PFFAP-PYP-21-1020-Doctors Passive Income
Ben: [00:00:00] Welcome to the physician, family financial advisors podcast, where we turn today's worries about taxes and investing an extra money into a comfortable feeling of financial security to last a lifetime. I'm Ben ugly. And
Nate: today's question is, should doctors invest for passive income? So, Ben, what is the deal with passive income?
Like what is it, why do I hear about it all?
Ben: Uh, passive income, passive income, my, my two favorite and most dreaded words. I hear it all the time. Um, passive income is, is the, the, the concept that you, you get your money for nothing and your checks for free, right? So, uh, the passive income is this. Mythical beast that I hear from physicians all the time who are experiencing real burnout and real Drudge at work and real difficult times kind of fantasizing of a way of making money without really doing anything.
[00:01:00] Hmm.
Nate: Sounds nice.
Ben: Yeah, it
Nate: sounds great. Doesn't it? Yeah. Okay. Uh, it also sounds a little bit too good to be true. Is it real? I mean, like. Can you do that?
Ben: Passive income, passive income is, is real, but it's not really what it's cracked up to be. I mean, the, the thinking on passive income is I can just, you know, invest in some way and, and make income.
That's going to replace the income that I have right now. So to a certain extent that's possible, but we'll, we'll discuss today. We'll, we'll figure out that it's not really all it's cracked up to be, and it's not as easy as it's cracked up.
Nate: Yeah, I'm, I'm kind of imagining, uh, replacing, you know, a salary of, let's say $500,000 a year.
I mean, that'd be, it seems like that'd be a lot of passive income to achieve.
Ben: Yeah. Yeah, it would be, I mean, uh, let's imagine. Well, we'll take that figure. That's a, that's a [00:02:00] high number. I think the average physician earnings, uh, somewhere between two 50 and 300, and let's go with, uh, an easy round number, like 300,000.
So this is like, Oh, uh, it's a household where maybe there's a primary care physician, which are the other guys that are really in the, in the meat grinder these days. Uh, marriage is somebody who's bringing in somewhere between 50 and a hundred thousand dollars. And let's say that we want to replace that income.
So how do we do that? Well, first off you have. You have to save some money, right? So you have to have money above and beyond what your, your daily expenses are. Okay. And that's, that's a stretch because a couple of hundred thousand is really what it takes to make it in kind of the modern family to be able to do a lot of things.
So you've got that extra a hundred thousand. All right. So let's talk about how much it would take to replace that 300,000. Let's say that we got, we get a rate of return. That is 6% on some fantastic passive income, 6%. Okay. So if we backed [00:03:00] through that calculation, uh, and we say, okay, well, 6% of a million is $60,000.
Right? Okay. Uh, so we're, we're getting close. Uh, so 6% of 5 million is $300,000. So then you have to ask the question. Where is a guy or gal who earns $300,000 gonna come up with $5 million, 5 million after tax dollars, which is like, you know, seven or million or so dollars to begin with on an income of 300,000.
So this concept of, you know, income replacement, passive income is, I mean, yeah, it's possible, but that's what we call it. Retail. Right. You said your whole life to be able to make money like that and to, uh, and to generate a passive income. So I would say passive income and retirement are, are kind of one in the same, but we're hearing a lot [00:04:00] about passive income as a way to make some money on the side, a way to make some, some money being something other than a doctor.
And, uh, I don't like
Nate: right. The field that I get from, from people who talk about passive income a lot is that it's, it's sort of like you mentioned freedom. It's free to get there. It's easy to get there. You can get there fast. If you ought to save $10 million or $7 million. What are the strategies that people are saying you can get there quickly?
Ben: Well, well, so, uh, anybody who's, who's drink coffee late in the day and couldn't sleep. He stayed up late at night and you're watching the, uh, the equivalent of QVC, uh, some financial porn late night. Get rich. Uh, you hear guys on there talking about real. Real estate real estate real estate. And you hear about real estate because they talk about no money down or low money down.
