Thesecategoriesaremeanttobe
ananalytictoolthatdivviesuptheworldtoincreaseourunderstandingofit.The
categoriesarethereforemeanttobeexclusive;oneformofpassiveincomecannotbelong
tomultiplecategories,andexhaustive;notypeofpassiveincomeexistsoutsideofthefive
categories.Buttheworldismessyandsomeformsofpassiveincomestraddlethe
boundaryofmultiplecategories,andsometypesofpassiveincomedonotfitneatlyinto
anycategory.We,however,findthatthecategoriesworkinsofarastheyinausefulway

sorts(almost)everyformofpassiveincome.Thestructureoftherestofthebookis
accordinglybuiltaroundthesefivecategories.
Infivechapters-chapters3through7-wearegoingtolookateachofthesefive
categoriesofpassiveincome.Foreachcategorywearegoingtodescribethegeneral
categorymoreindepth,andthenwearegoingtodiveintospecificexamplesofformsof
passiveincome.Thisismeanttogivethereaderconcreteexamplesofopportunitiesthey
mightgooutandexplore.Atthenendofeachofthesechaptersweconciselysumupthe
mainpointsoftherespectivechapter.
Inthefinalchapterwearegoingtoreviewandconcludeonourfindingsofforeach
ofthefivecategoriesandcomparetheresults.Itisnotthecasethatanyoneofthefive
categoriesholdinherentlybetterformsofpassiveincomethantherestbutsomeofthe
categoriesholdformsofpassiveincomethattendtobecapital-intensewhileother
categoriesholdformsofpassiveincomethattendtobelabor-intense.Thismeansthata
personlookingtobegingeneratingpassiveincomeshouldevaluatewhichtypesof
resourcestheyhaveavailabletothemandchooseformsofpassiveincomethatbestfit
theirresource-profile.Lastlywearealsogoingtoexploretheconceptofopportunitycost
andthehiddencostsofnotdoinganythingatall.Inchapter10wearegoingtoreviewall
thedifferentformsofpassiveincomethatwehavelookedatinthisbook.Wecallthis
chapterTheLongListofWaystoGeneratePassiveIncome.
Beforeallthisweare,however,goingtotakeashortdetourandexplorewhatpassive
incomeisnot.



Chapter2
SoWhatIsPassiveIncomeNot?
Okay.Sowejustdefinedwhatwemeanbypassiveincomeandeverybodyishappyand
readytogo.
Butfirstashortdetourintowhatpassiveincomeisnot.
Simplystartingabusinessoroperatingabusinessisnotawaytogeneratepassive

income.Inmostnormalbusinessesthereisaprettyclearcouplingbetweentheamountof
workputinandtheincomeearned.Ifyouopenapizzaplacethereisgoingtobeapretty
clearcorrelationbetweenthenumberofpizzasyouaremakingandtheamountofmoney
(*dough*)youaremaking.
Thisdoesn’tmeanthatitisabadideatoopenapizzaplace.Itmightbeagreatidea
ifyouarereallygoodatmakingpizzas.Butyouarenotgoingtobegeneratingpassive
incomefromyourpizzaplaceuntilyouparlayyourmadpizzaskillsintoforinstance
becomingapizzaplaceownernotneededfortheday-to-dayoperationandearning
propertyrent(profitorinterestdependingonyourbusinesssetup),orintoearning
royaltiesonyourpatentedpizzamakingprocess,ormaybethroughathirdorfourthway.
Itisalsonotpassiveincometogetasecondjoborworktwojobsatthesametype.
Sayyouareworkingnightsinahotelandhaveplentyoftimetoworkonyoursecondjob
asafreelanceeditor.Thatisobviouslyasweetsituationtobeinandgoodonyoufor
gettingintothatsituation.Butyouarenotmakingpassiveincome.Botharejobsandboth
haveaclearcouplingbetweenhoursworkedandincomeearned.Youneedtobedoing
somethingelsewithyouextratimeinthehoteltobegingeneratingpassiveincome.
Writingabookthatcanearnyouroyaltiesforinstance.
Savingmoneybycuttingdownonfrivolousspending.Agreatidea.Alsonotpassive
income.Notincomeatallreally.Butdefinitelysomethingyoushouldbedoing.Adollar
savedisadollarearned-actuallymorethanadollarsinceyouarenotpayingtaxeson
dollarsyousave.Andthemoneyyouarenolongerspendingfrivolouslycaninsteadbe
madetoworkforyoubyinvestingthem.

