Passive income is a big deal these days, just ask Passive Income MD. Everybody seems to want to get them “some of that passive income stuff.” Well, the truth of the matter is that income is a spectrum. It ranges from getting paid on an hourly basis to dig ditches on the 100% earned side and all the way through a whole bunch of stuff like rental properties, books, websites, and various types of investments until you get to the other side. But the truth of the matter is that most income has at least some sort of earned income component.
Think about a rental property. Sure, every month you get this sweet rental check in the mail. But you had to search for the property, buy the property, fix up the property, find the tenant, screen the tenant, and take care of any issues that came up. There are definitely some elements there that sound a lot more like “job” than “passive income.” You can hire lots of that out, of course, and the more you hire out the more passive the investment becomes and the lower the return you get from it because a significant chunk of your return is really payment for your work.
What about something like a book or a course? I feel like I can speak about this, having published both a successful book and a successful course. Both represented a big chunk of several months of my life. Hardly passive. In this sort of an income strategy, you put plenty of work in, you just do it upfront and often without any certainty of a payout.
Perfectly Passive Income
So if digging ditches is at one end of the spectrum, what's at the other end? What is the most passive of income that you can find? This would be something that takes only seconds to set up, that sends you “mailbox money” regularly, and that requires no ongoing work. That's a mutual fund. Specifically, an index mutual fund and even better, a fund-of-funds that invests entirely in other index mutual funds.
Consider the Vanguard Target Retirement Income Fund. This mutual fund has an all-in price of 0.12%, practically free to all but the pickiest of Bogleheads. It invests in a conservative mix of most of the stocks and bonds in the world. Here is its asset allocation:
- Total Bond Market (US Nominal Bonds) 37.4%
- Total Stock Market (US Stocks) 17.9%
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Nothing better than coming home from vacation richer than you left.
Short-term Inflation-Protected Securities (TIPS) 16.8%
- Total International Bond Market (International Bonds) 15.9%
- Total International Stock Market (International Stocks) 12%
70% bonds and 30% stocks. Its yield is about 2%. So for every $100K you invest in it, you can expect about $167 of passive income per month, $500 per quarter, or $2,000 per year.
It requires no research to buy and no managers to check out. Anybody can buy it in seconds with as little as $1,000 and there is no ongoing maintenance. Passive income in a package. The ultimate passive income.
In addition to the passive income it kicks out, the fund will likely continue to increase in value so that yield is calculated on a higher and higher amount of principal each year. Its total return has been 6% over the last 5-10 years. It rarely drops in value, the last time was in 2008 when it lost just 11% of its value in the Global Financial Crisis.
But 2% Sucks!
So what's the problem? Well if you ask anyone with an interest in passive income they'll quickly list off the issues with this fund as a source of passive income:
- Requires money
- Only has a 2% yield [Update 9/2020- the yield is now down to 1.76%]
- Only has a 4-7% expected return
They would argue that the perfect passive income requires neither large quantities of money nor significant amounts of work and has a double-digit return, most of which is yield. Guess what? It doesn't exist. The reason this mutual fund has such low returns is it requires you to take very little risk and do pretty much no work at all. Most of those big checks you get from more traditional sources of passive income come as a result of taking risk and/or doing work. I'm sorry, that's just the way it is.
Take syndicated real estate for instance. You're taking on manager risk, single property risk, and interest rate risk. You've got to be accredited (which means you lose a lot of the protections provided by government regulatory entities) and you've got to fill out dozens (and read hundreds) of pages of paperwork just to invest. And every bit of work you want to avoid is going to cost you something. Nobody works for free, and those in the investment industry have a nasty habit of wanting to get paid more than anyone else. And you've at least got to do some due diligence work upfront.
Well, what about your own business? You could start a blog. They're passive income, right? Consider that I wrote over 500 blog posts before ever making $20K with no guarantee I'd ever make any more than that. Does that sound passive to you? Everyone wants to “build an audience” with a blog, podcast, videocast, or Facebook Group. Guess what? It's not that easy to build an audience large enough to be worth your time generating income from it. How much income do you think you can generate from an audience of 100?
