When I began my career right out of college, my income was solely derived from my job. Fast forward to my forties, and after more than twenty years of work, I now enjoy multiple streams of income. While most of these are passive, none are particularly extraordinary.
However, the internet is flooded with “experts” eager to teach you about passive income. The truth is, there’s no secret course; it boils down to three simple steps:
- The only way to generate passive income is to invest in assets that produce cash flow.
- The only way to acquire cash for investment is to save your money.
- The only way to save money is to spend less than you earn.
Working backward, your initial goal should be to save your first $1,000, then $10,000, and eventually $100,000.
Consider this insightful quote from Charlie Munger:
The first $100,000 is a challenge, but you must achieve it. I don’t care what sacrifices you need to make—whether it’s walking everywhere or only eating food bought with coupons—find a way to accumulate $100,000. After that, you can ease off the gas a little.
If you don’t have $100,000 in a brokerage account, your primary financial goal should be reaching that milestone. For many, $100,000 can feel like an insurmountable figure, but let’s break it down into manageable steps.
Step 1: Get to $1,000 in Savings
Your first target is to save up $1,000. This requires diligent budgeting and cutting unnecessary expenses. Achieving this milestone is crucial because without $1,000 in savings, you lack an emergency fund. A minor financial setback can derail your plans for months or even years.
Need some inspiration? Check out this list of 105 easy ways to save money.
Eliminating unnecessary expenses is vital to reaching that first $1,000, ensuring that a financial misstep doesn’t set you back.
Step 2: Get to $10,000 in Savings
Once you’ve reached $1,000, congratulations! Your next goal is $10,000. While this may seem daunting, it’s achievable through careful budgeting and side hustles. Consider strategies like switching banks for bonuses to earn extra cash.
Saving your way to $10,000 is not only possible but essential.
Once you hit that mark, invest the $10,000 wisely (for guidance, check out a simple three-fund portfolio). If you achieve an 8% return annually, that initial investment could yield $800. While $800 may not seem life-changing, the power of compounding will work wonders as your assets grow.
Step 3: Get to $50,000 in Savings
After investing your $10,000, the journey to $50,000 becomes more challenging. You’ll need to focus on increasing your income, which may involve investing in yourself or starting a side business that has growth potential. While saving is still an option, it will be a slower process.
At $50,000, with an 8% return, your money could earn $4,000 annually. As your balance increases, so does your earning potential. The time it takes to add $10,000 decreases significantly as compounding takes effect.
This is the magic of compounding—eventually, your money can earn more than you do. Over 30 years, a $10,000 investment could grow to $100,000 without any additional contributions. This emphasizes the importance of saving that first $10,000 and getting the compounding clock ticking as soon as possible.
Where Do You Put It?
Start by placing your savings in a high-yield savings account to earn interest. While it may not be substantial, it’s better than the negligible rates offered by traditional accounts.
Next, transfer your funds to a brokerage account and invest in a three-fund portfolio:
- Domestic stock “total market” index fund
- International stock “total market” index fund
- Bond “total market” index fund
These options are available through Vanguard, but you can also explore low-cost alternatives like Fidelity or Charles Schwab:
- Vanguard Total Stock Market Index Fund (VTSAX)
- Vanguard Total International Stock Index Fund (VTIAX)
- Vanguard Total Bond Market Fund (VBTLX)
Once you’ve invested, it’s time to step back and let your money work for you.