Distinctions
Thethingslistedaboveareallthingspeopleatsomepointoranotherhaveconflatedwith
passiveincome.Thisiswhywearetakingamomenttopointoutthatthesestreamsof
incomeare,infact,notformsofpassiveincome-atleastnotinourdefinitionofpassive
income.
Thisis,itshouldbenoted,notanormativestatement.Passiveincome,aswehave
alreadyestablishedinthepreviouschapter,isnotinherentlybetterorworsethanother

formsincome.Butitisqualitativelydifferentandthesubjectofthisbookispassive
income.Wearethereforeconcerningourselvesonlywithpassiveincomeandnotother
kindsincomeinthisbook-althoughwewillbetakingaanothershortdetourfromthe
worldofpassiveincomeinchapter9tolookatwaystomakemoneyontheInternetthat


arenotpassiveincome.
Withthislittledetouroutoftheway,wemoveonwards.



Chapter3
PropertyIncome
Propertyincomecomesinthreedistinctvarieties;rent,interestandprofit.Weletthis
trichotomystructurethischapterandconsequentlydividethischapterintothreesubparts.
Firstupwewilltacklerent,theninterest,andfinallyprofit.

Rent
Rentcomesfromtheownershipofpropertythatisrentedout.Thiscanbehouses,office
buildingsorevennaturalresourcessuchasshalegas.Wewill,accordingly,inthisbook
definerentasincomefromtheownershipofproperty.Thisisaprettystraightforward
definition,whichmakestheconceptofrentprettyeasytounderstand.PersonAowns
propertyCthatpersonBwantstouse.PersonBthereforeofferspersonAmoneyforthe
righttousepropertyC.PersonAacceptsbecausepersonAdonotneedtousepropertyC
atthemoment.
Afewthingscanbeinferredfromthisgeneralunderstandingofrent.FirstlypersonB
mustbeinapositionwhereobtainingownershipofpropertyCisnotpossible.Thismight
bebecausepropertyCisexclusive(i.e.rare)orbecausepersonBdoesnothavethecapital
toobtainownershipofpropertyCandthereforeisconsignedtorenting.Secondlyperson
AmustbeinapositionwhereheorshedoesnotneedtousepropertyC.PersonAcan

herebybesaidtohaveasurpluswithregardtopropertyC.
InthislittlethoughtexperimentpersonAseemstobethewinnerandpersonBseems
tobetheloser.Itis,however,importanttonotethatintherealworldpropertyisnotthe
onlyresourceyoucanown.PersonBmightnotwanttoownpropertyCbecausepersonB
wouldratherhavehisorhercapitalliquidorinvestedinsomethingelsethanproperty.
PersonAconverselymightbeinsurplusofpropertyCbecausenobodywantstobuy
propertyC.Itisthereforeimportanttonotethatthereisnothinginherentlysuperiorin
beingrentier(personA)insteadofrenter(personB).
Sotosumupwecanconcludethattobearentieryouneedtobeinsurplusof
propertyforwhichthereexistsdemandfortherighttouse.Wecanfurtherconcludethat
beingarentierisnotinherentlybetterthanbeingarenter.Withthatwehavethe
theoreticalfootingtoexploreacoupleofconcreteexamplesofearningpassiveincomeby
rentingoutproperty.
TeenageLandlord
DowninFloridathehousingmarketexperiencedfirstanenormousboomintheearly
2000sandthenanevenmoreenormousbustwhentherecessionhitin2008.Thatisthe
kindofmarketvolatilitythatcreatesmarketopportunities.WillowTufanowas14in2012
andhadjustcomeintoafewthousanddollars,andsoshedecidedtobecomealandlord.
Willow’smom,arealestateagent,hadseenatwo-bedroom,concrete-blockhomeon
auctionfor$12,000.Thesamehousehadcost$100,000afewyearsearlieratthepeakof


