How Passive Is Your Income?

 


T
here continues to be a lot of discussion in finance and investing circles about something called “passive income.” With a name like that, is it any wonder that many people start to dream about laying on a beach, sipping pina coladas, and checking on their ever-growing bank account that requires zero effort to double every year? But what is passive income, how passive is it really, and how can you generate it?

The truth is there is nothing that is 100% passive, and the term has been abused by internet marketers looking to sell courses and books for their own benefit, not yours.

In this article, I want to walk through some of the common forms of “passive” income to illustrate how they work and how much work they take. This will help you ground your expectations as you progress on your journey to build wealth.

What is NOT passive income?

To me, the term “passive income” refers to making money from sources other than a day job that also doesn’t require your full-time attention to manage. I think it is easier to start with things that are NOT passive income strategies:

  • a second job is not passive income because you are trading your time for money
  • a side business that requires your constant attention is not passive income
  • trading options, which requires your full-time attention, is not passive income
  • flipping houses, which requires constant work to acquire, fix, and sell properties
  • running a hedge fund, which turns to invest in stocks into a full-time business managing investor money
  • syndicating real estate, whereby you bring investors into large deals that you find and manage
  • internet marketing, which requires significant work to build up followers and monetize your position

All of these strategies can be a good way to generate additional income if you know what you are doing, but they are far from passive.

Starting a new business is an intense process that will require significant time and effort to make successful (and often fails even with significant time and effort). Trading options takes a lot of time to learn sophisticated strategies, watch market movements, and manage risk.

There is nothing wrong with these strategies as long as you go in understanding that it will take significant time and energy to start up and to keep it running.

If you don’t spend the time, these efforts will fail.

What is passive income?

Although there is nothing that is 100% passive, some strategies do require much less ongoing effort than others:

  • owning a rental property (especially when employing a property manager) takes little effort to collect income and profit from the appreciation
  • investing in real estate syndications, whereby you give your money to a company that acquires large real estate deals
  • owning stocks in an index fund or high-quality stock portfolio that produces dividend income and price appreciation
  • collecting royalties from IP such as books, online courses, software, etc.

Note that none of the passive income strategies listed require “zero-effort”. There is no magic money that falls from the sky, not even crypto.

In general, passive income requires significant upfront work but then less effort to maintain the income stream once it is set up.

For example, it can take hundreds of hours to find and acquire a good rental property, but then maybe one or two hours per month to manage it if you have a property manager. So while the finding and buying property is far from passive, the income that you receive after you own the property can be.

I have built up a portfolio of seven single-family rentals and one commercial property. It took a lot of time and energy to learn about real estate and find good properties. But now that I own them and use a property management company, I only spend a couple of hours per month to keep the books and handle major issues. This allows me to earn over $30,000 per year in cash flow (plus debt paydown and appreciation) with very little ongoing effort and keeps my time free to acquire more assets.

The same goes for picking stocks, writing a book, or building an app. It takes a lot of effort to write a book, but once published it can generate income for years without much additional effort (assuming someone else is doing the marketing for you, like a publisher).

My father is a retired professor that has written numerous textbooks. Every three years he writes a new edition, which takes six to eight months of work, but then the income continues as the book is sold to students without any additional effort on his part. This is a form of passive income because the money keeps coming in even during the years when he is not actively writing.

One exception is investing in index funds. It requires almost no effort either upfront or to maintain (other than a bit of education and rebalancing), but indices also don’t produce much income in the form of dividends.

Photo by Anna Nekrashevich from Pexels

Summary

As you can see above, not all forms of additional income are equally passive. Starting a business can produce significant income when successful, but it will likely require significant ongoing effort to keep it going and the cash flow coming in.

On the other hand, investing in rental properties and/or stocks takes a lot of effort upfront to do right but then the effort required to maintain a large portfolio is much less than running a business. From my experience with seven single-family rentals, I have no doubt I could manage 20 or 30 properties while working a full-time job.

So think through how you currently earn income outside of your day job and how passive it is.

Then, as you consider new ways of trying to generate additional income, realize how much time and effort will be required and make sure your expectations are grounded in reality.

Again, there is no reliable way to make extra money with no effort, so be prepared by learning about the strategy you want to implement and ensuring you are ready to spend the time and effort needed to make it successful.

Good luck investing!

Building Arks

After struggling to build wealth early in my career while following traditional financial advice, I set out on a path to learn about investing. Over a decade later, I’m financially secure and working towards full financial independence through real estate and the stock market. I have succeeded in building my financial ark to help me weather whatever storms may come.

I founded Building Arks to help busy professionals like you ignore mainstream advice and build real wealth.

Post a Comment

Previous Post Next Post