So maybe 5% down. So now if we're looking at. You know, 5% down, that's a much smaller number. If a million dollars, you'd get your 5% down. That's [00:05:00] $50,000. Right. And if you need your to get your, your 5 million, you've got a quarter of a million dollars now. Well, that's the kind of money that a doctor can scrape together.
Okay. Uh, and so with that quarter million dollars, you could conceivably control $5 million worth of real estate. But when you're working with $5 million with, of real estate and you're leveraged, Hey, you're taking a lot of risk and B you're essentially starting another business. And unlike medicine, you know, where you've, you've trained for a decade or more with real estate and doctors don't have any experience with that.
And it's a, it's a real world tactical, uh, hands-on kind of thing. Whereas, you know, medicine is a little hands-on, but it mostly happens between your ears. There's a lot of thought and intelligence that goes into it. So it's risky because of the leverage. And it's also risky because it's, it's a new frontier.
Nate: Right. And, and it seems as though. This idea that it's passive, um, what gets lost in the mix there is that if it [00:06:00] is truly passive, um, someone's got to take care of the real estate. Yeah. So let's see, it seems like a, it's all pie in the sky, thinking that you're going to do this for low cost, um, leverage, you know, through your ears and, uh, Get this big return that somehow you couldn't get anywhere else, unless you took out $5 million in loans.
Right. Um, so that seems, that seems strange. Uh, if, if someone decided they didn't want to be leveraged in a millions of dollars in loans and, uh, deal with the hassle of real estate, they could just buy stocks and bonds. But we don't hear about that very often as this grand plan to. Quote, unquote, get rich.
What, why do you think that is? Well,
Ben: I think that most people perceive stocks and bonds to be risky. Like could lose all your money in it. People don't think of that in real estate because real estate is [00:07:00] tangible. You can walk into it, you can hold it. Um, but what they're not saying is let's say that you decide you want to buy a million dollar property.
You got 5% downs. You put your 50,000 bucks in you borrow $950,000 from. And that real estate appreciates by 20%. Okay. Now you've got a $1.2 million property and you've got, oh gosh, 950,000 plus 200,000 equity. You've got $1.15 million. You basically made $200,000 on your original 50 grand. So that's a four X return.
Okay. Leverage is a double-edged sword. It cuts both ways. So let's imagine that you go into the same deal of million dollar property, $50,000 down, and you get a slight down tick, a slight down tick and the real estate market. And it declines by 5%. Now you have a $950,000 property and a $950,000 loan, and you've got wiped out.
So you went from $50,000 down to nothing and just [00:08:00] for a slight down tick. So. You know, people think of real estate as something that is safe and they think of it as a, get rich, quick scheme because of leverage, but you could take those that same amount of money and go out and borrow to buy stocks. Now, this is heresy.
No one would do this. You wouldn't go out and borrow to buy stocks, particularly 20 to one leverage. Nobody does that. You know, if you had a fully paid off house and I said, Hey, you know, let's, um, let's borrow a million dollars out of your house and go invest in the stock market. Most people would be like, uh, Uh, I didn't hear about that in the podcast.
I'm not going to do that. Cause that seems like idiocy, but you're doing that when you go out and you borrow a little bit down and you put it in real estate, you're leveraging and leverage against real estate or leverage against stocks as the same leverage. It's it cuts both ways. Uh, and it stinks. This is dangerous.
So, you know, I think if people took those, those same metrics that they apply to real estate in that same strategy and they applied it [00:09:00] to something as common and ordinary as stocks or index funds that they would have comparable. In fact probably better results because when we look at the historical return series, the, of, of, you know, primary residence, residential real estate, when we look at the, the returns from that versus the returns from the equity markets, the equity markets actually edge residential real estate by about a point and a half over longer periods of time.
Nate: But Ben garden variety index funds are.