thehousingbubble.Willow,withthehelpofhermother,decidedtoinvestandbuythe
house.Willowthencleanedthehouseandstartedrentingitoutfor$700amonth(source:
/>Ona$12,000house$700dollarsinmonthlyrentamounttoyearlyreturnon
investmentof70%.70%isastratosphericallyhighannualreturn.FamedinvestorWarren
Buffet,theoracleofOmaha,historicaverageisonlyaround22%.Obviouslysome
percentageofthe$700goestomaintenanceandotherexpendituresthatcomewithbeinga
landlord.Butevenifwehalfthe$700,a35%returnoninvestmentisstillsomethingthat
wouldleaveanyhedgefundmanagersalivatinguncontrollably.Whatismore,that

$12,000housewilllikelyappreciateovertime.ThisismoremoneydirectlyinWillows
pocket.Allinallaprettysolidinvestmentfora14yearold.
Nowimagineapersonwantingtogenerate$100,000inyearlypassiveincomeon
rentingoutproperties.Whatwouldittake?Let’sbeconservativeandsaythatWillowcan
onlypocket$200amonthonher$700rentwhile$500goestomaintainingtheproperty
andotherexpendituresconnectedtobeingalandlordincludingfindingtenants.Thatgives
usayearlyreturnoninvestmentof20%onourinitial$12,000housinginvestment.Now
imaginewereinvestallourprofitintonewhousesthatwerentouttermssimilartothe
termsforouroriginalhouse.Howlongwouldwehavetodothatbeforeouryearlyreturn
is$100,000?Notthatlongactually.After21yearsofcompoundinginterestoursmallreal
estateempirewillbethrowingoff$110,412yearlyandbeworth$552,061.Willowwillbe
35yearsoldatthatpoint.Notabadtimetoretire.Butitgetsbetterbecausewehaven’t
factoredinanyappreciation.Aconservativeestimateisthatourhousesappreciatearound
3%yearly(that’sthehistoricaverage).Ouroriginal$12,000willthereforebeworth
$22,324after21years.Therestofourhousingempirewillhaveappreciatedsimilarly.If
wefactorinappreciationinourcalculations,Willowwillbereadytoretireat32years
withayearlypassiveincomeofover$100,000.
CaliforniaMogul
Holdonyoumightsay.Isthisisanywayreplicableandscalable.EnterDonaldBren,
chairmanoftheIrvineCompany,aCalifornia-basedrealestateinvestmentcompany.Bren
isestimatedtobegoodfor$15.1billion.Bren’sportfolioexceeds105millionsquarefeet
andincludes500officebuildings,41retailcenters,130apartmentcommunities,five
marinas,threehotelsandthreegolfcourses(source:
Things,however,didn’tbeginthisgrand
forBren.In1958hebuilthisfirsthouseinNewportBeachwitha$10,000loan.But57
yearsofcompoundinginterestisalongtime.Ifweassumethe$10,000wasBren’sonly
capitalin1958,atwhatratehashethenbeencompoundingthatinitialsum?Ata
stratosphericallyhighannualreturnlike70%youmightthink.Wellyou’dbewrong.Bren
hasbeencompoundinghishousingcapitalatanannualizeratearound28%.That’sthe
sameballparkasWillowisplayingin.

