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:
- You’ve got to work to get the money to invest in the first place, and
- 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 blog. With 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.