What about a book? You could write a book. You're a smart person. Guess what? The average book published through a traditional publisher pays you a buck or two per copy sold and the average book sells 3,000 copies. Do the math. We're talking $5K of income. Divide that by the number of hours you spent writing the book to get your hourly rate. But you could self-publish, some of those folks are killing it! Instead of only getting a dollar per book, perhaps you get $10 per book. Unfortunately, the odds are even worse for self-publishing. The average title sells 250 copies. No, I didn't forget a zero. Do the math — $10 x 250 copies = $2500. But now you have to include not only the time you spent writing but the time you spent marketing it to calculate your hourly rate of pay.
How about a franchise? You could get a Chick-Fil-A or a Baskin-Robbins. The truth is that most of those folks bought a job, not a source of passive income. Even if you hire managers, you've got to manage the managers. Now I'm a big fan of entrepreneurship, but I don't know any successful ones who consider their income to be mostly passive, much less completely passive.
Time to Get Real
No. If you want truly passive income, you're stuck with traditional investments. Treasury bonds, CDs, mutual funds, REITs and similar. So quit looking for something truly passive and realize that what you are looking for is mostly passive or even just partially passive income. And be prepared to both work and take some risk.
What do you think? Have you spent any time trying to find some passive income in your life? What has worked for you and what hasn't? Comment below!
I completely agree with this post.
The closest I’ve come to passive income is writing a book. Yes, it took time to write it and get the book published on Amazon/Kindle… But once the work was done up front, it is now as passive as it can be. I sell copies almost every single day, and get to watch as people enjoy it, rate it, purchase it, and get a monthly check at the end of the month.
In my experience blogs, courses (particularly active courses with Facebook groups, etc), real estate are anything but passive. All of those can create very real income, but very little about them is passive.
TPP
There is always an active component upfront to get a passive income stream rolling. And unless you inherit it or won the lottery, the capital to even begin the process is a direct result of active work.
There is a sort of survivorship bias at play as well. We tend to know about the successes and the many more failures out there tend to be overlooked. Your blogging example is perfect. There are blogs that make 7 figures a year that a lot of us know about. So everyone thinks that blogging is an easy way to cash in. Speaking from personal experience it is nothing further from the truth.
Blogging takes an inordinate amount of time (at least for me it does). Plus at my level it has not grown to the point where it makes sense to have other people take some of the load off. As a one man show blogger you have to always try and come up with good content, write it down, edit it, market it, try and get or maintain sponsors etc. Even after all that work you are not guaranteed that it will take off. I’m almost up to 250 posts (and 19 months in) in now so I am glad you mentioned that it took you to about 500 posts before Momentum took over (again not a guarantee). I only now truly appreciate the work behind the scenes for the blogs I read.
Books are another thing I think people underestimate the work that goes into it.
Military pension is an extremely nice ultimate passive income stream. Money is deposited on the first of every month as long as you were living and breathing for the 30 days of the prior month. This passive income has been hitting our wallet for over 10 years now. our neighbor collected his for 56 years before he died…. As an aside the stream comes with healthcare….
The other pro to this stream was money was never put in to collect, only time…not money. That’s the con obviously it takes 20 years to collect the stream, but that is roughly less time to build a portfolio to kick off equal 2% yield. Many folks (and doctors) can’t even build a large enough portfolio in 20 years to generate decent passive income despite making large incomes compared to what we did in the military. Meanwhile in the same amount of time we also built a passive income generating portfolio due to saving 50% of military income.
I agree that having a military pension is a great passive income stream. That said, I’m not certain it’s worth it going through the medical route. The opportunity cost (for many specialties) of making a much lower salary the entire time that you’re active duty to reach 20 years of service and then retire can likely be easily surpassed in the civilian world as long as you save diligently. I retired from the Army 3 years ago, and am grateful to be collecting monthly retirement checks. Another benefit is that the Survivior’s Benefit Plan allows for a spouse to be paid 55% of the benefit for as long as they live if they outlive you. While it’s nice to believe that collecting $60K a year is equivalent to having a stockpile of $1.5M and withdrawing at a 4% rate, there is no principal for you to pass on to your heirs.
your key words are “save diligently”. it find it (well not really) amazing that pretty much nearly every military colleague of mine that did their minimum time and bolted is wayyyyyyyyyyyyyyyy behind our net worth. not even close! despite their “perceived greater earning potential” as a civilian. Part of military income being non-taxable, no healthcare or pharmacy costs, subsidized childcare and a whole host of benefits the differential isn’t as large as most think…maybe a few specialty outliers…but one of us is one of the high paying specialities and it made zero difference compared to pretty much every single person i know who got out early…. and many now wish they stayed because of healthcare, property tax savings for veterans (ours is an extra 50K exemption)…..it adds up over time.