SoWhatShouldYouDotoGetInOnThisThing?
Wellyouneedtostartbuyingpropertyandrentingitout.Itisreallyprettysimple.The


trick,though,istobuytherightpropertyattherighttimeandherewecan’thelpyou,
otherwisewewouldberealestatemogulsandnotauthors.
ShouldyoubuypropertyinSanFranciscoandridetheSiliconValleytraintoriches?
Maybe,ormaybethemarketisoverheatedandabouttocrash.Shouldyoubuycheap
propertyinDetroitandwaitforthesecondcomingoftheAmericancarindustry?Maybe,
ormaybeDetroitisnevergoingtobounceback.Wedon’tknowandneitherdoesanybody
else.Peoplecanmakeeducatedguessesbutnothingiscertaininadynamicworld.
Whatwecansayisthis:
1. Historicallyinvestinginrealestatehasbeenasolidinvestmentalmosteverywhere.
2. Thetrendistowardsincreasingurbanization.Thatmeansinvestinginrealestateina
metropolitanareaisprobablygoingtobeagoodidea.
3. Therealestatemarketisgoingtocontinuetoexperienceboomandbustcycles.
That’sjustthenatureofthemarket.Thiscreatesopportunitiestobuycheaply.Such
opportunitiesshouldbetaken.Beinggreedywhenothersarefearfulisgenerallya
goodidea.
Practicaltips
BuildcapitalbyrentingoutaroomorbyrentingoutyourhouseonAirbnband
similarsites.
Buyamultiplefamilyhouseasyourownhouseandrentoutthepartyouaren’tusing
yourself.Thiswayitiseasytobethelandlordandkeepaneyeonyourtenants.It
alsomakesfinancingeasier(lookintothefirst-timehome-buyerprogramifyouarea
first-time-buyerintheUS).Onasmallerscalethesamecanbedonewithamultibedroomhouse.
Don’tbuybuildingsyouwouldn’twanttoliveinyourself.Thatishowyoubecomea
slumlord.Andyoudonotwanttobeaslumlord.Itismoretroublethanitisworth.
LookintoRealEstateInvestmentTrusts(REIT).REITsaresecuritiesthataretraded
likestocksandrepresentsinvestmentsinrealestatethrougheitherpropertiesor

throughmortgages.REITsreceivespecialtaxconsiderationsandgenerallyoffer
investorshighyields,aswellasahighlyliquidmethodofinvestinginrealestate.
WithREITsyoucanearnrent(indirectly)withoutdoinganyoftheworkyourself.
Pitfalls:
Arentierneedsrenter-peopleoftenforgetthatittakestwototango.Ifnobodywants
torentyourproperty,youhaveexpendituresandnoincome.That’sarealfastwayto
losealotofmoney.Makesurethatthereisdemandbeforeyoubuy.
Badtenants-sometimesnotenantsarebetterthanbadtenantsbecausebadtenants
canactivelydestroyyourpropertyandyourlifeandtheycanbereallyhardtogetrid
of.
Regulation-rentingisregulatedheavily.Thatisnotnecessarilyabadthingasa
propertyownerbutitrequiresyoutostayontopoftheregulationtomakesurethat
youarenotdoinganythingillegal.
Notsopassive,passiveincome-beingapropertyownerissteadyworkandifyoudo


notpaysomeoneelsetodothework,alltheworkisonyou,thelandlord.
Overleverage-leveragingupisawaytomakethingshappenedquicker-e.g.
borrowingmoneyandbuyinganextrapropertybeforeyoucanactuallyaffordit.But
ifthingsdonotgoyourway,beinghighlyleverage(owingalotofmoney)canforce
youtoliquidateassets(sellproperty).Andifthereisonethingpropertyowners
shouldneverdo,itistosellpropertyatinopportunemoments.Overleverageishow
peopleendupbuyinghighandsellinglow.

Conclusion
Rentcanbeanamazingsourceofincome.Butitrequiresyou,thewould-berentier,tobe
insurplusofpropertyforwhichthereexistsdemandfortherighttouse.Thisisnotas
easyasitsoundsandrequiresstart-upcapital.Italsorequiresyoutoseizetheright
momentlikeWillowandBrendid.

