Are you tired of seeing the passive income ads with the rented Ferrari parked in front of someone else’s mansion?
It leads one to ask: Is passive income real? The answer is yes, passive income is real, with these important caveats below which no one mentions.
In this post I’ll share some truths for income seekers that want to add one or more new passive income streams before or during retirement. After decades of creating passive income streams, I’ll share our experiences while emphasizing finding a balance between risk, time, skills and lifestyle that works for you.
To our happy surprise, we saw that some ways to generate passive income also build wealth over time, as you’ll read below.
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Is Passive Income Real?
Yes, passive income is very real, sort of. The issue that forced me to add “sort of” to this statement is this: Everything requires effort, as you’ll read more about below.
For now, let’s address the wonderful aspects of passive income, because I can vouch that after setting up multiple streams of passive income over the past decade plus, it can really be done, and is very nice to have in place.
Passive Income Vs Active Income
Passive income refers to income that flows into your bank account without effort on your part. Active income, on the other hand, takes time and energy to get.
Let’s take the passive income vs active income scrutiny a bit further by adding the one thing that money cannot buy: Time. Active income takes time. It trades dollar for hour equally. Passive income doesn’t take time to maintain, at least it doesn’t take much time.
Robert G. Allen referred to active income as linear income in his 2000 book, Multiple Streams of Income. I like this explanation.
Given the limited time that everyone has, you can clearly see the advantages if passive income.
Passive Income Strategies
The most common passive income strategies come from two major sources. The first is from investments. The second is from online business. We love using a combination of the two major passive income sources.
Passive Income Investments
Dividends from stocks and interest from bonds are the easiest passive income. Dividend income from 1 million dollars in stocks generates income about $20,000 a year when invested in the S&P 500 index as of this writing.
You can check the current yield on the S&P 500 stock index here. (I have no affiliation and don’t get paid if you click here. I just think it’s great info for my readers.) You can read my article Interest Off 1 Million by clicking here.
The same 1 million dollar portfolio invested in intermediate Treasury bonds generates about $ 32,000 a year in passive income as of this writing. You can check the current yield here on this government website.
If you divide your investment portfolio equally between stocks and bonds, you’ll get about $26,000 a year, then, in passive income, not considering taxes, and not factoring in the cash portion of your portfolio.
This seems a bit low, given the risk, especially near retirement. Most bonds drop in value when interest rates rise, and stocks experience bear markets, on average, every 3.5 years, with the past two bear markets dropping over 50%. You can read my article How Will a Stock market Crash Affect Me? by clicking here.
From this, we can see that this income is very nice to have but has some issues. Investment income is the easiest form of passive income.
Problems with Passive Income from Investments in Stocks and Bonds
The problems with passive income from stocks and bonds are that it is risky in terms of your net worth dropping. Fortunately, the drop in net worth is temporary, unless you decide to sell at the lows and miss the eventual upswing in the subsequent bull market, which many investors do.
No one likes the drop in net worth, though, temporary or not, so this is the first problem with passive income from stocks.
Bond cycles last longer. If you get on the wrong side of a long term bond cycle, it can be decades before your bonds go back to their pre-interest rate rise cycle. The good news is that you usually get to collect the income anyway.
The bad news about passive income from bonds is that when interest rates rise, you are locked in to lower interest rates than are available elsewhere, and your net worth drops when the value of the bonds drop. Bonds are also problematic during inflation.
For this reason, passive income from bonds is not one of my favorite strategies. On the other hand, interest income from municipal bonds allowed my dad to take an early retirement when this passive income opportunity presented itself many years ago. I write more about that here.
Cycles can make or break an excellent passive income strategy that also builds wealth. They influence the risk level of passive income from investments and should never be ignored.
Is Income from Stocks and Bonds Really Passive?
The reality is that nothing generates 100% passive income. This is because everything includes at least the initial learning and implementation to get a level of acceptable risk and sustainable income streams in place.
Maybe you can find a great financial advisor that finds investment income for you. Even hiring a financial advisor and evaluating their performance requires effort and knowledge about investing. This is a reality that most investors avoid but I have learned the hard way.
Then someone needs to do the accounting, tax reporting, tax strategies (such as tax loss harvesting), estate planning and cash flow management related to that passive income from investments.
Having said that, passive investment income from stocks and bonds is the closest thing to true passive income. It can be ideal for the person who has a high enough net worth (usually well over $1,000,000) to cover their lifestyle expenses (while also possibly withdrawing from their retirement account). Click here to read my article Retirement Withdrawal Strategies – Do They Still Work?
Passive Income Examples
Examples of passive investment income from more traditional investments can include:
- High Yield Bond Income
- Municipal Bond Income
- Bond Fund Income
- US Treasuries
Slightly alternative income from stocks can come from writing covered calls. You can read my article about living off covered calls by clicking here.
Passive Income from Real Estate
Real estate rentals have been mostly passive income for us. Rental income is a type of passive income from investments, but it is usually leveraged income, too.
However, passive income from real estate rentals is not without risk. First, the large down payment makes real estate rentals only suitable for those with large amounts of capital and a good credit profile.
Second, real estate cycles add a layer of risk from a decline in net worth, even if it is only temporary.
Third, there is added risk if your properties are leveraged. Not only this, but real estate comes with other risks that don’t exist with stocks, bonds and even most online businesses.
