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Beginner’s Guide to Passive Income (11): What to Do? How to Do It?
Continuing from the last post, I discussed the risks and returns of various asset classes such as litigation financing, private credit, entertainment financing, collectibles, private equity, angel investing, and pre-IPOs. I also discussed which types of people are suited for these strategies. After identifying which category you fall into—meaning if you believe you’re capable and willing to accept capital loss in exchange for potentially higher returns, and you have spare funds that won’t affect your life or mood—then you can start thinking about passive income. So, if you’re ready to try, how do you start? What do you do? How do you do it? In this post, we’ll discuss the umbrella topic of asset allocation, and I want to share some basic principles for allocation, including some mainstream allocation strategies and my own approach. After reading this, you can apply the strategies to build your own system based on your situation. Firstly, passive income is not an asset class in itself. I’m probably one of the few bloggers who has systematized the concept, theorized the practical details and wrote it all out for you. Therefore, in mainstream discussions, you won’t find data on passive income allocation. The closest thing to it is alternative asset allocation data, which is why I often talk about passive income and alternative assets together. Traditionally, the common approach was to allocate about 10% of your total assets into alternative assets. However, in recent years, the allocation percentage for alternative assets has increased significantly. Some family offices now allocate as much as 35%, and surveys show that younger generations with substantial wealth are eager to increase this percentage, even up to 50%. Within this 35% allocation, about 12% each goes into private credit, private equity (including pre-IPO), and angel investing. As for my own allocation strategy, it’s somewhat different. As many of my long-time followers know, I started with private credit, then explored countless strategies, eventually focusing on legal-related strategies. As a result, my main sources of passive income now come from legal lending and litigation financing. I have heavily invested in these areas, adjusting my positions yearly based on results. Currently, more than 50% of my passive income comes from alternative assets, and if the results continue as expected, this percentage will grow even more over time. Here’s my approach:
- Time
When testing new strategies, I use my spare money to experiment quickly. Most strategies will result in losses, with only a few making profits. After running through a few cycles, I get a sense of the risk-return ratio. I eliminate the lower-performing strategies and gradually increase my position in the successful ones. If a strategy starts to lose money, I cut it off and continue increasing my position in the ones that are still generating returns. Time is a key factor in my strategy—the longer a strategy continues to bring in money, the bigger my position in it becomes.
- Liquidity
I value cash flow most when it comes to passive income. My order of operations is to first ensure that my lifestyle is secured, so no strategy testing affects my family’s daily life. Only after that do I test various options. I focus on strategies that generate cash flow in 6 to 12 months, which allows for quick testing, rebalancing, and stop-loss actions. If a strategy requires more than 12 months to return, it no longer fits my definition of passive income. I calculate the amount of capital I need to cover my family’s living expenses for the year, and invest that into strategies that generate cash flow in 6 to 12 months. The remaining funds go into other strategies, such as private equity or angel investing, which don’t provide cash flow and are more like long-term speculative plays. I never heavily invest in these.
- Diversification
Even in my concentrated positions, I never go all in. I know that I don’t have that kind of luck or courage. Instead, I diversify extensively and make returns slowly. Fortunately, I started earning passive income early enough to live the life I want, so the process feels less lengthy and pretty smooth. With diversification, if one strategy suddenly fails, I won’t be starting all over again from scratch—I can maintain my foundation and avoid excessive anxiety. Inner peace is crucial.
- 60% in legal lending
- 20% in patent litigation financing
- 20% in other strategies, including private equity, angel investing, pre-IPO, etc.