Interest
Interestcomesfromtheownershipoffinancialassets.Thiscanbedividendsformstocks,
stockgains,andinterestfromowningsecuritiessuchasbonds.Interestinthisbroadsense
issometimesalsocalledportfolioincome.Inthefollowingwearegoingtofocusonlyon
stocksandbonds.Thatmeanswearenotgoingtobelookingtthetypeofinterestmost
peoplearemostfamiliarwith-interestfromyoubank.Thereasonwearenotgoingto
dealwithbankinterestisbecause1)everybodyknowshowinterestonyourchecking
accountworks,2)theinterestbankpaysonnormalcheckingaccountistodayso
infinitesimallysmallthatbankaccountscannotfunctionasaninvestmentvehicle.Weare
alsonogoingtobelookingatthemorecomplexformsofinvestingsuchasshort-selling
andderivatives.Ordinarypeopleshouldstayfarawayfromsuchcomplexfinancial
instruments,astheycanbeveryhardtopredictinanymeaningfulwayandcarrytherisk
ofunlimitedlosses.
Stocks-BasicConcepts
Thestockofacorporationreferstothecapitalstockandconstitutestheequitystakeofits
owners.Thestockofacorporationispartitionedintoshares,thetotalofwhicharestated
atthetimeofbusinessformation.Ashareinacompanyherebyrepresentsafractionof
ownershipinacompany.Additionalsharesmaysubsequentlybeauthorizedbythe
existingshareholdersandissuedbythecompany.Thishappenswhenacompanyneedsto
raisemoneyandwillcauseeachindividualsharetorepresentasmallerfraction
ownership.Shareownerwillacceptthisdevaluationoftheirsharesiftheythinkitwill
strengthenthegrowthofthecompanyandtherebythefuturevalueoftheirshares.Stock
cantaketheformofeithercommonstockorpreferredstock.Sharesofcommonstock
typicallycarryvotingrightsthatcanbeexercisedincorporatedecisions.Sharesof
preferredstockdifferfromsharesofcommonstockinthattheytypicallydonotcarry
votingrights.Sharesofpreferredstockareinsteadlegallyentitledtoreceivingacertain
levelofdividendpaymentsbeforeanydividendscanbeissuedtoothershareholders.Most
sharesaretradedonstockexchanges,whicharewaystofacilitatethetradeofshares.

Incomeisearnedfromsharesinoneoftwoways.1)Acompanycanpayout
dividendtoitsshareholders-thisobviouslyrequiresthecompanytohavemoneytopay
out.Whendividendispaidout,eachsharewillreceiveasetamount.2)Thevalueofa
sharecanrise.Thishappenswhenotherinvestorswantstoownpartofthecompanyor
whenthecompanybuysbackshareandtherebyraisesthevalueoftherestofthe
outstandingsharesaseachoutstandingsharecomestorepresentalargerfractionofthe
company.
Itfollowsfromthisthataninvestorlookingtomakemoneyonstockswillbelooking
forsharesincompaniesthateither1)earnprofitandpayoutdividendor2)arelikelyto
increaseinvalueovertime.
SoHowDoYouMakeMoney?
Investmentstrategiesareadimeadozen.Somepeopledotechnicalanalysis.Otherpeople
lookatanimalentrails.Someclaimhighsuccessratesandotherspromisequickriches.In
theworldofinvestingthereisnorightwayofdoingthingaslongasyouaremaking
money(hint:youshouldn’tdotechnicalanalysiswhichinmostofitsiterationsisbasically
justpseudo-phycologynorlookatanimalentrails).
Wearenotgoingtoaddtothegreatplethoraofbooksoninvestmentstrategies-ifwe
trulyknewafool-proofinvestmentstrategywewouldberunningtheworld’slargest
hedgefund,notgivingawayourgoldeneggtoanyplebewillingtobuyane-book.Instead
wearegoingtodiscusshowtomakemoneywithnostrategy.
Butfirstaquickdetourtotheworldoftheefficient-markethypothesis.Theefficientmarkethypothesisstatesthatitisimpossibleto“beatthemarket”becausestockmarket
efficiencycausesexistingsharepricestoalwaysincorporateandreflectallrelevant
information.Inotherwordifyouhavediscoveredsomethingthatmightmakeastock
over-orundervalued,themarketalreadyknows.Theefficient-markethypothesisassumes
thatallactorshaveperfectinformationallthetime.Thisisprobablynottrue,andsome
investorsdo,infact,beatthemarketconsistently.Advocatesoftheefficient-market
hypothesisclaimthatsuchinvestorsaremerelylucky-lineupenoughmonkeysflipping
coinsandoneofthemiseventuallygoingtoflipathousandheadsinarow.Butany
controversyaside,forasingle,ordinaryinvestortheefficient-markethypothesisismust
assuredlytrue.Asingleinvestorisnevergoingtohavemoreinformationthanthe

