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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. Modern Western society and capitalism rely on the Puritan work ethic. The idea is that labor is valuable to society, and that hard work leads to success. But the truth is that most people would prefer not to trade their time and effort for financial survival.

There are good reasons for this. A strong work ethic is designed to benefit employers, not employees. Even though the labor movement worked hard to ensure humane conditions for employees, some businesses still reward countless hours of time in the office. Businesses load on the guilt for employees who desire work-life balance. And excellence in many organizations requires imbalance. Unwavering dedication to the job above all other priorities is often rewarded.

This approach might make sense if your 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 aren’t often able to turn these passions into a sustainable income. And when work requires at least eight hours of the day, they lack time to develop these other areas.

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.

From Active to Passive Income

It’s no wonder at all people view the idea of passive income as salvation. You don’t have to trade your time for a paycheck. Instead, your assets generate income while you relax, spend time with your family, or pursue your less lucrative passions.

This is why so many people search for ways to generate income without trading their time. And it seems like there are plenty of options for generating this type of income. But are there really?

What the IRS Considers Passive Income

You may not think about the IRS when you’re considering this question. But it’s actually a good place to start. The IRS considers two forms of income passive, for tax purposes:

  • Rental property
  • A partnership where you aren’t actively involved

This type of income is treated differently from other types of income, even income and profits generated from an investment portfolio.

But is either of these options truly passive? Probably not.

Managing real estate can be a full-time job. Even if you hire a management company to do the day-to-day work, you’ll have to manage the managers. And unless you have the assets to amass a lot of real estate, you’ll likely need to do the work yourself to turn a profit.

You can build up a real estate business to the point where your involvement is less than a full-time day job, sure. But that takes time and loads of effort up front. And the management aspect never fully disappears.

What about the case of a business partnership? Even here, you’ll need to keep an eye on things to ensure your interests are being met. Again, this may not be a full-time job. But being in such a partnership implies that you’ve worked your tail off to invest in a successful venture. You can take some time off now, but you’re not totally off the hook.

What About Dividend Investing?

Dividend investing is often touted as the holy grail of a passive income. You invest your hard-earned cash, and companies pay your money. It’s easy to see the income generated as passive. But there are two problems with this approach:

  1. You’ve got to work to get the money to invest in the first place, and
  2. You need to monitor your investments.

Let’s tackle these issues one at a time.

Saving $1 Million

If you would like to replace $50,000 of your toil-based income, you’ld need to invest $1 million in investments paying a five percent dividend. (I’m ignoring the difference in income tax just to keep things simple.) A million bucks is a large bank account balance. But it’s achievable with hard work and planning.

So here, already, we admit that to get even a semi-passive income, we first have to work really hard. Perhaps even harder than everyone else at the office. Saving $1 million doesn’t happen overnight. It might require a side gig or longer hours at work. Or you might have to work harder at home to trim expenses. It’s an achievable goal, but you’ll need time and work to get there.

Monitoring Your Investments

But once you work your tail off to save $1 million, you can just sip margaritas on the beach all day, right? Not so fast!

You can’t just let that investment sit there and expect it to continue making that same five percent return. You need to keep researching and monitoring your investments. You should follow the company’s financials to spot signs of trouble before the executives decide to reinvest profits rather distributing them to shareholders. And you’ll need to make sure the investment continues to perform. If not, you’ll want to move your money elsewhere.

Sure, monitoring your investments doesn’t take forty hours a week, most likely. But it’s a mistake to think of dividend income as entirely passive, either.

Reframing the Goal

So here’s the bottom line: no form of income is truly, 100% passive. Sure, some trust fund kids may do nothing to keep their income coming in. But someone is managing that money. If not, they’ll quickly find themselves running out of it.

My guess is that if you’re reading a blog like this, you’re willing to work hard to reach your goals. And maybe those goals include opting out of a full-time job so that you can opt in to other things. Maybe for you it’s spending more time with your kids. Maybe that’s pursuing a passion that doesn’t make much money. Or maybe it’s just having more financial breathing room to try out a new business idea.

All of those are excellent goals. But here’s the thing: none of them requires you to have a 100% passive form of income. So instead of looking at passive income, why not look at how to get the most return for the investment of your time? With good up-front decisions and management patterns, dividend-paying investments may just be that option for you. But here are some other ways you might generate more income in less time so you can spend your life elsewhere:

  • Invest in bonds. They may not earn as much as stocks, but they’re a way to generate steady income year over year without much management.
  • Start a blogWith hard work and a little luck, a blog can become a money-maker, even when you’re not actively working on it. You can sell ebooks in your sleep, or make money from ongoing ecourses. You’ll still have to keep things up. But you might be able to make a full-time income with less than full-time work after a few years.
  • Settle into a job you love. If the real goal is to avoid slaving away at work you hate, make a way to do something you love. Maybe it means a pay cut. Learn to live with less, or start a side gig to supplement your income.
  • Work towards early retirement. With a couple of decades of solid hard work and thrift, you can retire early. Maybe this is partial retirement that leaves room for a part-time job. But it could still get you where you want to go.

How about you? Have you chased the holy grail of passive income?

Photo: Raido Kaldma

Updated May 27, 2017 and originally published 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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