Passive Income: Only for Real Estate Tycoons? | Erik Averill, Brandon Averill, Justin Dyer | AWM Insights #74
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Episode Summary
You see it all over the news and social media: wealthy people talking about how they generate monthly income without ever having to work. Purchase a home or rental property, then open your mailbox every month and collect a check. Rinse and repeat.
Do you really need to become a real estate tycoon to build wealth? Is it really that easy? Of course not.
In this episode, Erik, Justin, and Brandon highlight how to view passive income, and its role in building wealth. They discuss viewing it as a means to an end - the end being financial freedom. At the end of the day, wealth is what you take home after taxes/expenses, so it's important to have passive income conform to your priorities, and not the other way around.
Episode Highlights
(0:38) The news you should know: Good July jobs report, but it's more important to look at the trend;
(1:37) Rihanna is now a Billionaire. How celebrities and are taking agency over their earnings;
(3:21) Pepsi gets rid of Tropicana, and rebalances their portfolio of drinks. They objectively evaluate their drink lineup, which provides a good model for how people should evaluate their investment lineup.
(4:46) Being financially free is the end goal. Being able to live life on your terms is what's important. Passive income shouldn’t be an end in itself.
(6:52) Passive income v. Capital Appreciation. Judging a winner depends on net of cost return.
(9:41) There's no bank teller in your home or rental property that can deposit cash on demand.
(10:35) What you pay for an investment matters. Costs erode returns.
(12:18) Risk and return are related. Does my return justify the risk?
(14:29) Generational wealth is never built on a one-size-fits-all approach. Your priorities should inform your passive income allocation, not the other way around.
(16:11) Rockefeller family case study. How they have built wealth through seven generations. Hint: It wasn't because they put all their money in rental properties.
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Justin Dyer: LinkedIn
Erik Averill: LinkedIn | Instagram
Brandon Averill: LinkedIn
+ Read the Transcript
Erik Averill (00:01):
Hey, everyone. Welcome back to AWM Insights. It is your power three, two CPWAs, and a CFA. We are Eric, Brandon, and Justin. And, each week we cut through the noise of what Wall Street is selling you to bring you the knowledge, skills, and access to the information you need to invest like a pro. And today's topic is one that we have heard day in and day out, and we get so many questions about. So, we are excited to talk to you about generating passive income. But before we do that, as always, let's jump into what's going on in the markets.
Brandon Averill (00:38):
Yeah, Eric, we've got a pretty fascinating print coming out from the labor department. So, we've had a little bit of a surprise here with the July jobs report, actually had a whopping 943,000 jobs came back last month. And we had that unemployment rate really fall down to about 5.4%, which is the lowest level since March of 2020. We also saw part of the report that there's actually upward revisions to the past two months payroll gains. And so, what this just means is that at the end of the day, the U.S. labor market is really making those solid gains. And, we're seeing that worker shortages are really starting to ease, which is awesome.
Justin Dyer (01:18):
What's important to just highlight... Sorry to cut you off there.
Brandon Averill (01:22):
No, it's good.
Justin Dyer (01:22):
These statistics are super noisy. What statisticians call it, or finance experts, right? Meaning, the trend is truly what matters. You can't put a whole ton of weight on any single report.
Brandon Averill (01:37):
That's very true Justin, but as we know the media loves to put tons of weight on every single report, right, so. But yeah, no, the trend is moving in a positive direction, which is great. Other big news, Rihanna gains billionaire status, pretty crazy. She's now the second richest female entertainer only to Oprah. And it's thanks to Fenty, the celebpreneur, whole business model is really thriving. It's pretty fascinating just to see these stars getting paid to put their name and face behind a brand's product. I think, in Rihanna's case, probably more involved than that, and really what's made Fenty pretty successful. So, been really good stuff. We've seen other businesses that have led to successes like this. We had Kim Kardashian and Kylie's beauty companies are now worth a billion dollars. Jessica Alba's Honest company just IPO'd. Jay-Z's TIDAL was snatched up by Square. So, pretty fascinating to see these entrepreneurs, or athlete celebrities becoming entrepreneurs, for sure.
Justin Dyer (02:49):
Yeah. And, they're really taking the bull by the horns, right? Scarlett Johansson also just came out with a big lawsuit. I mean, talk about a shot across the bout of Disney, basically saying, "Hey, you guys didn't hold up your end of the bargain." And, the dollar amount that I think she's trying to get damages for is pretty substantial. It escapes me right now. But yeah, celebrities athletes, they're really taking agency, grabbing the bull by the horns, trying to get a little bit of that upside.
Brandon Averill (03:21):
Yeah. I think that power shift has really happened, right. That would have never happened in the past, because she would have been so worried about angering Disney and not getting another job. But, it's fun to see the real talent take over here, and force their way into the position of power that they should be in. And turning to that, even with Pepsi had some good, interesting news came out, they actually sold Tropicana. So, that orange juice isn't coming on the Pepsi truck. And I think it's just a really fascinating example of how brands are actually investments, just like individual investors. So, when we're working through our client portfolios, we're looking at, when are there times to rebalance and to change the mix if needed. The same thing happens with large companies.