institutionalinvestors(e.g.bigbank,hedgefund,pensionfundsetc.),andifyouaregoing
togambleonbeingaluckymonkey,youmightaswellgotoacasino(orazoo).
Tomaximizereturnsasingle,ordinaryinvestorshouldthereforeworkonminimizing
costs.Thismeansmakingasfewtradesaspossibleatthelowestpossiblecosts.Inother
wordsdon’tdaytradingandfindthecheapestpossiblestockbrokerage.Asingleinvestor
shouldbuyandhold,hold,hold.
Sowhatkindofstockshouldtheinvestorbuyandhold,youmightask.Accordingto
theefficient-markethypothesisthatdoesn’treallymatter.Justasitisn’tpossibletopick
therightstock,italsoisn’tpossibletopickthewrongstock.Everythingthatmightbe
wrongwithacompanyisalreadypricedintothestock,meaningyoucannotpickabad
stocktoinvestin.


Itis,however,riskytobeinvestedinjustonecompanyasyoubecometotally
dependentonjustthatonecompany’seconomicoutlook.Itisthereforeagoodideato
diversifywhichsimplemeansbuyingstockstherearenotsimilar.Diversifyingprotects
youagainstsuddenchangesoffortunesforcompaniesandindustries.Diversifying,
however,jivespoorlywiththeprimedirectiveofanysingle,ordinaryinvestorminimizingcosts-asbuyingmanydifferentstocksinordertodiversifypushesup
transactioncosts.
Ingeneralthebestbetforasingle,ordinaryinvestoristhereforeacheapindexfund.
Anindexfundisaninvestmentfundthatreplicatesthemovementsofanindexofa
specificfinancialmarket.Throughaninvestmentfundasingleinvestorcaninvestinthe
entiretyofthestockmarket,i.e.achieveperfectdiversification,atminimalcosts.Atthe
sametimeitisthemosthasslefreeinvestmentyoucanmakeasallyouhavetodoisfork
overmoneytotheindexfund.
Buffett’sGreatBet
In2008WarrenBuffett,thefamedinvestorfrombeforeandoneofthewealthiestpeople
intheworld(top3),betProtégéPartners,ahedgefundthatmanages$3.5billiondollars
that“[o]veraten-yearperiodcommencingonJanuary1,2008,andendingonDecember
31,2017,theS&P500willoutperformaportfoliooffundsofhedgefunds,when

