Blogsphere seems to be obsessed about the concept of passive income. If you listen to many of the bloggers out there then passive income is the secret (and only true path) to early retirement.
My idea when creating this site was to chronicle and document my thoughts as I continue to grow my Money Tree. In fact on the about page of this blog I refer to my extra curricular income as passive. Currently outside of my day job I have three main ‘passive’ income streams:
- Dividend income from equity portfolio
- Rental income from buy to let properties
- Advertising revenue from an internet marketing business
I’ve decided that after a bit of reflection there really is no such thing as a free lunch. In reality none of the sources of income above are truly passive. Below I’ll try and explain why this is the case.
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Dividend Income
Many of the financial independence blogs I ready often state that their dividend income is passive, as mentioned above I’ve even done it myself. However this simply isn’t true. Even if you take the classic Buffet investment time horizon of 20-30 years then there is in my opinion even more reasons not to leave that investment as truly passive.
In my opinion it is the job of an investor is to allocate investment capital in order to maximize returns within his or her risk/reward appetite. Even if you consider shares in a company to be a 20 year play you should still be constantly re-assessing your decisions, the reasons you took them and potentially looking for opportunities to top up your holdings at cheaper prices or consider the opportunity cost of leaving your capital stationary.
Any investor that has a set and forget attitude to capital allocation is in my opinion making a terrible mistake. Even if you’re investing in index funds it’s my belief that you should at least be regularly reviewing which type of index funds and which specific indices you want to allocate your capital.
No matter how diversified your index funds are, it’s your job as an investor to be reviewing your allocations regularly and checking the fees (fund + platform) that you are paying. My point is that if you go purely passive on these investments you’re probably leaving money on the table.
Property Rental
Get a cheap mortgage, buy a house, rent it out and simply sit back and watch someone else pay off the mortgage at the same time as you collect some nice passive income. Owning a rental property sounds easy but the reality isn’t really like that.
Having been a landlord for over 10 years I know there is a fair amount of work involved. Below are a few examples of things I do regularly to earn my so called passive rental income:
- Deal with the inevitable ‘the boiler has broken down’ call on a Saturday morning 1
- Regularly check your properties for ‘non emergency’ repairs that if left untended can cost you serious money in the long term (e.g. leaking guttering = long term damp)
- Optimise my mortgage overpayments
- Arrange inventories/check ins for ingoing/outgoing tenants
- Screening potential new tenants
- Do your record keeping and fill in the property section of you tax return
- Perform some detailed tax planning to decide when it makes sense to pay down a but to let mortgage
- Constantly remind myself of the buy to let rules
Given the large capital outlay and the (potential) illiquid nature of property investment you’d be a fool to enter into a buy to let situation expecting a passive income as your reward.
Internet Marketing
Making money from the internet makes me feel dirty. Search the web for “passive income internet business” and you’ll get in the region of 2 million results! That tells me one thing – there are a hell of a lot of people out there making money on-line by telling other people how to make money on-line. It is the classic self fulfilling industry.
I’ve made a fair bit of cash over the last 10 years from the internet. I’m glad to say that none of it has been from telling other people how to do it! In fact most of it from producing content sites (on a variety of different sites/subjects) and selling advertising on them. There are plenty out there that would try and tell you that this is ‘passive income’. Wrong.
With patience and work I can increase the revenue generated however as I’ve found out over the years that the traffic these sites get (and therefore income they produce) is completely susceptible to Google’s search algorithm. On a few occasions a solid income from a site has disappeared over night. In addition most sites need regular maintenance and updates in order to maintain their traffic and revenue.
From my experiences the less morally sound your product/website the easier it is to make money on-line. The more you spam, lie about products and bombard people with information the more you make. This is one of the main reasons why I’ve let my on-line income ‘passively’ taper off. I just don’t like some of the things I found myself doing on-line to make a few more $ each month. To cut a long story short I ‘sold out’. Now I’m truly passive this income stream is in decline!
Conclusions
I’m a believe that passive income in the literal sense doesn’t really exist. If you disagree then you’re most likely not maximising that income stream to it’s fullest.
As a general rule, the more attention I pay to my net worth, and the income my portfolio 2 produces, the better the performance gets. By allocating capital, appraising potential investments, comparing yields, managing risks and looking at opportunity costs I am being far from passive in my investment approach.
Notes:
1 I had this one happen last weekend as it happens!
2 Portfolio here = assets
I’ve also seen Internet ‘passive income’ become too much like hard work. It isn’t just Google, it’s the shift to smartphones and the balkanisation of the open Internet into facebook mini-sites etc. It’s no longer worth the candle, but it was a good ten years while it lasted and was fun. I don’t count blogging in the category of income 🙂
> If you disagree then you’re most likely not maximising that income stream to it’s fullest.
I only need enough. But then you have a far wider and deeper understanding of the investing scene from being in at the sharp end. I probably couldn’t maximise that return without increasing downside risk.
It’s a good general point though – any truly passive approach to income will be fragile long-term- over years the competition will move and run rings round you
I tend to think in similar terms as Paula from Afford Anything here. You have to separate the active part from the passive part, even if just mentally. You pay yourself a wage for the active part, and think of that as just another expense. The rest of the net income is the part that is passive.
The property example, for instance. If you were to bring on a property manager / letting agency to take care of all that work for you, you wouldn’t expect them to work for free, but nor would you give them all the net profit. If you are your own property manager, you’re still also your own investor. Part of that profit is pay for a job (hopefully) well done, the rest a return on investment.
I suppose it all amounts to much the same, though. Different ways of reaching the same conclusion: if you want to earn almost-passive income without hiring people to manage your investments, you have some work to do.
Still better than the 9-to-5.