Agreed. I think another factor is benchmarking or “keeping up with the Joneses”. That lowers your hedonic inflation. I have always made a little less than other academic surgeons, but my colleagues seem very envious of $102K/year of truly passive inflation adjusted income for life. And the healthcare issue is mostly solved, so early retirement is an option if you want
IMO the best thing you can pass on to your heirs is your own financial security. If they have no worry about taking care of you then they can focus on taking care of themselves and the next generation if they choose. Leaving a pile of money to my 50-60 year old kids sounds nice but I really hope they have their life in order by then.
Thanks for writing this. I’m a bit sick of hearing folks start talking about passive income and then immediately start discussing real estate. Real estate is definitely not passive. It takes a lot of work on the front-end, and even if you have a property manager, it’s certainly not ‘set it and forget it’. And a lot of people discovered a decade ago that real estate has risk.
Hallelujah. It’s the same kind of BS stock pickers forget to mention: “my portfolio is up 35% this year [although I’m neglecting the three stocks that I sold for 20-40% loss and also not accounting for the fact that one of my stocks is up 50% this year but was down 34% last year]”…same vein as “real estate is so easy [if you discount times like last year when I had to take my tenants to court or the property sat empty for 3 months because no applicants had a credit score that was a positive integer]”
I was thinking the best ultimate passive income would be marrying well, but I suppose that takes some work. Like many, I’ve heard some doozie divorce settlements, but that still takes work leading up to it. I guess best would be being born well…which is something that Jim has mentioned many times.
You can most likely draw down on the principal as well and take about about 3.5% for the next 50 years.
Our “nearly-passive” income (Doc and G) investments are single family rental properties. Yes, this form of investment requires money up front and periodically some elbow grease in between tenants, but once you’ve got a mortgage and the rental is cash-flowing, it’s passive income from there. Choosing the right price point for rent and selecting the best tenants will lead to lower turnover, thus less elbow grease required. And when you consider the tax benefit of depreciation of the properties, this really is nothing more than a printing press that spits out dollar bills.
Uh-huh.
I am definitely not a simple boglehead indexer; I actually own (just one) SFH rental. (I freely admit it would be easier if I had multiple properties due to economy of scale.) But: “periodically some elbow grease,” “once you’ve got the mortgage,” “and the rental is cashflowing,” “choosing the right price point,” “selecting the best tenants,” “lower turnover”…seriously, that sounds like a nearly passive printing press.
Admittedly, we’ve been fortunate. But most of that good fortune has been due to choosing the right properties, keeping them in excellent condition, inside and out, charging higher-than-market rent (thereby self-selecting tenants) and then carefully evaluating said tenants prior to offering the lease. On average, our tenants stay over 6 years, about the same length of time before the printing press needs more ink. And yes, it is true the economy of scale works wonders in the rental property market.
Certainly real estate can be a very effective investment. But my point above was and is that money made in real estate is not passive income. Roofs need replacement. Appliances go out. Toilets flood. Tenants leave. All this and much more needs someone’s attention. Yes, a property manager can do a lot of it, but it’s not ‘set it and forget it’.
It’s a spectrum from you owning and managing a house down the street to publicly traded REIT index funds. It gets more passive the more you move along the spectrum.
Allow me to summarize:
There is no free lunch.
The end.
I will offer one other perspective as it relates to “Passive Income”. Get paid for what you truly love to do. If that is writing a book, or a blog, or practicing medicine, or digging a ditch then getting paid for it is truly passive income.