Ben: Yes, they are boring. Uh, if you own a garden variety index fund, you will have nothing to talk about in the hot tub. So, you know, when you're sipping your beer and the guy across from you, who's got his champagne. You're sitting in the hot tub with your friends and he's shooting off his mouth about us latest rental real estate.
You won't have anything to say because you got index funds. They're boring. Right. But boring is beautiful when it comes to. Things that are things that are not sexy, tend to stick around. Uh, they tend to be stable. Sometimes they go up over a long [00:10:00] periods of time. Uh, and, and ultimately it's about not getting wiped out.
You know, uh, part of investing is not losing their money
Nate: so it seems as though a lot of the people that talk about real estate or passive income, they do talk about, you know, stocks and bonds sometimes. But like you said, it's not. As sexy. So if this is the math at the math you just described, and there's really smart people writing about this, why are they talking about real estate so often?
Ben: Here's exactly why the blogosphere is rife with conflicts of India. So when you hear the pundits talking about passive income, there will inadvertently be a link to their passive income page with their top 10 passive income ideas. Most of which are crowdfunded real estate, or, uh, maybe it's peer to peer lending or something like that.
In these cases, when you click on those links and you go sync your 500 or a thousand dollars in that investment, the person who's hosting [00:11:00] that. Link known as an affiliate link is getting somewhere between a hundred and a thousand dollars for that activity. So this is a real moneymaker for people who spend time, supposedly doing passive income by writing about passive income, which is not really passive because they're actually making money on the backs of people that are, that are going into these investments.
So really they're selling, and there's a conflict of interest there, like in all sales of financial products. So, you know, since there's a vested interest in talking about it, you're hearing about it a lot. And, and to the contrary, uh, index funds, these days are practically free. Uh, you know, you can buy and sell index funds at some of the major brokerage houses and pay literally no commission for that zero transaction costs.
So in that sense, it is free to trade them and to own them. The cost of ongoing cost is down in the, you know, Point three 0.4 0.5%. I believe that there was a company out there that has some zero index [00:12:00] funds. Uh, I won't name names, but there, there is some zero cost index funds out there. So those things are literally free in many cases and something that's free is not generating any income.
And since it's not generating income, no one's talking. But it works great. In fact, I got a call from a guy the other day. He was a dog in his mid fifties and he says, you know, um, I've got money saved for retirement, but I feel like I need to be doing more. And I said, well, what's your situation? He said, you know, I'm in my fifties, he says, I'm approaching retirement.
I got about 10 years out. He says, over the last several years, I've invested in just garden variety mutual funds. And he said, I've managed to amass about five or $6 million. So this guy is just right on the edge of being able to retire. And I said, You've done all this. Like, why are we talking? He says, I feel like I'm missing something.
I feel like I'm hearing about this passive income. And I'm wondering if I ought to be doing something else. And I said, you know, you're hearing a lot about it, but you know, it doesn't, it doesn't make sense. I mean, you've already had success doing what you're doing. So why would [00:13:00] you switch horses?
Midstream? fear of missing out. Yeah. FOMO, fear of missing out. Yeah. He was really relieved when I was like, no, what you're doing will work. In fact it will, it will work for the rest of your life. Just keep doing it, uh, you know, put your earplugs in and go back to work.
Nate: Hmm, yep. Yeah, it seems, it seems like, uh, when most people hear this, it seems it does seem reasonable to them.
it also. Doesn't get rid of that fear because it's impossible to completely turn off your colleagues. So for a moment, I want to at least entertain something that they say that does make sense to me. It doesn't make sense that you're going to get free money, but when your colleague says, oh, it's a, what about diversification?
And then we get clients that ask about that. All right. So, what do you say about, uh, the diversification that real estate offers? And if it's worth it to, I guess, take some, some more risk to get that diversification?
Ben: Well, that's one of the [00:14:00] interesting things about real estate. It's really hard to get diversification.
