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Passive income is the holy grail of financial independence and retiring early (FIRE). By saving and investing over time your money you will gradually accumulate and develop streams of passive income. Eventually, the various passive income streams will provide enough income to meet (or exceed) your living expenses. At such a time you will have ‘FU money’.

Before discussing passive income in further detail, let’s outline why FU money is so great. FU money gives you the ability to tell your boss to ‘F$*! Off” and quit or retire. There are unlimited options when someone has FU money. FU money provides the freedom to stop working, work a lower paying job that you are passionate about, travel full-time, stay at home with your kids, or just veg out and watch Netflix (and chill) all day. In a nutshell, FU money provides the flexibility to do what you want when you want. Who would not want that?

Now what is passive income and how does it compare to other types of income? The chart below outlines the 4 traditional ways to earn income; which are being an employee, being self-employed, being a business owner (others working for you), and being an investor.

Being an employee (top left on the chart) is the most common and possibly WORST way to earn an income (but not a PASSIVE income…. hang with me. we will get there soon).

As an employee, you are trading time for money. Essentially, you are a paid servant to your employer and your livelihood DEPENDS on you showing up to work Monday thru Friday from 9-5. You are sacrificing your most valuable resource (time) in exchange for money.

Sounds… well… HORRIBLE.

Ironically, the worst form of income is also the most common form of income. In the United States, many people never escape this form of income because of the consumer lifestyle and individuals’ tendencies to live paycheck to paycheck. This is also known as ‘the rat race’ or ‘being stuck on the hamster wheel’.

Also see: 6 Steps to Saving a 6-figure Net Worth

Being self-employed (bottom left on the chart) is another form of income. However, like being an employee, you are still trading time for money. Self-employment does provide more flexibility and freedom than working for someone else, which is a big plus.

However, not everyone can or wants to be an entrepreneur. Some people like the safety net of a salary and working for ‘The Man’ (sounds a little crazy). Other people thrive working for themselves and being able to make as much or as little as they want. Being self-employed also allows you to set your own hours and own pace.

The third way to make an income is from owning a business (top right on the chart). In this instance, you are utilizing leverage of OTHER people’s time to make money. Depending on the nature of the business and how well established the business is, this can provide a (mostly) passive income. While it is nice to profit off of others time and effort, owning a business will require at least some oversight.

Also see: 8 ways to crush it after graduation, in your 20s & beyond

Last but certainly not least! Being an investor (bottom right on the chart) provides passive income (WE FINALLY MADE IT!). Now, what the heck is passive income?

Passive income is “income that is received on a regular basis with little or no effort required to maintain it”. What does this mean? It means you are getting paid while giving up little or NO TIME (remember, time is the most valuable resource). Sounds too good to be true, right? But it’s not!!! Passive income is quite commonplace if you know where to look! [hint: keep reading! I am about to tell you about several types of passive income]

Unfortunately, this concept is foreign to many people, especially Americans. According to one survey, a majority of Americans plan to work into their 70s or never retire. Another survey stated, “1 in 3 Americans has saved $0 for retirement.” Clearly, many people do not know about or understand the concept of passive income and what freedoms saving/investing provides (Blame the lack of financial literacy in the education system).

Also see: Offensively Building Wealth Through Earnings & Investing

There are several forms of passive income. Two of my favorite sources of passive income are dividends from stocks and rents from real estate (more types later).

Dividend stocks are an amazing thing! Most dividend paying stocks provide shareholders with a predictable income every quarter (3 months) in the form of cold hard cash. However, some companies offer monthly, semi-annual or annual dividends. Many companies increase their dividends every year and the increase often outpaces inflation. This means you are actually making more money over time without even lifting a finger (say wow)! Additionally, dividends have preferential tax treatment and are subject to the capital gains tax and not personal income tax (read: dividends are taxed less than income earned from a job).  Sounds pretty good, right?

Real Estate or rental income from properties is another form of (mostly) passive income. Personally, I love real estate and the passive income that it provides. Most months, the only time commitment is collecting the rent checks. Over time, like stocks, rents generally increase with or outpace inflation. This equates to greater earnings over time. Additionally, tenants are paying down your mortgage and there are tax benefits to owning the real estate.

