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Investing for Dividend Income: Not All That Passive

This article was written by in Investing. 12 comments.

Passive income is the Holy Grail of financial independence. Although modern Western society and capitalism relies on the Puritan work ethic, the idea that labor is a value to society and hard work is the path to a spiritual and successful life, most people would prefer not to trade their time and effort for an opportunity to survive financially.

There are good reasons. The work ethic is designed to benefit employers, not employees. Even though the labor movement worked hard to ensure humane conditions for employees, in the business world, the idea of spending countless hours at the office is rewarded in some working environments. Employees are made to feel guilty about desiring work/life balance, as excellence in an organization is a goal that requires a measure of imbalance. Unwavering dedication to the job above all other priorities is rewarded.

MoneyThis approach might make sense if a job is also a passion, but for the vast majority of people, passions exist outside the office. Families, hobbies, and personal missions all have higher importance on the scale of values, but they often don’t have the ability to provide the financial incentive necessary to make life easier for families, hobbies, and personal missions. When eight or more hours of the day are lacking passion, the results are the tired memes of the ordinary workplace:

  • Is it Friday yet?
  • I can’t wait to get out of here.
  • She’s retiring this year; she’s lucky.
  • My coworkers are so annoying.
  • The boss expects too much and then raises the bar when I exceed expectations.
  • I can’t get anywhere in this job.

The list goes on.

It’s no wonder at all people view the idea of passive income as salvation. Rather than trading in effort and time for a paycheck, your assets generate income while you sit back and relax, spend time with your family, and pursue your less lucrative passions.

Passive income exists, at least from a tax standpoint. Income from a rental property or from a partnership where you aren’t actively involved is considered passive income. The IRS treats this type of passive income differently than other income, even if that income comes in the form of dividends from an investment portfolio, what some might also call “passive income.” The truth is that all income requires active involvement, but perhaps it’s a matter of degree.

The IRS considers income from real estate investments passive income, but managing real estate can be a full-time job. Don’t expect to sit back and your investments to thrive, even if you have a management company handling the day-to-day work. In fact, unless you’re able to amass a significant volume of real estate, or if you do most of the work yourself, it’s unlikely the time and effort you spend will be as profitable as you expect.

Expect the same disappointment if you’re looking to dividend income as your path to wealth. If you calculate that you would like to replace $50,000 of your toil-based income, you would need to have $1 million invested in investments paying a 5 percent dividend. (I’m ignoring the difference in income tax just to keep the example simple.) $1 million is a large bank balance, but it is achievable. You can’t, however, just put $1 million in an investment paying a 5 percent dividend and forget about it.

Any investment requires active involvement, starting from the beginning. You need to choose the right investments to start, and you need to monitor your investments over time. Sure, you’re not toiling in the field or wiping sweat off your brow at a construction site, but you are spending time researching your investments. You also need to pay attention to ensure your investments continue to perform. Companies decide to cancel their dividends without so much of a warning, so you should follow the company’s financials to be aware of any signs of trouble before the executives decide to reinvest profits, if any, rather than continue the distribution to shareholders.

When it comes to letting your money earn your income, nothing beats bonds. Suze Orman and financial planners offer advice to the general public, extolling the virtues of investing in a portfolio made almost entirely of stocks, but if you look at Suze’s own portfolio, which is designed not to increase value over time in exchange for risk but to generate income year after year, she invests primarily in bonds. (Her investment was in bonds as of a few years ago according to her own admission in a news story. I don’t know whether this is still the case, but it’s likely.)

Taking a step back, while Suze — and many other investors, but she is a good example — invests her portfolio for passive income, she’s not sitting back and relaxing with her life. While she may have money managers who handle her investments for her, she still trades her time and effort for an income.

Are you seeking the Holy Grail of passive income?

Photo: Raido Kaldma
Wealthy Turtle

Published or updated May 23, 2012.

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About the author

Luke Landes is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about Luke Landes and follow him on Twitter. View all articles by .

{ 12 comments… read them below or add one }

avatar 1 Anonymous

I often use the term passive income to describe dividend investing, but you are correct when you say it isn’t truly passive. I don’t think anything could ever be 100% passive because you always need to monitor and make sure everything is still on track.

