I received a great question/comment from an unusual source: Scott who is a prolific inventor, known actor (ever see Beethoven 2 and 3?), and movie industry ‘mover/shaker’:
I generate income through intellectual properties… Inventions, movie royalties and so on. I receive royalties every quarter (or so) from many sources, the total of which far exceeds the return on one million dollars in the bank. This is passive (royalty) money.
Irrespective of one’s actual money in the bank, is it safe to say that if one is realizing the income (passively) as if having the millions in the bank, that they are living the life of a millionaire?
Is it safe to assume that if someone were doing this for a living they’d be living as if having the million(s) in the bank?
Even though Scott seems comfortable in the continuity of the income streams (he has “many on the retail shelf and on T.V. with many more coming. It’s just what I do.”), I am not quite as comfortable.
As I said to Scott:
You need to look at the certainty and longevity of those royalties and incomes … unlike cash in the bank, your ‘Life of Riley’ lasts only as long as the income keeps coming in.
You see what Scott has is NOT passive income; it’s BUSINESS INCOME and business income is most assuredly not ‘passive’ … it’s ACTIVE.
‘Active’ implies risk …
Even though Scott can create a product, put a team around it, and set it free to generate ‘passive income’ via royalties, etc. it is not enough to say that Scott is as rich as, say, somebody with enough cash just sitting in the bank on CD’s generating the same income, merely from interest, as Scott earns from the fruits of his creativity.
The money in the bank will keep generating interest for ever … the capital NEVER changes (let’s forget inflation for now, which is the real risk for this ‘money in the bank’ strategy).
You see, each ‘product’ (be it a movie, an exercise bike, a kitchen gadget, or whatever) has a ‘life cycle’ – it will either make money from the get-go or flop … if it is a winner (and, it seems like Scott has the Midas Touch, here) it will sell for a period of weeks, months, years until eventually another product will take over and product sales will die … along with Scott’s royalties.
This may happen quickly or slowly, but it will happen!
Since Scott is great at what he does – and loves doing it – this isn’t a problem for Scott: he just goes ahead and creates the next product.
Financially, though, this means that Scott is like any other professional in private practice: once he does stop creating, either by choice or because of disaster, sooner or later the income will stop coming.
Now can you see the difference between the ‘passive income’ generated by a few million in the bank and a similar level of ‘active income’ generated by Scott’s creativity?
Great! So, what can Scott do?
Well, the same thing as anybody earning an income either through their own sweat/blood/tears or through a business:
Scott could try and estimate the future cash flows of each of his product streams and see how long they will take to die down/ disappear as if he never created another product as of today and basically tie his current life-style to the present value (smoothed) of that future income stream.
If disaster doesn’t strike, Scott can review each year and adjust his ‘smoothed’ income stream, accordingly … but, this doesn’t solve the fundamental problem, so Scott should also:
Build a Perpetual Money Machine …
To Be Continued … 😉