performanceismeasuredonabasisnetoffees,costsandexpenses.”(source:
Buffettthoughtthattheindexwouldoutperformthehedgefunds
whileProtégéPartnersthoughtthattheyandtheircolleaguescouldbeattheindex.Sofar
sevenofthetenyearshavepastandBuffettiscomfortablyinthelead.AsofMay2015
theS&P500hasproducedanawesomereturnof63.5percentwhilethehedgefundshave
onlymanagedameasly19.6percent,thoughthemanagersofsaidhedgefundshave
probablypulleddownsomeheftymanagementfeesforbringingtheirinvestorsthat
measlyreturn.
Buffettreasoningisthateventhough“anumberofsmartpeopleareinvolvedin
runninghedgefunds”theireffortare,toagreatextent“self-neutralizing,andtheirIQwill
notovercomethecoststheyimposeoninvestors.Investors,onaverageandovertime,will
dobetterwithalow-costindexfundthanwithagroupoffundsoffunds.”Andsofarthe
databacksBuffettup.Soifyoudon’tbelieveus,believeBuffettandinvestyoumoneyin
alow-costindexfund.
TheCounterproductiveExampleSetByBuffett’sAction
Thereis,however,asmallproblemwithBuffett’sargument.Thelogicissound,thedata
backsitup-andthisbookfullysupportsthemessageBuffettistryingtosendtosmall,
ordinaryinvestors.YetBuffetthimselfisnotfollowingtheadvise.Buffettdoesn’tinvest
hismoneyinindexfunds.Hisinvestmentsareaggressivelyactive.Throughouthislong
careerthathasmadehimoneofthewealthiestmenintheworld,Buffetthasbuildfarreachingconglomeratebuyingstockscarefullypickedoutasundervalued.Buffetthasin
effectdisproventheefficient-markethypothesis(thoughproponentsofthehypothesiswill
-andhas-calledhimaluckycoinflippingmonkey).Investorsallovertheworldhave
triedtoemulatehisstrategy.Somewithgreatsuccess.Otherswithdecidedlylesssuccess.


TheeasiestwaytoemulateBuffett’sinvestmentstrategy,however,issimplytobuyshares
inBuffett’scompanyBerkshireHathaway.
Sodoesthismeanthatyoushouldbeanactiveinvestorafterall?Noyoushouldn’t.
Onaverageyoucan’tbeattheaverage.Thatisjusthowmathworks.Andthemoretime
andmoneyyouspendtryingtobeattheaverage,thebiggertheholegetsthatyouhaveto

climboutoftobeattheguywhojustlockedhimselftotheaveragebyinvestingwitha
cheapindexfund.
OnChess,RiceandWealthBuilding
Imagineachessboard.Achessboardhas64squares.Noimaginethatweputagrainofrice
onthefirstsquare.Twograinsofriceonthesecondsquare.Fourgrainsofriceonthird
squareandsoonandsoforth.Howmanygrainsofricewouldwebeputtingonthelast
squareofthechessboard?Alotprobably.Wellalittlemorethanalot.
18,446,744,073,709,551,615grainsofricetobeprecise.Thatis18quintillion446
quadrillion744trillion73billion709million551thousand615grainsofrice.Rice
enoughfortheworld.Thisisthepowerofcompoundedinterest.Eventhesmallestof
principalscangrowinfinitelylargegivenenoughtimeandasteadyreturn.
Thisiswayitisagoodideatoinvestearlyandtowait,andwaitandwait.Andthatis
alsowhyitisagoodideatoinvestwithanindexfundasitmakesitfrictionlesstoreinvest
yourgains.

Bonds-AndOtherWaysofMakingMoneybyLendingMoney
AbondisbasicallyanIOU(IOweYou)thatstatesthattheissuerowestheholder(s)a
debtand,dependingonthetermsofthebond,isobligedtopaytheminterest(thecoupon)
and/ortorepaytheprincipalatalaterdate,termedthematuritydate.Theholderofabond
cansellittoathirdpartyiftheholdernolongerwantstobetheholder.Theinterestofa
bondisnormallyfixedattheissueofthebond.Thismeansthatthevalueofthebondrises
andfallsinverselywiththegeneralinterestrate.
Anexample.SaythatIhavesoldyouabond.ThetermsofthebondisthatIpay3%
peryearfor10yearsatwhichpointthebondmaturesandIpaybacktheprincipaltoyou.
Let’ssaythebondisfor$100.Thisallmeansthatyear0yougiveme$100andIgiveyou
abondcertificate.Year1Igiveyou$3(theinterest).Year2Ialsogiveyou$3.This
continuesuntilyear10whereIgiveyouthefinal$3,paybackthe$100,andripupbond
certificate.Thisallseemslikeaprettysweetdealforyou.Youare$30richerandhave
doneanythingbutborrowyour$100tome.Howgoodadealitwasforyou,however,
dependsonalotofthings.Howmuchinflationhasoccurredinthelast10years?What

