Ahh, passive income. That wonderful, utopian ideal of a never-ending stream of cash into your bank account, allowing you to focus purely on other things in life. Like tending to your unicorn herd or grabbing a drink with the leprechauns.
Because the truth is, the concept of a purely passive income stream sits firmly in the realms of make-believe.
Now that’s not to say that there aren’t some forms of investment that require less work than others, but expecting to have zero input into your investments altogether isn’t realistic. Especially when you see ‘gurus’ on TikTok or Twitter talking about creating a supposedly passive income through things like dropshipping, content creation or real estate.
So today, we’re going to explain why exactly we’re so adamant that true passive income is very hard to come by, why you shouldn’t be looking for it anyway, and which investments get as close as possible to that dream.
It’s easy to see why this dream persists. Of course, we all want to be able to get to a point where money is something we don’t ever have to think about, other than how we’re going to spend it.
The idea that we can build an asset base that takes complete care of itself while we spend more time with the family or pursue hobbies and other interests is intoxicating. And with long-term planning, it’s possible to get somewhere close to this.
But the truth is that no form of asset is completely passive. And even if you are able to set up an income stream that is able to be totally passive for a time, it’s not likely to stay that way without someone keeping an eye on it to ensure it remains on track.
To work through the realities of passive income, it’s probably easiest for us to break down some of the most common examples of asset classes that are sold as this dream.
We’re going to start with the biggest, most common asset, which gets billed as passive income. Let’s be really clear. You can make great returns by investing in real estate. There are many ways to do it.
But it’s no longer the 1980s. The space is fiercely competitive, incredibly expensive and filled to the gills with regulatory roadblocks. To win at the real estate game, you need significant capital, deep connections and relationships and specific expertise.
And even if you have all of that, it’s an asset class that is far from passive.
Even the typical buy-to-let investment portfolio takes a huge amount of work on a weekly and even daily basis to manage. You need to manage building repairs and maintenance, chase rental payments, arrange inspections, respond to tenant problems, ensure compliance with legal requirements and more.
We’ve seen this first hand, time and time again. Investors hoping to drop all their investment capital into a few properties and sail off into the Mediterranean are likely to find their time on the yacht seriously interrupted.
And yes, you can get a property manager, but the reality is that just means all those calls come from them rather than the tenants directly.
Here’s another one. Buy a cash flow business. Often you hear options like an e-commerce store or a micro-SaaS. I mean, yes, these things could potentially provide you with an income, but buying a business, any business is about as far from passive as you can get.
If you’ve ever been self-employed, you’ll know how much work goes in behind the scenes to even the most simple-looking venture. And while these sorts of businesses might look low maintenance, the reality is likely to be far, far different.
Even if the fundamental day-to-day operations were pretty smooth, or you could hire a good manager to take care of them, everything else that goes into the business makes this closer to a full-time job than a passive income.
Just start a blog, YouTube channel or Instagram account, whack up a Linktree with some affiliate links and watch the cash roll in. These days, content creation can be a legitimate form of income.
There are many, many people who have launched multi-million dollar/pound businesses off of blogs, YouTube, Instagram and TikTok.
But again, these are not passive. To begin with, it takes a huge amount of upfront work and investment to build an audience. There are no shortcuts, and it can take years before it ever comes to fruition, and indeed it might never happen.
Even if you manage to get to a point where you’ve got a big audience, and you’re making cash from various sources, you can’t just stop creating content and expect the revenue to keep rolling in.
Creator burnout is a real thing, and it’s because the algorithms for these platforms need constant new content in order to keep the creator relevant.
So sure, start a YouTube channel if you’re interested in it, but don’t expect to be cashing cheques without some serious ongoing work and effort.
So we’ve burst your bubble on passive income, and honestly, we’ve only just barely scratched the surface on the different schemes and strategies that are being sold as totally hands-off. At best, these require a lot more work than advertised. At worst, they could be a complete scam.
So, in that case, what’s the next best thing?
Well, it’s through investing in a diversified stock-based portfolio. Now don’t get it twisted, there is nothing passive about the way this type of investment generates returns. The only difference is how easy and cost-effective it is to outsource all the work to other people.
When it comes to this management, there are essentially two levels that you can outsource.
This is the first part that you outsource when you buy shares directly. As we explained above, starting a business of your own takes a ton of work. When you buy stock, you’re buying a business just the same, but it comes in-built with a CEO, a board of directors, marketing managers, accounts, HR and everything in between.
Inherent in the buying of a stock market asset itself is a complete structure that will allow it to run, generate returns and reinvest capital without any input from you. If you buy Apple stock, Tim Cook isn’t going to be calling you up and asking what he should do about the factory problems in China.
The trade-off is that the costs for running the company are taken out of your shareholder profits. And depending on the company, those costs might mean there aren’t any profits at all (i.e. no dividend payment), leaving you to hope for a rise in the stock price to generate a return.
The other way to do this is through the use of ETFs or funds. You’ve still got your underlying stocks or other assets such as bonds, real estate trusts or commodities, but instead of picking the individual assets yourself, you have a fund manager do this for you.
This takes some of the work off your plate, allowing you to pick individual funds or ETFs to select the stocks or other assets to include in your portfolio. Many of these are asset specific, such as investing only in US or UK stocks, while others invest more broadly.
Like the stock market, there’s a simple, in-built outsourcing mechanism for this, allowing you to pay a relatively modest percentage fee to the manager to take care of the day-to-day for you. Again, no input needed from you.
But there’s another layer which stops the outsourcing of your asset management from being completely passive. And that’s the management of your overall portfolio. This includes looking at how much to allocate to the various different funds or ETFs, but it also goes much further than that.
Choosing the right assets to invest in is hugely important, but even more important is which accounts to use, how much to invest, when to invest and how to manage your overall plan and tax position.
This, too, is easily outsourced to a wealth manager. Now to be clear, this is as close as you possibly can get to a completely passive source of income. Set up right, and with a long enough time frame, you can get to a point where you have both the day-to-day and the long-term bigger picture being managed by teams of professionals.
But it is not completely passive. You still have to do your annual review to see if your wealth manager is performing above the market and if your investment strategy is still in sync with your life situation. You still have to take the time to sit down and update your wealth manager on your current situation and future objectives. This is important because to allow them to do their best work, they need at least some input from you.
To make sure that you reach your financial objectives, achieve financial freedom and stay there, you do need to be prepared to provide input and feedback to your wealth managers. Sure, meetings and questionnaires and updating apps can be a bit frustrating. None of us like admin.
But in many cases, it’s necessary to ensure you get the best long-term results. And actually, the more engaged you are with the process and the better the plan and investments can be tailored to you, the less likely you’re going to need to adjust things on the fly or make last-minute changes at other times throughout the year.
If you want to get started on creating your own as-close-as-is-possible passive income, get in touch with us today.