Passive Income: Not As Passive As You Think

If there is one topic personal finance bloggers absolutely love it is passive income. According to wikipedia, “Passive income is an income received on a regular basis, with little effort required to maintain it.” There are two key phrases in this definition that will help you define what passive income is to you.

Passive Income: What Qualifies According to You

The two things you have to define in order to know what qualifies as passive income are “regular basis” and “little effort required”. Let’s examine these one at a time.

Regular Basis

This is the easier term to define for most people. When I think of income on a regular basis I think of paychecks. While passive income sources won’t give you paychecks you should probably be receiving income in the same types of intervals. This could be daily, weekly, biweekly, semi-monthly or even once a month.

Little Effort Required

This is the trickier one. Effort can be defined in many ways. The two things I think of when defining effort are how much time something takes and how difficult the task is. The combination of those two determine the level of effort required in my mind.

So how much time do I think should be involved in a passive income stream? For it to truly be passive I don’t think you should have to spend more than two to five hours per week. Anything more than that and I think you’re ventured into part time job territory. This number may be different to you and that is fine. We all need to come up with our own definitions.

Difficulty is the second factor. For an activity to be passive it has to be pretty easy for me. If it is hard to understand or causes me any stress at all then it doesn’t represent the easy passive income life many portray.

Now that you have your own definitions for what “little effort required” and “regular basis” you also have your definition for passive income. Let’s look at one of the most mentioned passive income instruments and see how passive they really are.

Dividend Stocks

Dividend stocks can put off a nice income stream and for the most part the payments should be pretty regular. Most stocks pay quarterly with some paying twice a year or annually. I’d say this qualifies for the first part of my passive income test.

While you could spend no time researching and keeping up to date with your dividend stocks I advice against it. Jim Cramer from Mad Money on CNBC recommends you spend at least one hour per week per stock doing homework to ensure you keep up to date on your investments. This gives you the opportunity to keep up with the information that would help you make the determination of when to buy or sell your stocks.

If you were just going to have one stock this would qualify as passive income. However, having all of your eggs in one basket is never a good idea. Jim Cramer suggests you own a minimum of five stocks and a maximum of 10 stocks to be diversified. This pushes us awfully close to the part time job classification.

Stocks can be difficult to understand if you don’t have a financial background. They can also be stressful if they make huge moves up and down over short periods of time. Overall, the combination of time involved, knowledge needed to understand and potential stress put dividend stocks out of the passive income category to me.

Turns Out Passive Income Isn’t Always So Passive

If you listen to Jim Cramer it turns out dividend investing isn’t so passive for me. You may have a different opinion and that is completely fine. Wednesday I’ll be diving into blogging and rental real estate and applying my definition to see whether or not they’d be passive activities to me.

So what do you think about my definition of passive income? Do you agree or disagree? I’d love to see what your opinion is in the comments.

 

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About Lance Cothern

Lance Cothern, a Certified Public Accountant (CPA) licensed in the Commonwealth of Virginia, is the founder of Money Manifesto. You can read more about him here or connect with him on Facebook, Twitter, Google+ or Pinterest.

Comments

  1. You could hire an advisor and let the advisor do the work therefore making it passive. However, you would take out some of your profit margin though.

    I think it’s hard to get REAL passive income. If you own rental property then you need to have a property manager, if you own a blog then you have to outsource everything, etc.

    • I have no clue why I didn’t think of this. You make great points! Advisors should be up to date, you just have to make sure you have a good one 🙂

  2. Passive income is hard to find. Some people consider blogging to be passive income, but I can’t fathom how that is so! I spend so much time working on my blog that any passitivity that might come from blogging is exhausted by the effort.

  3. People used to refer to rental income from income property as passive income. In fact, the IRS distinguishes between passive and active regarding income property. I do not think any income is truly passive although some is more easily earned than others. I am a big believer in multiple income streams though.

    • Multiple streams is awesome just don’t call it passive if it isn’t! I think people get passive income (without work) confused with the IRS definition of passive income sometimes.

    • The IRS interpretation of rental property as “passive” income is the biggest joke in the history of taxes …. I’m convinced that no one who writes the rules at the IRS is actually a landlord.

  4. I’m a big fan of passive income. I completely agree with you that perhaps it is more time-consuming that we initially think. The trick is to build it up to the point where it no longer requires our attention.

    When I first started my blog, I was excited about the prospects of it becoming a passive income stream. Instead, I found myself working at it 20 hours a week with no real income until recently. Now I could hire out all my writing and SEO, and reap the net rewards from the affiliate marketing. Then I’d be truly making passive income!

    On the dividend income, this is something I’ve been spending a lot of time researching and getting excited about. I might have a solution for you. If you use the Dogs of the Dow theory, you don’t have to spend any time researching at all! You just make one set of transactions on 12/31 and 1/01, and then reap the rewards all year. (I will have a post about this upcoming) Now that is passive income!

    • I hope that I eventually have something that becomes passive income but I don’t think bloggers show enough that it takes a ton of work to get to the passive point. I have heard of dogs of the dow before but I don’t personally invest in individual stocks so I never looked that much into it. I’ll be interested to see your article!

  5. I’m eager to see what you have to say about real estate and passive income – I think if you use a property management group to manage your rentals, then it can be passive… although then there’s decidedly less income!

    • Regarding rental income, you are correct that a management company will take a large share of the monthly profits, but many believe it’s the easiest check they cut all month. Being on the hook for repairs, complaints, yard work, etc. will totally consume a person’s free time and in my book I’d rather have little profit in the near future for free time. Also, once the property is paid off, you’ll be getting a much larger chunk of the rent.