hasthegeneralinterestratebeen?HowbigwastheriskthatIwasn’tgoingtobeableto
paythe$100back?
Youcanalsospeculateinbonds.Returningtotheexampleabove,let’simaginethat
theinterestrateplummetsto1%year1.Suddenlyaguaranteedinterestrateof3%over
thenext9yearsislookingprettygoodandyoumightbeabletosellyour$100bond
certificatetoathirdpartyfor$115.Converselytheinterestratemightskyrocketto10%.


Nowyourguaranteedinterestrateof3%islookingprettymeaslyandpeopleonlywantto
buyyour$100bondcertificateforlessthan$100.Youmightstillsell,though,soyoucan
reinvestatthehigherinterestrate.Thevalueofabondmayalsomovewiththefortunesof
theissuer.IfsuddenlyitstartstolooklikeIwon’tbeabletomakegoodonthebond
certificate,thevalueofthebondcertificateIhaveissuedwillplummet.Speculatingin
bondsis,however,somethingmostinvestorsshouldstayclearofforthesamereasonsthat
theyshouldstayclearofspeculatinginstocks.
Generallyowningbondsislessriskythanowningstock,sinceyouknowexactly
whatyouaregettinginto(barringbondsdefaulting).Generallythepayoffisalsoless.For
asingle,ordinaryinvestorinvestinglong-termstocksthereforebeatsbonds.
Peer-to-peerLending
Owningbondsisnottheonlywayoflendingoutyourmoney.Youcanalsocircumvent
thetraditionalfinanceindustryandlendmoneytostrangersthroughpeer-to-peer-lending
services.AserviceliketheLendingClubhashistoricallygiveninvestorsreturnsonthe
orderof5.06%to8.74%(source:whichisverygoodforasupposedlysafeinvestment.Butitisimportantas
aninvestortorememberthatwiththesekindsofservices,youarebettingnotonlythatthe
stranger,youhavelentyourmoneyto,isgoingtopayyouback.Youarealsobettingthat
theserviceyouareusingisnotgoingtogooutofbusinessorinanyotherwayinvalidate
yourinvestment.Howriskythissecondbetis,onlytimewilltell.Butnewbusinessesgo
bankruptallthetime,meaningthattheriskisdefinitelynon-zero.

Conclusion

Youarenotgoingtobeattheaverage.Soputyouyourmoneyinanindexfundandwait.
Andwait.Andwait….…Andwait.Thatishowyougetrichoffofstocksasasingle,
ordinaryinvestor.Letotherpeoplegamble.Andifyoutrulycannothelpactively
managingstock,thengetajobatWallStreetandgamblewithotherpeople’smoney.
Ifstocksfrightenyou,youcanbuybondsorlendyourmoneytostrangersthrough
peer-to-peerlendingservices.Thoughtheseoptionsonthesurfaceappearlessriskythan
investinginstocks,therearealsoseriousrisksinherentinbothoftheseoptions.Theonly
completelysafe(orascloseasyoucaneverget)bondsareissuedbystateswithsolid
creditratingsandtheinterestpaidonthesebondsareaccordinglyabsurdlylow(andin
somecasesevennegative!).Ourunequivocaladviseforanybodyreadingthisbookwith
thegoalofwealthbuildingisthereforetochoosestocksoverbonds.

Profit
Profitcomesfromtheownershipofcapitalequipment.Thiscanbeassimpleasowning
yourowncarorascomplicatedasowninganentirefactory.Theprofitcategoryofthe
threecategoriesofpropertyincomeisprobablythemostdiverseandhardesttoeasily
condense.Weshalltry,nevertheless,buttheknowledgeablereaderwillnoticegapsand
holesinourdescription.Thisisbydesign.Wecannot(andwillnot)covertheentire