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It’s a long-running debate.
Is passive income a holy grail, or is it as much as a myth as the pot of gold at the end of the rainbow?
Here’s why I definitively fall on the first side of that argument, with proof from my own personal experience of building from negative net worth (owing more than I owned) almost 30 years ago to my very comfortable current circumstances.
The Argument for Why Passive Income May Be a Myth
In a cogently argued and well-worth-reading case, Ben Le Fort says basically the following:
- “Passive income is money that you did not have to work to receive.”
- Passive income now appears to include selling information products, affiliate marketing, AirBnB, and hosting ads on blogs, podcasts, and YouTube videos
- With the exception of investing in stocks, bonds, etc., all so-called passive income avenues actually require a lot of effort.
- Investing requires you to work really hard to come up with the initial funds.
Why I Take the Position that Passive Income Isn’t a Myth
If we accept Le Fort’s initial definition, and especially if we modify it a bit to say: “Passive income is money that you never had to work to receive,” then indeed, the only truly passive income is when you get cash gifts such as an inheritance or winning the lottery (especially if it’s because someone gifted you the winning ticket before the drawing).
These are hardly things you can count on or control.
However, I would push back against Le Fort’s definition as being counterproductive. I think a much more nuanced and helpful definition would be this: “Passive income is money that you don’t have to continue working to receive.”
Stated like that, you’re looking for ways that you can invest your time, effort, and expertise now to build something that will throw off continued income later. Instead of fighting the famous TANSTAAFL – “There Ain’t No Such Thing As A Free Lunch,” you’re looking for ways of investing upfront and reaping the benefits later.
7 Examples of Truly Passive Income (even if Le Fort Disagrees :))
Using this more nuanced definition, we’re well prepared to consider what is or is not truly passive income, supported by my personal experience and results.
Investing in the Markets
Yes, you need to work overtime to come up with your initial investment funds, but you can then let the markets do what they do. As of this writing, our investments brought in over double our businesses’ profits for the past 12 months. How much did I need to work on my business? More than full-time. How much did I need to work on our investments? A handful of hours just to keep track.
Renting Out Real Estate
Another absolute yes. We’re renting out our previous home and hired a property management company to run it for us. Over the past 12 months, this brought in a 10.4% return on our equity. My total time spent on this was limited to recording income and expenses, and exchanging a few emails or text messages with the property manager. Our office space rental was even better, returning 13% on our equity over the past year. Here my effort was limited to depositing rent checks and sending out lease extensions to our renters.
Selling Information Products
Here it’s less clear cut. I agree with Le Fort that it takes a lot of time and effort to create an ebook, and even more so to create an online course. I also agree that marketing these products takes additional time and effort. However, supporting students depends on your price point. If you create a course that teaches how to make origami animals for your kids and sell it for $20 per student, you won’t need to provide much if any support. On the other hand, if you sell a course for $2,500 that helps students become expert foreign currency traders, you bet you’ll need to provide a lot of support. That’s why creating ebooks and “low-touch” courses do count as passive income, while “high-touch” courses are not. Even those, if you can hire someone, train them to do the marketing, and provide outstanding support for your students while you spend very little time managing the effort, then even a high-touch course can become passive income.
Selling a Physical Product
Here too, you’ll need to spend time, effort, and expertise to develop a product. You’ll then need to market and sell it until you prove there’s a profitable market. Once there, you could license or sell the whole thing for an ongoing royalty where someone else takes care of all the work, and you get a portion of each sale. Alternatively, you could hire staff, including a manager, so you have little or no additional demand on your time to keep the money coming in. Either way, this is a plausible passive income source.
As Le Fort says, affiliate marketing requires building a following, a tribe, an audience that trusts you and values your opinion. It also takes effort to market those links, at least if you want them to bring in more income. However, once you’ve built up the audience, and after you’ve created the review post or video that discusses the product or service you’re marketing, affiliate marketing doesn’t take very much continued effort. Hence, it does pass the test as far as my definition of passive income.
Setting aside the current near-comatose status of the travel industry, if you’re renting out space in your home, again, I agree with Le Fort as far as he goes, that it takes some setup effort to create the space, list it on Airbnb’s site, and then promote it. If you want to create rabid fans who will come back and rent from you year after year (assuming you’re in a “destination location” like a beach town), and who will write rave reviews, then yes, you’ll need to spend some effort on providing a special “extra mile” experience. However, if you treat this as a business, perhaps you’ll buy one or more properties, and hire a property manager. True, this takes a much greater investment up front, but it does become a truly passive income source, similar to the rental real estate path described above.
Hosting Online Ads
This is similar to the affiliate marketing path in that it requires you to build a following and the content where you’ll host the ads. However, if you’re already working with that following for other purposes, the extra effort of hosting online ads is negligible. Thus, whether this counts as passive income or not depends on whether you account for maintaining and continuing to grow your audience. If online ads are your sole monetization strategy, I’d agree with Le Fort. Otherwise, it is indeed passive income that feeds off a different, but active, business.
The Bottom Line
Unless it’s a matter of someone gifting you cash or a winning lottery ticket, there’s no way you can create a stream of passive income without investing time, money, and expertise upfront.
That’s not the point, however.
The point is that while creating passive income does take that upfront investment, once you’ve invested in it, you can reap the benefits over the long haul. And isn’t that the basic premise of any retirement plan? Work for years or decades and set money aside along the way, then stop working and get ongoing income for years or decades more?
You can’t, and shouldn’t, expect to have a stream of cash come in without ever providing any benefit to anyone. After all, money is simply a proxy for somebody’s being productive. If you want that proxy to come in without any further effort and productivity on your part, you need to invest that much more ahead of time.
Once you accept this fact, you’re ready to build the machine that will bring in truly passive income at some future point, with little or no additional time and effort spent by you. The above shows seven plausible paths for building such a future edifice for yourself and your family.
About the author:
My career has had many unpredictable twists and turns. A MSc in theoretical physics, PhD in experimental high-energy physics, postdoc in particle detector R&D, research position in experimental cosmic-ray physics (including a couple of visits to Antarctica), a brief stint at a small engineering services company supporting NASA, followed by starting my own small consulting practice supporting NASA projects and programs. Along the way, I started other micro businesses and helped my wife start and grow her own Marriage and Family Therapy practice. Now, I use all these experiences to also offer financial strategy services to help independent professionals achieve their personal and business finance goals.
Disclaimer: The information in this article is not intended to encourage any lifestyle changes without careful consideration and consultation with a qualified professional. This article is for reference purposes only, is generic in nature, is not intended as individual advice and is not financial or legal advice.