I mean, you know, let's say that you can scrape together the 250 to $750,000 that you need to buy a residential rental property. You know, how it was for someone to live in it. Let's say it's a half million. You got one. Right. And if you want to diversify that house, then you go get another half million, and now you're up to a million dollars.
So it's notoriously difficult to diversify real estate. And when people dream of owning real estate, they're typically thinking about selling that or renting the house that they lived in, or, uh, buying a house that's down the street. Something that's really tangible that they can hold on to. They can see it every day and know that it's still there and it's not going away.
That's. That's the thought. So if that's the prevailing thought, you're never going to be able to diversify. I mean, you can buy all five houses on the street, but when a wind storm comes or, you know, a firestorm like we have here, they all get wiped. So hard to diversify. Uh, let's say that you could own a house in [00:15:00] a couple of different states.
That would be a little bit of diversification, but they're all in the United States. So, you know, the only way that you're going to be able to truly diversify in real estate is to own properties all over the place. All over the planet, all over the globe. And interestingly, that's something that even fortune 500 companies typically do not do.
So if you walk into a retail store like a Walmart or a target or something like that, you're walking into a Walmart or target the business, not the real estate, because typically these companies don't own the shell, the building that their businesses operate in. And the question. Why don't they? Well, the reason they don't is because they know that the return on their capital, the, the return that they're going to get for operating the business inside that shell is greater than the return that they're going to get for owning that shell itself.
They they're choosing to put their chips down in the place where they're going to get the most money, the most return for their buck, and they're leaving those lower returns to other people. So if the smart people who run these fortune [00:16:00] 500 companies and these S and P 500 companies are not willing to invest in real estate, why would I invest in real.
Nate: Okay. It makes sense to me. Tell me a little bit about the options for.
Ben: REITs. So, you know, Reed stands for real estate investment trust and, uh, read is, uh, you can think of it like a mutual fund where they own instead of stocks and bonds, they own real estate. And so, you know, a big buildings in major cities, you know, a hundred story skyscrapers are typically owned by real estate investment trusts and, uh, REITs are a legitimate way to invest, but they're also.
You're investing in the real estate sector, you could invest in a utility fund. You could invest in a tech fund. You could invest in all kinds of specialized sector funds, but then again, you have the diversification problems. So if you're going to own a REIT, you need to own all those other things. But the other way to do that is to simply own a broad based index index, like a [00:17:00] world stock index, or, uh, a broad market us index, because you're going to get some REITs and there, and you're going to get an appropriate level of exposure without overweighting those.
The other thing that I find interesting is if we're in a rising interest rate environment that makes borrowing capital more expensive. And when, when capital is more expensive, it's harder to borrow to leverage. And when that's the case, it's harder to borrow to buy real estate. And so real estate typically suffers in a rising interest rate environment.
And that's beginning to look like the secular market that we're in for the coming decade, 2, 3, 4 decades as the. The outside world begins to realize that our is not as credible or credit worthy as we would seem.
Nate: Okay. So, uh, the whole, I buy real estate as diversification from my stock portfolio kind of falls apart.
When you realize you already have real estate, as long as you're buying the garden variety index funds, uh, it's all wrapped up in there.
Ben: That's correct. Yeah. It's kind of all, it's all baked in. You don't have [00:18:00] to take your extra vitamin C it's all packed in your, your once daily vitamin. Got it.
Nate: Okay. So, I mean, it's, it's kind of obvious where you stand on it, but.
Do you think physicians need any passive income and maybe why exactly do they think they need it so badly?
Ben: Well, I think that they do need passive income, but not in the sense of. Go out and do something other than becoming a physician. I mean, the ultimate application of passive income is as a retirement strategy.
I mean, in retirement, you go do something other than medicine, right? You go do something other than your day job and you still have money to live on. But I think that the pursuit of income itself is only part of the formula. So when you go to the grocery store and you show up and they say, Hey, um, that loaf of bread is going to be $4.