Brandon Averill (04:07):
And I think, people don't realize that Pepsi, all they did is they just rebalanced their portfolio of drinks, of beverages, to favor those faster growing market segments. And, really in Pepsi's own words, what they were engaged in, was portfolio optimization for juice businesses. So, if anybody ever wondered, if there were just schlepping orange juice over sugared drinks to fuel our diabetic culture, they actually are looking at it as a portfolio. So, pretty interesting stuff. But I know we're going to get into the passive income piece. And, the allure of this passive income, so.
Erik Averill (04:46):
Yeah. And one note, just before we move on to the passive income conversation. I think it's so great to learn from seeing what real companies do, right? Or the way that sports teams treat their athletes, or endowments and pensions. And what we had talked about on last week's podcast that, any professional investor thinks in portfolios, they don't think in individual investments. And so, it's just another sign of this is the professional way to approach your investments. And, transitioning into this passive income conversation, it's an exciting one, right? And, it's one that's very common in our language, because most people don't desire to work forever. The goal is whether athlete, non-athlete is, "At what point do I have enough money coming in that I do not have to go to work every day, and the only way that I have money to pay for the things that are important to me is doing work."
Erik Averill (05:50):
And so, this idea... There's a conversation we had yesterday with a client that said, "Hey, Eric, when my career's done, I just want to have money coming in that I don't have to do a lot of stuff for, so that I can pay for things that are important." Which is a great conversation, yet where this gets reduced down to, probably because of just mainstream media and books like Rich Dad Poor Dad is thinking that passive income means real estate, specifically, rental real estate. And, yes, that could be a component of it. But, what we're going to talk about today is, that passive income is actually not the goal. It's a means to an end. And there's a much better way to give you what you're actually after, which is freedom, right? The power of wealth, the true privilege of having wealth is freedom, that you can wake up in the morning and literally do whatever you want, because you have the financial certainty and ability to do that.
Justin Dyer (06:52):
Yeah. And, it dovetails with the conversations we've had and what you just mentioned around portfolio construction, portfolio optimization from that Pepsi highlight, where passive income is a component of portfolio construction or portfolio optimization, but the sole focus on it, especially if you're only focused on rental real estate. Is missing the forest for the trees. The way we think about it, when we're constructing a diversified portfolio is, yes you want some income, but you also want what we call capital appreciation or just price appreciation, think about that. That's the difference between a stock being worth a $100, and then appreciating rising to $110. That is a capital appreciation movement, versus the dividend it kicks off. Or think about a home, you buy a home for a million dollars and it appreciates to $1.2 million. That's capital appreciation, versus the rent that you may collect on that same home, that's passive income.
Justin Dyer (07:56):
Those two things are taxed differently, and that matters. So, we focus on both of them, because you don't want 100% passive income. That's all going to be taxed at your ordinary income rate. If you have some long-term capital gains sprinkled in there, or favor those, if you will. And, you do that with a diversified portfolio. Guess what? You're paying substantially lower tax rates on that. And so, that's what makes venture capitalists so successful. The vast majority of their upside is through capital appreciation and growth, not through passive income. So, you can't just focus on any one driver of appreciation, whether it's income or purely capital gains. And, same thing with asset classes, which we've talked about over the last couple of weeks, right? You need the diversification across all different income streams, appreciation drivers, asset classes, bonds, stocks, et cetera, et cetera. Right? You can't just solely focus on one, because then you're putting your priorities at risk.
Brandon Averill (09:01):
Yeah. I think that's a great point to hit on Justin, because at the end of the day, right? That mix too is so individualized. Everybody is different. What we do know is that if you're just taking an income approach, it's the least tax efficient way to go about your situation about investing. Now, if you're an extremely low tax bracket, maybe that's great for you. Most of the people listening to this are not in the lowest tax bracket, and they're probably going to be in the highest tax bracket for some time. So, when you think through this, and you reduce it down to income, in a lot of ways, you want to avoid income, right? It's, what are you actually going to eat at the end of the day? What's going to provide for your family.
Brandon Averill (09:41):
And, it's much easier to understand income kicking off. But I think, there was a great example, I was driving down the road the other day with somebody and they're like, "Oh, my dad was kicking himself. He could have bought one of these houses in Arcadia, Arizona." Very desirable neighborhood. Most people listening that are out there understand that it's a great place to live. All this, "Oh, if you would've bought it, it was 2008. He would have bought this house, it would have doubled in value." I stopped him. And I said, "Well, okay, let's play this out. Was that a good investment? Doubled in value, right? That sounds phenomenal, right? Well, that was 12 years ago. If you would to put that same amount of money into the diversified portfolio and just sat there, you would have ended up with a better after tax return than if you would've just sat there in that house in Arcadia. And you would've have done so with liquidity, you could have pulled your money out when you needed it..."
Justin Dyer (10:32):
The transaction cost.