Perhaps semi-passive income would be a better description since you will continue to receive dividends without doing anything, but you do need to monitor your account to make sure the stocks is still worth holding and the company doesn’t cut or eliminate its dividend.

My goal in terms of dividend investing is to amass a dividend account that can supplement my retirement income with at least $1000 a month. Using your 5% return figure I’d still need about $240,000 invested. With consistent contributions for another 30 years or so and reinvested dividends that should be doable.

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avatar 2 Anonymous

I’ve been fascinated by the idea of passive income since I opened a passbook savings account at about age 8 and was astounded the ‘savings & loan’ would pay me money (interest) for doing nothing. Amazing! My aim since has been exactly as you say: “[Trade] in effort and time for a paycheck, your assets generate income while you sit back and relax, spend time with your family, and pursue your less lucrative passions.” I’ve found, however, that though your passions may initially be less lucrative, money can follow when you put your time and energy into endeavors you actually care about and feel a strong interest in.

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avatar 3 Anonymous

Great post! That $1 million you mention is also known as drop dead money, i.e., enough to tell your bosses (or customers) to drop dead. :)

And it probably is everyone’s number one financial goal, whether they’ve articulated it as such or not. It’s what the retirement fund is supposed to be, right?

And you’re absolutely right that “fuggedaboudit” is not an option. That’s true with anything in life – you might be able to get by with the lazy option, but to get the best, you need to put in a little extra. But, let’s face it, scanning the portfolio on the iPad beside the pool sure beats the heck out of fighting for space on the crowded train or bus. Or, setting aside an afternoon or two each week to go by the rental properties to check on them beats having to put up with dysfunctional bosses.

And the good thing is that $1 million sounds like such an unachievable goal, but, with prudence and a little time, it’s amazing how within reach it becomes…

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avatar 4 Ceecee

I’ve been aiming for this for the last few years. Unfortunately, the plunging stock market often seems to eat up the benefit of the dividends. I try to focus on cash flow and not the balance of the account, which isn’t always easy. I agree, this is hardly a totally passive endeavor, it takes research and attention……and limit orders.

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avatar 5 wylerassociate

I focus on a well balanced portfolio with a good percentage of stocks & bonds. I don’t focus exclusively on dividend income but dividends are one of many factors that I look at when I buy stocks.

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avatar 6 Anonymous

I absolutely want to get myself a nice big stream of passive income. Its OK if the passive income isn’t totally passive though.

True, most investments people make do require some activity. If you just bought a pile of dividend paying stocks and then ignored your portfolio for 10-20 years you could end up with some big problems. Rentals are definitely not passive as far as the amount of work required. Even managing a property manager can require a fair amount of work. Granted its not a full time job by any means but you usually can’t just sit and cash a check and expect everything to take care of itself.

I think the only truely passive forms of income are things like pensions or social security or things like that where you just get a check once a month with no involvement required.

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avatar 7 Anonymous

Not sure I need passive but I absolutely am in search of alternative and multiple income streams.

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avatar 8 Anonymous

It seems the primary difference between passive and active income is that active income is primarily trading time for money, and passive income is primarily trading assets for money. However, in both cases you are actually trading both time and assets for money. Active income is more time, e.g. working at a day job, but also assets like skills, talents, training, connections, sunny personality, etc. And as per this article, passive income always involves time managing or at least occasionally monitoring the income stream.

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avatar 9 Anonymous

I definitely am seeking passive income but I realize that nothing is truly 100% passive. If you don’t manage your passive income it will likely disappear or decrease over time and when you are depending on it to live on that is not a good combo.

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avatar 10 Anonymous

Great article! The most important and informative part of this article was debunking the myth that passive income is actually passive.

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avatar 11 qixx

The best form of passive income is annuities and structured settlements. Not in the sense of investing in them but in the “Need cash now” buying them route. Paying 50-75% the total value as a lump sum for a guaranteed return is truly passive in my opinion. In only i had the funds to invest. That and people wanting lump sum payments.

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avatar 12 Anonymous

Sounds like trying to find the fountain of youth.

Passive income is like radioactive material. It has a half-life. So while something can passive, it doesn’t last forever. The reasons can be because number causes:
– Markets change and someone else figured out a better way to skin a cat
– Entropy. Items tend to fall apart overtime and move towards kaos.

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