They don't ask you next, will you be paying with income or will you be paying with. Right. They, they ask, we w we want $4. They don't care where it comes [00:19:00] from. So income investing, sidesteps, the whole concept of total return. Total return is the return that you get from capital change. So that's whether or not your investment goes up or down in value, plus the income that you get off that investment.
So when you invest solely for income, particularly when you invest for higher income, you're typically investing in something that is, has a lower. The credit quality and you're putting your money at more risk. In fact, junk bonds have a high yield junk bonds are a form of passive income. But what we find is that junk bonds are highly correlated to stocks, which also pay a dividend and also have a growth component.
So if you're being an effective investor, You're not really concerned about income. You're concerned about total return. You're concerned about getting the maximum return that you can for that the unit of risk that you're taking, which we would call an optimal return. It's that balance of risk and return, rather than just looking at one component of total.
I would also go so far as to say that the, the pursuit of passive income during a [00:20:00] physician's working gears, you know, as a way to replace their income is nothing more than a distraction. If you look at who earns money in this economy, outside of people that are starting businesses, it's lawyers and doctors and more, so doctors and lawyers.
And so, you know, since that's one of the most highly paid professions, if you're doing something other than that, you need to be darn good and certain that you're really going to be making money at it because there's a chance that your time is worth less there than it is in what you're doing, which is what I like to call a distraction is distracting from the thing that you're really good at the thing that you're trained to do.
And. If you feel like medicine is hard or challenging, or it's not mentally for you, maybe the thought here, instead of looking for passive income and working harder in metastatic to make that passive income would be a way of maybe. Containing your expenses, you know, finding a way to squeeze your costs of living back down and taking a lower paying job, maybe [00:21:00] moving into, uh, academia where there's a little bit less pressure, or maybe look at moving into management where you're not in the, the line of fire, uh, looking for ways out of medicine that.
Are not passive income, but just reducing expenses because you can, you can do this. There are all kinds of people in America who make far less than doctors do. And with the headstart that a person has being a physician, there is a chance that they could kind of downshift their quality, uh, not their quality of life, but their, their income and enjoy perhaps a better or more balanced quality of.
Um,
Nate: yeah, I really liked that. I mean, essentially what I hear you saying is improve your life and don't, don't try to, uh, let money solve all your problems by getting more of it. Um, just take less and, and live the life that you is more
Ben: sustainable. Yeah, it is entirely possible to live on less. I mean, uh, you know, running the gamut from neurosurgeons to pediatricians, not all doctors make the some same, some make far less and some are far.[00:22:00]
There's no correlation between the amount of money you have and the happiness that's in your life or your success, a big correlation between status and perceived power, but status and perceived power don't necessarily make people happy. And there are some things in medicine that make people miserable.
Nate: So it sounds to me like doctors don't need passive income. Is that, is that about.
Ben: Yeah. Not, not during their working years, but I think that passive income is, uh, uh, a reasonable goal for someone who is looking for a, a reasonable retirement age, because it does take an entire lifetime to build passive income.
Nate: Okay. Well, I think that's it. I think mainly it's a, it, what I hear about is that rental real estate and, and, uh, other than that, uh, You know, it seems like the other passive income doctors are investing for now is the garden variety, stocks and bonds. So more of that and less
Ben: distractions. Yeah, just, just a final note here.
[00:23:00] There's nothing wrong with garden variety, stocks and bonds. There's nothing wrong with index funds. I've seen plenty of people will be able to retire with those investments and you don't have to be a guru to do that. You don't have to be, uh, as bright as a physician is to make that you don't have to get out of your lane.
You don't have to spend time driving around, uh, you know, looking for the next rental property, looking for the next deal. Uh, it is perfectly okay to just be a good physician. Just be good at your job. Just make a difference in the lives of others without having to go so far outside the box. So with that said, I think I'm going to wrap us up today.
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