I know of very few individuals who do not at some point dream about the ultimate liberty when you do what you love, make decent money out of it, can go on vacations or take a break for a day or a week without asking for permission. Oh and did I mention being able to work from anywhere in the world from your basement to Beijing or Moscow? Very few of us actually get the opportunity to live such a lifestyle but aspiring to it would actually be considered a good first step. Making a plan and following through is the more difficult and challenging part.

What is passive income?

There is probably a different way to express passive income for everyone as even words like retirement can have a million different meanings. But to me, passive income is “Income that is generated with such a small effort that it would continue to stream through even if that individual took extended holidays”. There are an infinite number of ways to create passive income streams and I decided to take a quick look at a few of those in this post by sorting them into a few categories:

1-Investment

1.1-Dividend Portfolio: This is something we will be spending more energy into in the coming weeks but I think many investors see real potential here. The idea is to generate a big enough portfolio to be able to live on the dividends that are received every year. Once the dividend portfolio is built, it can be maintained with little effort. Of couse, as we wrote in the past, it’s not always about getting the highest dividend yield but you can look at our list of top dividend yields.  The goal is twofold here: Building a portfolio with enough income to: Live by and avoid using the capital (selling shares). Once you reach that level, you can in theory live off of this income for a long time. Ideally, you can even increase your “Portfolio value” to account for inflation. More on this in coming weeks….

1.2-Fixed Income Portfolio: The most common source of income for retired individuals is a portfolio mostly composed of fixed income. I’m personally not a fan because the fees involved on trading these are incredibly high. There are cheaper ways to do this including investing in Fixed Income ETF’s. They provide the same exposure (more or less) but diminished fees. Building an efficient and diversified Fixed Income ETF portfolio is a bigger challenge than a Dividend Stock Portfolio but can be done more easily as new ETF’s are released every month or so…

1.3-Real Estate: A real estate portfolio that includes residential and/or commercial land and properties can also provide a very important source of passive income. Basically, if you are able to buuy properties that generate enough monthly cash flows to pay off the loans and expenses (taxes, handyman, etc). Real Estate is generally a safe way to avoid losing money in case of inflation as the value and cash flows will generally increase as well.

2-Own a business

2.1-Online: I will be writing more about this on Thursday but there are a ton of opportunities in terms of building a steady and fairly passive income flow on the internet. This can be done by buying or building internet websites that either provide information, sell a product or even a blog like this one. IntelligentSpeculator’s goal is not to discuss this type of income too much and you would find more information on TheFinancialBlogger but I will still be writing about this soon, including a post on Thursday.

2.2-Offline:There are a billion different things that can be done from opening a lemonade stand to opening a restaurant, a hotel, etc. The objective however remains the same: Buying a business that can be basically managed by someone and generate a steady cash flow every month. The upfront costs are usually more important especially compared with an online business but even that varies a lot from one business to the other

3-Government or Pension plan

This one is smaller and rarely enough to have a great lifestyle but it does help out. Many companies or governments offer pension plans that will pay you X dollars every month once you retire. That is not something we’ll discuss because you do not want to depend on that for your retirement or passive income. Imagine those who had a great pension plan offered by Enron or GM…

Reinvest till you need it or till you are ready

In all of these cases, building this portfolio can turn out to be a lifelong goal that is part of how you manage your personal finances. The recipe is quite simple though. Slowly create your passive income sources, try to grow it every week and every month and re-invest as much as you can instead of spending it. The more money you can reinvest into your current passive income streams, the faster they grow. If you are building a dividend portfolio, you can reinvest all dividends received until you truly decide to live off of the portfolio. Over a couple of decades, that is a huge difference.

How much do you need ?

That number is different for everyone. I guess the main question you need to answer is how much you need every year to be satisfied. If you need 50,000$, then you either need a 1,000,000$ dividend portfolio with a 5% yield or perhaps a few appartment buildings with no mortgage, or a website that sells ebooks, etc, etc. There are so many possibilities.

Diversification

Like any investment advice, I would say that it is critical to not count on only one source of passive income. There can be events that greatly affect your income source even in a well diversified dividend portfolio. But if you depend on 2 or 3 different sources, the chances of having a serious disruption are much more remote.

It’s all about small things and a daily dedication

I think it’s important to always keep the big picture in mind. If every time you think about spending 100$ you imagine that this 100$ could also be spent in a dividend stock that will pay you 5$ every year for life, you might spend a little less. It’s not about always being frugal but simply being smart about your money, paying yourself first and sticking to your plan!

So my question to you is do you aim for such a goal, if so, how do you do it? How well are you doing?

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• Why you haven’t started building your passive income portfolio yet
• How to start a dividend portfolio with $5,000
• Starting over from point zero….
• Top Stock Picks: Dividend ETF’s
• Best REIT ETF’s… May 2010 analysis