    • You make some good points. Check back Wednesday to see my verdict!

  6. Passive income is hard to generate – but not impossible. I think that the stepping stone is automated income (this is the one that is predictable and needs little effort).

  7. I would think 20 hours a month would be side income. I program on the side 10-20 hours a months and would not consider this passive income, but instead a side job. Maybe the fact that it could end at any time qualifies it as side instead of passive, but if so I would put blogs in the same category.

    • 20 hours is the max I would consider passive and I think that could be stretching it myself. If the income stops because you stop the activity I’d say it is a side job too. The regular payments would not continue.

      • I’m not sure why more people don’t consider blogging and other internet ventures as side income. Yes, you can probably take a week or even a month off and not do any updates, but if you ignore your audience for very long, they are going to leave in droves. Every captivating blog I’ve read has updates about 2-3 times a week. Any less than that and I eventually lose interest. I also don’t think I’m in the minority.

        Regarding e-books, they are a temporary source of income and all of the work is done up front. I can’t see writing a “good” book taking less than 100-200 hours. After a few years, chances are the book is making very little if anything and is probably out of date.

        I recently read an interesting post about internet-based passive income here: http://www.forbes.com/sites/michaelellsberg/2011/06/24/the-top-4-reasons-why-passive-income-is-a-dangerous-fantasy/

  8. The one part of your definition that I would disagree with is saying that it has to be easy work. I make passive income from some of my old websites, but occasionally I have to make changes that are sometimes a little difficult. I don’t think that makes it any less passive though, especially since I spend way less than 2 hours per week maintaining those websites. I would think dividend investing is one of the most passive forms of income you can develop unless you do something like write a book.

  9. Passive income is always a tough one. I can see where little effort is required “NOW”, but for most sources of income, it did require a lot of work at some point. Even dividend stocks required selecting, but after you choose them, you only have a little effort keeping an eye on them.

  10. My real estate investment has been anything but passive. Lots of tenant and property mgr issues to deal with. Depending on how you define it, it may not exist.

  11. Getting passive income becomes everyone’s dream but only few actually gets it because it never comes in a day job but in a profession or business.

    Thanks for composing this article where I got a chance to think about the bloody passive income.

  12. Good definition, and quite achievable – it is exactly what I do for a living. Warren Buffett famously said his job is waiting for the phone to ring. Mine is waiting to see if my dividends have been deposited.

    What’s the number one financial goal most of us have? It’s to have enough money that it will earn enough passive income for us. So all of us are interested in passive income sooner or later. So thanks for this good article!

    A decade or two ago, someone in a book coined the term “drop dead money” to mean enough money you can tell your bosses (or customers) to drop dead. Just a fun name for the source of our passive income. 🙂

    Personally, I’ve opted to go the dividend stock route, with one difference. Contrary to Jim Cramer, Warren Buffett says pick one company and put all your eggs in that basket. he made $8 billion on Coca Cola doing that.

    Obviously, you do your homework about that one company. Just like you don’t marry a random member of the opposite sex, you take a lot of care. But if you choose right, it’s a long term relationship.

    It’s not rocket science, but it does take some up front work. After that, it’s just watching the bank account to see if the money came in on time. Literally.

    There is one thing to watch out for, though, for when relying on passive income from stocks, bonds or real estate. That’s the economy.

    We have recessions every 7-10 years like clockwork (there are charts to prove it) and as anybody knows, a recession can wreak havoc on passive income sources. Just being forewarned is usually enough to avoid total disaster, but that usually takes less than an hour a month. (And it also takes some discipline not to overreact.)

    So… it is indeed possible to have passive income if you’re prepared to do a little work up front and twice in a 7-10 year period make a few adjustments.

  13. I wrote a piece called The Passive Income Lie, which hammered your same point. I think lots of people are chasing a free lunch, and there isn’t any such beast.

  14. Rental properties are supposedly “passive” income, but there’s still a LOT of behind-the-scenes management associated with them. I see my rentals as a second job, not as passive income. Outsourcing the work to a property manager will defray some, but not all, of the work. Ultimately, the property manager will need you (the owner) to make all the major decisions.

  15. Liked the post and I am very careful to differentiate “passive” income vs “side income”. Blogging is side income unless you own it and contract out all the work (including editing). Rental income is side income unless you contract out all the management and majntenance. Right now my focus is on side income, paying down debt, and building up assets that could translate into passive income.

  16. I’m the type that watches my portfolio from 9:30 – 4. I wish I could look away, but it’s just too hard when the computer and streaming quotes right in front of me. In that case, my investments would be considered active income. However, I frequently write covered calls against the stocks I own. I will hold the option position for 2 – 3 months so I guess that could be considered passive.

  17. The only incomes I consider passive are my CD, Dividend, and Rental incomes.

    Everything else requires work, but in various stages.

    • CDs are definitely passive and something I didn’t consider listing. I’d say your blog definitely takes a lot of work but at the same time if you enjoy it some people don’t consider it working.

  18. I think most people have a skewed idea of what passive income is. Very few income streams are truly passive. If it takes 30,000 hours to build up the income stream before the residual checks start rolling in…is it really passive?

  19. MemeGRL says:

    Awesome eventually-passive revenue stream: books. My mother wrote bestselling phonics texts and workbooks. Forty five years later, I still get residuals on them and I use it for vacation treats (eating out, tickets to attractions, etc.).
    She worked her butt off writing those books so it was not passive for her at all for the first few years. But there were lots of years after where the books paid the taxes or the vacation or bought the car.

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