Owning rental properties does come with occasional expenses such as repairs and maintenance. Tenants may cause an occasional headache as well. Thankfully, I have been fairly lucky with screening my tenants; most of them are very pleasant people who I have a great relationship with. Individuals may hire a property manager for a modest fee (typically 8-10% of the gross rent) if they do not wish to deal with tenants or repairs. Utilizing a property manager makes owning real estate 100% passive income. I will write more on my real estate endeavors in future posts.

There are countless other types of passive income. Bonds provide passive income through their regular interest/coupons payments. Peer 2 Peer lending, which has grown tremendously in the past few years, can also provide passive income to investors.

Royalties are another form of passive income. A royalty is a small payment received by a creator every time an item is purchased or a song is played. Individuals can invent a product, write a book or song and receive royalties for the intellectual property they create.

Banks will pay you interest on your deposits held at their firm. Additionally, Banks offer a product known as Certified Deposits or “CDs” for short. Banks also pay interest for money held in a CD. Both of these are examples of passive income since your money just sits there MAKING YOU MORE MONEY. Historically, interest rates for deposits and CDs have rewarded savers/investors. However, given the current low-interest rate environment, many individuals would be better served putting their money elsewhere.

In conclusion, there are four traditional ways to earn income. Some methods for earning income are very time intensive while others are very passive. Working for a company or individual provides income in exchange for time. Stocks, bonds, and real estate are a few of the many ways to generate passive income. Time is the most finite and valuable resource that we all possess. By saving money earned as an employee, we can invest the savings into assets that will provide passive income. Over time the passive income will grow, provide financial freedom and give you the flexibility to spend your time as you please.

Currently, I find myself positioned in all 4 quadrants on the chart above. Unfortunately, a majority of my income comes from the left side of the chart. I value my time more than anything and am working towards leaving the ranks of an employee. As a result, I am focusing my efforts on growing my passive income through investing in dividend stocks, rental properties, and other passive income producing assets. No one has ever laid on their death bed and said, “Gee, I wish I spent more of my life working.” With that said, what quadrant do you want to be in?

Let me preface this article with there is no absolute right or wrong answer regarding front-loading vs. dollar cost averaging contributions into a 401K or other tax deferred accounts. Decisions are mostly preferential and partially situational. Madfientist and Enchumbao both offer their views on why front-loading works for them. Both authors provide great insight and are worth reading.

1. Losing Free Money

The first reason why I do not front-load my 401k? My employer does not offer a “true match” for my contributions.  My company is rather generous with their 401k match; they provide a 6% match if we contribute 4%. BUT I will loose out on FREE MONEY If I maxed out my 401k in the first quarter of the year.

Assuming I maxed out my 401k in the first quarter, my employer would NOT contribute a 6% match based off my pre-tax income for the entire year. Rather, my employer would only contribute 6% based on my pre-tax income for the first quarter. By spacing out my contributions over the entire year, I will earn the full benefit of my employer’s match. This is an example of a situational reason for not front-loading a tax deferred account. I fully recognize that this does not apply to everyone.

Additionally, I like the predictability of the same lump sum being deposited into my checking account every two weeks. Front loading my account, though easily manageable, reduces cash flow for 3-6 months out of the year. I prefer constant cash flows, which allows me more flexibility to invest elsewhere (Real Estate).

2. Timing the Market

Generally speaking, I prefer my portfolio allocation to be overweight low-cost index funds (benched marked to the S&P 500) along with individual stocks that demonstrate strong fundamentals and dividend growth. My 401K contributions are allocated to index funds since my employer’s plan offers limited investment options.

By front-loading investment accounts, you are betting that the first half of the year will offer better buying opportunities than the second half of the year. This is considered “timing the market”. I do not believe in timing the market for index fund purchases, HOWEVER, I do believe in timing the market for individual stock purchases (more on my stock purchasing process in a future article). As a result, I elect to periodically purchase index funds 26 times a year (paid every two weeks 52/2 = 26) via my 401k account. This is an example of a preferential reason to dollar cost average 401k contributions.

Spreading out contributions evenly throughout the year allows for everything to be automated and function like clockwork. This systematic approach removes the guess-work out of investing and allows for a consistent paycheck all year long.

Several individuals argue investing a lump sum right away if you are comfortable with the market risk. I am comfortable with market risk but am not comfortable with this strategy. Some years this method pays off. Other years, this would cause you to miss out on substantial returns.

