Passive Income: It’s Not What you Think

What Is Passive Income?

(This key article also appears on the home page of this website)

Passive income is money you personally receive from assets, businesses, intellectual property, trust funds etc. in which you are not actively involved.

Your job is not passive income because you are exchanging hours worked for a pay check.

Your side hustle is probably not passive income either for the same reason.

Passive income needs to be just that – passive.

Passive means low effort, low activity, low involvement and low need for attention.

For most, passive income seems like an impossible dream. Hopefully we can help shift that paradigm.

True Passive Income Is Rare

In its purest form, passive income is rare.

For income to be truly passive it means we have never had to work for, or work towards, or work on the assets that produces our income.

Examples of this might be:

• A trust fund built by our parents of which we are the beneficiary
• An inheritance of dividend paying shares, rental properties or investment bonds
• A gift of an insurance annuity from a deceased partner or relative.
• A lottery win.

When Passive Income Isn’t Really Passive

There are many assets that produce good cash-flow for their owners and are labelled as passive income, but in fact they are not truly passive. Examples of this might be

• Real Estate – Often labeled as passive income, however anyone who has a self-managed portfolio of real estate assets can attest, that once maintenance, tenant management, advertising, rent payment chasing, repairs, taxation and insurance are all attended to, it can hardly be labelled as passive income.
• E-commerce shops – Often advertised as set-and-forget or sometimes advertised something like ….. “Only requires 2 hours a month to replace your income”. Those who run e-commerce shops have a different tale to tell – plenty of work is still required.
• FOREX trading, Stock trading, Crypto trading etc – Again, often hailed as lifestyle activities only requiring small amounts of effort for large profits. The truth of the matter is quite the opposite. These business require very high attention to detail and market awareness combined with not-so-cheap software and plenty of risk.
• Bank interest – Too frequently referred to as “money for nothing”. This ignores the sheer effort required to earn and save up the corpus. Even more devastating is the fact that bank interest almost never exceeds the current inflation rate. The same can be said of certain government bonds and the countless high fee investment products available to most consumers.

None of these or similar strategies are set and forget, nor are their cash flows passive. Thus when we read articles that spruik this-or-that product or system producing passive income, it’s likely that this is not entirely truthful. Either we are going to purchase that product with money we’ve actively earned, or more likely, there is an unmentioned requirement to input significant time and effort before the said product begins to produce income under its own steam. Often, sadly, the offering is snake oil.

Nevertheless, many income sources from businesses and side hustles are excellent and quite lucrative – certainly worthwhile doing but just not passive.

First Active Income, Then Passive Income

Most passive income streams require a significant amount of upfront work or savings before they can become self-sustaining as a passive income source.

For example, the hard work required to save up and buy dividend producing shares is not passive, even though the dividends themselves are truly passive.  In much the same way the time, blood, sweat and tears required to save up and buy a portfolio of commercial properties is certainly not passive, even though the rental income received from those properties is probably quite passive.

However, this is the pathway to passive income available to most of us. It’s honorable.

Additionally, we will certainly appreciate the resultant passive income when it is ourselves alone who have put in the up-front hard work. Things that are worked for, are much less likely to be squandered.

We cover my preferred strategy of creating passive income under the section of this site entitled Income Investing. 

Briefly, this method consists of three steps:

1. Purchase cash-flow assets
2. Purchase income growth assets
3. Build your own income asset

All three steps can be achieved incrementally over time, there is no rush ….. or maybe there is a rush, and that’s doable too. 

The fun starts when your assets begin to eventually snowball and their income outstrips that of your day job. There’s a lot to like about that.

Cheers

Hugh Walker