Does Passive Income Really Exist?

by Mr. Cheap

I love the idea of passive income.  Some magic is performed, and a steady stream of money comes into your life every month.  A Google search on this site with the term “passive income” turns up 55 hits, so its definitely a popular topic.  As much as I think passive investing in index funds is pretty tough to beat, real estate and dividend paying blue chip stocks that offer regular cash payments are pretty enticing.

Mike has made the point that there isn’t a big difference between being sent some money every month or redeeming a small portion of a stock portfolio as needed.

People will sometimes suggest things like writing a book or writing a song as a way to generate royalties which becomes a “passive” income stream.  While collecting the royalty checks is passive and easy, writing a book sure wouldn’t be (especially if it was any good).  Taking a risk that the public will like your work, investing all the labour upfront, then getting paid out over time seems like reasonable trade-offs for the income stream.  Why is this better than working hard at a 9-5 job and collecting a check for your efforts?  Both seem like reasonable compensation for the amount of work, risk and delay of payment involved.

Often passive income streams are proposed that aren’t very passive, such as real estate or starting a business.  I don’t buy the suggestion that a property management company or hiring employees will make these totally passive.  I’d say with either of these options you’re sacrificing income to DECREASE the amount of labour you need to invest (which is ok, but its just a trade off like any other, nothing magical).  If you turn over the company ENTIRELY to other people to run, I think you’re sending your risk into low Earth orbit.

Paul Graham proposes the idea that startup companies condense a lifetime worth of labour into a couple of years (and pay accordingly). While this isn’t a passive investment (usually founders sell their company and walk away with a big check rather than getting monthly payments for life), it does seem like a reasonable way to spend a couple of years if you have a good idea and are confident in your ability to build a company that could be sold.  It would be possible to live off the the proceeds of the sale for the rest of your life.  Similarly someone could sell the rights to a book or song, and then live off that money.  How is this getting paid upfront worse than an income stream?

GICs (or CDs for our American readers) pay money over time, but these are rarely recommended as a passive investment.  The higher returns from what is usually considered passive income seem to me to mostly be a risk premium.

Choosing the right combination of length and amount of investment, amount of risk tolerated and labour invested seems to me to be considerations all investors make, from Donald Trump to whether you want to work at the McDonald’s or at your friends new car detailing business.

Is there an important aspect of passive investing or income streams that I’m missing?

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