How we’ll track passive income on a monthly basis

December 3rd, 2008 · 1 Comment

As the saying goes, “what gets measured, gets done” and our goal for geographic independence is not likely to be an exception.  As a result, we’ve put some effort into figuring how to consistently measure our passive income so that we can track progress toward our goal.  We want to start with some sort of monthly measurement at this early point in our goal, even though the income will likely not roll-in as equal, monthly payments.   Here is a summary of our thought processes.

Charting a path to success

Charting a path to success

The first thing we had to figure out is what income we’d actually count as contributing toward our goal.  There are two aspects of this that jumped out at us.  First, we will not count any income that can only be generated by active efforts tied to a specific physical location.  Second, we won’t count any income that is captured by selling assets that aren’t self-replenishing or otherwise easy to acquire again with minimal effort. The self-replenishing comment is somewhat in jest as we don’t picture striking it rich in “black gold”, farming wool from sheep, or anything of those sorts.  What it does mean is that we can’t count growth in assets unless we convert those assets to something that throws off income, at which point we can only count the income and not that value of the asset itself.

One additional thing that should be called out explicitly is that we WILL count income even if we don’t spend it on living expenses or otherwise “consume” it.  I don’t think anyone in their right mind could picture hitting our goal without a plan to reinvest the income along the way and “snowball” it.

Anyway, now that we had a definition of the income to count, we tried to gather information about the passive income we had generated over the course of 2008 to see what we’d need to do to track it.  Luckily we keep pretty good records of our income and expenses in Quicken so this process was a simple data-mining operation of finding deposits in all of our various accounts.  In the future, we might be able to use Quicken reports for this but we hadn’t categorized everything appropriately to be able to filter things out at this point.  When we’d finished, it turned out we didn’t find anything that forced us to rethink or clarify our above decision on what income would count — all we found was interest, dividends, and income from blogging.  From the glass half full viewpoint, there’s lots of room for improvement!

I’m sure everyone is completely surprised to hear that what we ended up doing next was creating yet another spreadsheet.  In this one, the columns represent the type of the income and the rows would represent each actual deposit from a source of that type.   We’d then group rows and calculate column sub-totals to find monthly totals for each income type, and then calculate a cross-column total to find the total income for that month.   Here’s a simple hypothetical example:

After a little bit of time spent filling this out, it became clear that there was significant volatility in our monthly income.  This would obviously make it hard to tell when we’d really hit any short-term or long-term goal.   A very short analysis showed that the the volatility comes from investments that don’t pay out on a regular monthly schedule, rather than income sources that have an inherent varying monthly amount.  For example, I’ve shown dividends paid in January but that doesn’t mean you’ll get another payment in February — unless you carefully pick your investments to spread your dividend payments out and that just seems like a very silly way to pick your investments.   While we expect the second type of volatility in the future, most everything we can really picture ourselves doing now involves the former, so clearly we need to come up with a reasonable scheme to keep a running average of sorts.

After a little discussion, we decided that some manner of averaging over about three months seemed reasonable.  This equates to tracking income over a quarter of a year which means it would average out things like quarterly dividend payments, but more importantly, it would also give us a short enough tracking period that we can start to see the effects of changes we make without waiting too long — which we felt was very important.   Anyone who has tried to train a pet will understand that any significant delay between the action of the pet and the resulting praise or corrective action just confuses the pet and gets you no where in your training.  While I’m not trying to equate ourselves to the intelligence level of a common pet, it is important for us to be able to correlate behavior changes with results and the shorter time period makes it easier to do so.

In the end, we decided not to use a simple 3-month sliding average as we felt that would still represent a little too much volatility that we could easily pick up from looking at the actual monthly income totals.   Instead, we wanted to somehow weight heavily the most recent month, and then weight every previous month proportionally to how far in the past it was.   After playing around a little bit, what we came up with is the following equation:

    TI = (I + 2*(TI-1)) / 3

or closer to English:

    trend income = (actual income + 2 * previous month's trend income) / 3

If you expand this out across a number of months, and carefully pick the equation’s reduction for the first two starting months, you’ll find that the current month is always 33% of the current trend income, the previous month is always 22%, the month before that is 15%, and the contributions from months prior to that continue to decrease as a month gets further away from the current month.  The special exceptions mentioned earlier, for the two first months, are critical to making this work out but I’ll leave figuring them out as an exercise for the reader.

After updating our spreadsheet with this formula, and a few other tweaks, we are now set to track our passive income for each month, and each year.  We’ve filled it out for 2008 and found that we started January with a monthly passive income of about $35 but that our efforts throughout the year, before we formalized our goal and took it seriously, have already led us to a monthly (trend) income of just under $200 in November.  The average income per month over the whole year will be north of $100/month.  One positive way to look at this is that we’ve already exceeded our monthly income goal for the end of 2009!

More on this topic (What's this?)
The Perfect Way to Make Money
Daily ETF Trend Report – Fix Income
Read more on Income, Passive Management at Wikinvest

Tags: Geo Ind Goal · Passive Income

1 response so far ↓

  1. 1 Geographic independence: July 2009 & first half update | Geographic Independence // 2009.08.02 at 9:05 am

    […] weighted average GI income for the month was $594.55, which is a decent jump up from the last time I did a similar analysis.  […]

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