You don’t believe me? Ok, try this mental exercise. Find something you would do for free no matter what you got paid to do it. Let’s call it Wake boating (surfing/boarding etc). If there was a way to get paid for wake boating one could consider that passive income.
Now, lets say you absolutely LOVE practicing medicine….you would do every part of it for free no matter how much you get paid. But for whatever reason people want to pay you to do it. Boom, Passive Income.
🙂 Thanks,
Nah, loving your work doesn’t have anything to do with it. Everyone does things they love without earning a penny. Stay away from the clinic for a month and you don’t get paid. That’s called a job. Passive income is money that magically (mostly) appears and let’s you do pretty much anything every day without worrying about buying food.
What happens to your “passive” wake boating income when you break a leg? Or get sick? Or get bored?
That’s the irony, isn’t it. Most of our “passive incomes” take at least a little work to keep rolling, and a hell of a lot of work to set up. Mine is self publishing and while it does pretty well now with very little effort, it was a hard slog to get it going.
Trust funds meet the impossible criteria of “the perfect passive income requires neither money nor work and has a double-digit return, most of which is yield.” Not exactly a reliable formula unless you pick the right parents. Maybe lottery winnings paid out over two decades would be another good option assuming you can borrow five bucks from a friend.
Well, I guess if people are expecting unlimited free money for doing little or nothing – sure. This is a wakeup call for them.
But I don’t want to be just passive. Neither do the people I know who are smart, goal-driven, and energetic ( like say 100% of physicians!).
I think of passive income as money I receive for something other than exchanging an hour of my time. And it is awesome!
I think of residual income as something that keeps paying me long after I did the work.
I got a taste for both passive and residual income (and portfolio income) as a teen and never looked back.
I make more from investments than from working even though I spend a LOT more time on my day job of clinical medicine.
I spend only a few minutes a month on my business ownerships, rental houses, commercial medical office building investment, apartments, intellectual properties, etc. Furthermore, that money pumps in whether I’m on vacation or not. And it is taxed at a much lower rate.
So yes, making money requires work. But don’t let that discourage you from seeking all kinds of income. That includes active, passive, semi-active, residual, portfolio, dividends, rent, profits, etc. It is all out there. The more types of income you have the better.
I’ve read a lot about passive income and completely agree that index investing is one of the best options. Writing a book and mantaining my website still require quite a lot of work.
This post is about the inevitable – you will have to learn to live a life at 4% or less of all your investments if you want the investments to last 30 years or more.
Figure out your age and pick 1 of the 3 Money Plays (REGARDLESS OF YOUR INCOME)
1. The 60-40 Money Play (20 Years) – train yourself to live with 60% of your after tax income and invest 40% in passive investment discuss in the article.
2. The 50-50 Money Play (15 Years) – train yourself to live with 50% of your after tax income and invest 50% in passive investment discuss in the article.
3. The 40-60 Money Play (10 Years) – train yourself to live with 40% of your after tax income and invest 60% in passive investment discuss in the article.
You can start today or wait until you 60 years old – the choice is yours!
Government handouts are the ultimate passive income. The less you work, the more you get.
[Rude comment deleted.]
I did it due to my early circumstance and I can tell you abject living from government handouts is not fun!
Lots of truth there.
Wonderful article. Id even take it a bit further and say the mutual fund isn’t passive income either. I’m retired and live off of my financial assets. Even so, I never think of that income as passive. I was self employed with a small service business. I’ve got the arthritic hands and recently repaired double hernia as mementos from many years of hard work. Those investments represent a lifetime of work to me, not easy street.
Uhhhh…but they’re passive NOW. From the time you buy them, even if the money you used to buy them was earned.
Considering the inflation, 2% return is not a passive income, you are just keeping up (or even falling behind).
So, there is no true passive income.
You seem to be confusing income and return. Yes, you should subtract inflation to get your real return. But you don’t subtract inflation to get your income.
True passive income is hard to get, and often does require some form of active involvement (being in the start or maintaining some level of keeping things up to date). I do have had some nice passive returns on stocks with high dividend ratio’s though (the dividend aristocrats for instance). Also your point on buying REITs is something I can advise people to look into. They can offer nice returns as well.