Brandon Averill (10:35):
The transaction cost. And so, I think it's also that example of real estate we hear all the time, "Hey, if I can get $3,000 a month in rent, that'll cover my mortgage, and blah, blah, blah." Well, it's like, "Well, that's true. You want to cover your mortgage, for sure. But, you should have higher expectations than that, as well." And then, we've covered that over time. But, just because somebody is writing a check every month, psychologically, that feels really good. But if you can afford to take a step back and... So hopefully that's one benefit of having advisors, remove your emotions and look at it objectively. There's much better ways to go about planning for the period of your life when you do not have a paycheck coming in.
Erik Averill (11:19):
And that's where the, I would say, demystifying what passive income is and where it comes from, was super helpful. And with our clients, they're just incredible people that, they were really good at saying, "You know what? I'm not really stuck to real estate. It's just that, that's how I've understood where this conversation of passive income comes from the general population." But, we went back to a childhood fable, right, about this golden goose. Ultimately, it's about this goose that is producing eggs, right, in perpetuity. When we started to talk about how do you actually build the ideal golden goose, because that's what is going to kick off this income. Now, when you turn the spigot on, depends on your tax situation, your current lifestyle, what your priorities are, but that golden goose is... What you don't want to do is put it all completely risky.
Erik Averill (12:18):
So, even having the conversation of, "Yeah, you bought a few residential properties, most people only start with one. Your golden goose is extremely risky. You only have one asset. If renters happen to move out, if renters happen to decide not to pay rent and you got to go collect it and home ownership things happen." And so, now all of a sudden saying, "What if, instead of just having one rental property, we said, 'Let's go buy pieces of businesses that provide liquidity across the world, right, that are growing in value, that have a higher expected return, a positive return in the future, and start to construct what this golden goose is.'" So a lot of times, I think it's just making sure that we provide the education of ownership of companies, as opposed to one of the things we had to deconstruct was thinking... Once again, the misunderstanding that the public stock market, they were treating it as if that was an investment, as opposed to a location to go get access of the different types of companies and asset classes to build their own customized golden goose.
Justin Dyer (13:26):
Yeah. And, those companies, generally speaking, pay a dividend, which is a form of passive income. But then, Brandon, you hit on it. How this is such a tailored approach, the way we implement this, when that time comes to turn on the spigot of let's just call it generally speaking income from the portfolio, having a professional advisor that really can think about things holistically, be doing things in your best interest is incredibly important, because it might make sense to take income from the portfolio in a given year, given your tax situation. It might make sense to sell in realized capital gains, because we've been able to harvest some losses in the past and we can offset those two things, so you get to withdraw money from your portfolio with no tax impact at all, right? There's so many unique aspects to this topic and conversation that are specific to each and every client and individual.
Justin Dyer (14:29):
And so, being able to have that professional, have that framework to basically say, "Oh. I need, whatever, $10,000 a month, $20,000 a month from my portfolio, what's the best way to do that?" Well, that's how we approach that. It's not just this simple, "Hey, we're going to build a portfolio that pays you $20,000 a month blindly. And, no, don't adjust it, or don't think through where it's coming from on a given basis." We want to optimize it. We want to make sure it's tax efficient, which we talk about time and time again, but it's true. And then, what that allows is for you to continue to compound your long-term wealth, your generational wealth, and leave more either to your next generation, leave more to charity, whatever your unique priorities are. It leaves more for you to do what you want to do.
Brandon Averill (15:18):
Yeah. I think that's a great point. So, we're not going to create a portfolio of closed end funds, just kicking off income, Justin, for people. That's a low blow. But, I think it's just a good... Again, to make sure that people aren't sitting there going, "Oh, wow, that was a click-bait passive income lead. And, you guys switched it on me." Passive income, right, in the form of real estate or dividends may make sense for you. But I think the big point here is, it's really not that simple. And you have to look objectively your individual situation, build out a customized portfolio, remove that emotion. Hopefully, you have some really highly qualified people to help you through that process, because it definitely takes more than one mind to work through that in the most effective way.
Erik Averill (16:11):
And, one thing I want to say is, "We will generate passive income when it is appropriate for the client in their given time. I return to the Rockefeller family, because I think this is actually what we're shooting for is, seven generations later, a $10 billion net worth, still there's about 150 Rockefeller family members that are receiving income from their individual trust, that is going to exist in perpetuity. They did not do that, starting out with saying, "Hey, we want to buy a bunch of individual rental properties to generate income, right?" John D. Rockefeller built a business, the most iconic one in American history. And it was that enterprise value. And then, the reinvestment in companies that creates this golden goose for them to be able to draw income when necessary and appropriate. And so, I love this conversation around passive income, because it's a good intent.
Erik Averill (17:19):
What we're saying, that we say every single week, is that we just want to make sure that you are capturing the returns you deserve, and you are achieving your priorities in the most effective and efficient way. And the good news is, there's tons, and tons, and tons of evidence to draw from that says, "You don't have to take the risk or accept the lower returns of what the average individual is doing. You have earned the right and put yourself in a position that you get access to better investments, better expertise to capture returns that you deserve." And so, make sure you head over to awminsights.com, you can access all the show notes there. And of course, we would love to hear from you, topics like these. If there's something you want us to cover, please hit us up on Instagram, hit us up via the website. We'd love to hear from you. Until next time, own your wealth, make an impact, and always be a pro.