Lets start off by looking at 2015. The S&P 500 was down 2.15% for the year, which is not a stellar by any metric. The chart below shows the market was mostly up for the first part of the year, however, the market experienced a strong pull back during the fall and dropped 9.7%.

S&P 500 Performance 2015:

If an investor elected to dollar cost average throughout the year, they would have enjoyed the benefits of the market pull back. In fact, the S&P 500 rebounded 7.96% from the August 25th low (see chart below). In this instance, dollar cost averaging proves to be more beneficial than front-loading.

S&P 500 Performance August 25th, 2015-December 31, 2015:

Let’s look at another example. In 2011, the the S&P 500 was up for a majority of the first half of the year but finished the flat. The market dipped by almost 15% in August from it’s recent highs. The market also dipped significantly in September and November. Dollar cost averaging would have provided an investor substantial gains in the last 6 months of the year. Likewise, a front-loader would have lost money and missed out on these great buying opportunities.

Alternatively, some years present great opportunities to front-load investment accounts. 2013 is one of the best examples for front-loading tax deferred accounts. The S&P 500 was up 31.3% for the year and did not experience any major pull-backs (see below). An investor would have benefitted by maxing out their accounts as early as possible and enjoyed sizable gains.

S&P 500 Performance 2013:

In conclusion, there is no right or wrong answer on wether an investor should front-load or dollar cost average contributions throughout the year. There are dozens of examples where each method would have been “better”. Timing the market is a fool’s game but can sometimes be beneficial (see the graph for 2013). Dollar cost averaging throughout the year provides systematic  approach that removes the guess-work out of investing and allows for a consistent paycheck all year long. Selecting a method is mostly preferential and partially situational. Which method is for you?

…and a high power offense can help get you across the goal line more quickly. The same holds true in the race to achieving FIRE (financial independence; retiring early). But what does this mean on your journey to crossing the FIRE finish line?

Defense

A strong defense is paramount to financial independence. I am not talking about having the best linebacker on your fantasy football team or signing Josh Norman during the off season.

Every month, money comes in (income) and money goes out (expenses). Controlling the outflows of cash is the defensive battle towards achieving financial freedom. Preventing unnecessary dollars from escaping is the epitome of a strong DEFENSE.

How do you play strong defense? This is achieved by budgeting, cutting out or reducing unnecessary expenses, living below your means, frugality and avoiding life-style inflation. Preventing money from flowing out allows an individual to accumulate cash which can then be invested. Over time, an individual can accumulate enough to live off of passive income generated by their investments; thus achieving financial independence.

A weak defense full of holes allows money to flow out very easily. This is prevalent in the United States since the country is built on consumerism and a “keeping up with the Jones” mentality. Most Americans have a weak defense, which causes them to burn through their cash, or worse, take on debt because they live and spend beyond their means.

Offense

Income is the offensive part of the game that can come in many forms. Salaries, interest, dividends, part-time jobs, hobbies and rental income are just a few of the many ways to generate income/offense. Increasing offensive production allows an individual to save more assuming they do not give in to the pressures of life-style inflation.

Some individuals are fortunate enough to earn a high income from their day job. However, for those of us not blessed with a six-figure salary, there are still ways to improve the offense. Individuals can earn a ‘side hustle’ by working part-time, renting out an extra room in a house, producing income through a hobby, blogging, dog-walking or cutting grass.

Now that you have the basic idea of offense and defense, how does your team stack up? Do you need to improve your defense and clog up holes that are allowing money to flow out? Are you ok with your current rate of savings/accumulating? And your offense, do you need to generate more income, or are you at a comfortable level to where you can save a large portion of what you take home?

Welcome to Guy on FIRE (Financial Independence; Early Retirement), this site will share the journey of an average millennial (hate that term) guy on his quest to leave Corporate America at an age many deem impossible.

Sitting at a desk all day did not sit well with this guy. One day, he came to the realization there was more to life than wasting away in an office all day and being really, really ridiculously good looking (kidding!).

Through frugal budgeting, thoughtful planning and pragmatic investing anything is possible. Guy on FIRE plans to retire in his late 20s or early 30s to pursue his passions in life; biking, fishing, hiking, traveling, cooking and enjoying the simple things in life.