Don’t get me wrong, our real estate rentals outside of Austin have been a good investment for mostly passive income and capital appreciation. They were purchased at a very good value, with extremely low financing, which lowers the financial risk. This also provided an income stream that also builds wealth. Click here to read my article How to Build Wealth.
Not only this, rental income is an excellent inflation hedge. They also tend to hold up well during recessions since people tend to rent vs. buy homes.
In hindsight, online businesses have been more lucrative at a tiny fraction of the financial cost of our properties. The online businesses have been more work than real estate rentals.
We bought the rental properties before we ventured into online business, so we didn’t really know how to compare real estate income with online business income. Now that we do, I am sharing the reality we experienced with income from real estate vs small business.
You can figure out what works best for you on the time, capital and income continuum. This is the focus of RetireCertain.com, sharing our experience with multiple income streams with the intention that you can see what works for you to generate an extra income stream or two before retirement. Click here to read my article Retirement Income Planning.
Passive Income from Small Business Investing
It’s possible for investors in small businesses to experience passive income. Think Shark Tank, which I highly recommend for both entertainment, education and inspiration.
We ventured into small business investing a little before we decided, instead, to be creators of our own small businesses online due to the low capital cost, flexibility and control. (More below.)
Typically, small business investing is done first at the “friends and family” level. The next level of small business investing is often some form of more formal financing from angel investors.
Accredited investors can participate in angel investing.
In the past, local angel investing was the only way to invest in small businesses that belong to others. Now, there are online platforms that allow investors to easily invest in small businesses. Crowd funding has become very popular.
Typically, to get passive income the deal will need to be structured as at least partial debt (see lending below), or royalties, a favorite income generator for Mr. Wonderful from Shark Tank.
Without a debt or royalty component, small business investors will be waiting for their share of the profits to be paid out as income. This can be a long road.
Problems with Passive Income from Small Business
There are several concerns with small business investing for passive income.
Much like stock and bonds investing, small business investing is capital intensive. In other words, it cost a lot to make a little. This is why Mr. Wonderful points out on Shark Tank that if he puts in $500,000 and makes $25,000 a year it’s just not worth his money and energy.
Talk about high risk! The huge majority of small businesses fail. During year 1, 20% of small businesses fail. In their second year, 30% of small business fail and after five years 50% of small businesses fail. (1.)
Diversification Lowers Risk of Small Business Investing But…
It is recommended that investors diversify among ten different small businesses. The problem with investing in ten small businesses is that this is a lot of work to track. Unless small business investing is your only extra income stream focus, this probably won’t make sense.
Small Business Investing Isn’t Always Passive
There are countless stories of small business investors having to help run a business with the hopes of just getting their initial investment money back.
Small Business Lending
Small business lending can be truly passive income. With small business lending, you loan the money for someone to develop and grow their small business. Given the higher risk, the interest rates are much higher than other types of loans.
When I launched my personal finance book, Earn, Grow, Give on Amazon a few years back, I put $1 from each sale to fund a micro lending account at kiva.org. a tiny loan of just $100 can make a huge difference for a woman funding a tiny business in Africa. All the investments have been paid back with interest over the years, and it funded a great cause.
I credit the success of this small business funding experience to the careful screening process that kiva does. They were one of the first online small business lending companies, but now there are many.
The goal with small business lending is to get passive income in the form of higher interest from these higher risk small businesses. I plan to participate in small business lending early in the next economic expansion.
The small business lending options available online nowadays offer carefully prescreened options for investors, thereby lowing the risks. Lowering risk is always good.
Disadvantages of Passive Income from Small Business Lending
I have, however, lived through too many recessions at this point in my life to discredit the impact they can have on small businesses. As with publicly traded small business stocks, small businesses thrive during the early phases of economic expansion. The small business opportunities are abundant near the end of an economic cycle, but they have an added element of risk.
Small business lending is capital intensive. Much like bonds, if you loan with a 7% return, you get just that on your capital.
Confession: I made a small investment in a startup health care business a few years ago in the initial “friends and family” funding. Their product is now in CVS stores and has massive online sales, too. It is doing quite well. I am years away from passive income since my investment was ownership vs lending, but I knew that when I made the investment. My plan is to sell this company for a capital gain.
Real Estate Lending
Real estate lending through online platforms has also become very popular since the financial crisis during the real estate rebound. The financial crisis led to more rules and regulations being put in place, which leads me to think real estate lending is safer now, yet still subject to real estate cycles and the economy.
The good thing is that real estate lending can be another form of truly passive income. This means an investor can easily diversify into this area. I have not done real estate lending yet, but I would consider it if I were looking for more income streams.
Investing in Your Own Small Brick and Mortar Business
Starting a small local business takes a lot of capital. Not only this, risk is extremely high. The most obvious and “normal” transition from employment to alternative income, however, is starting or buying a business or franchise. For this reason, we began looking there first over a decade ago when we began our journey to replace career income with income streams.
We looked very seriously at buying several businesses, including an Alamo Drafthouse® and an established very profitable service based business with warehouses and staff. These would have required some travel and forty hours a week plus for both of us. This meant neither of us would be able to pursue employment should we need to do so.
Plus, we still had children at home. The lifestyle just wouldn’t work. An even bigger problem was risk. Buying an established business required too much capital for our desired level of risk.
After working with the bank, I saw that if we made a mistake, our investment accounts would be wiped out since they needed to secure the loans. Even though probability was high that we could have created significant income while building an asset, it was just too risky. This ruled out buying an established business of the size which we wanted.
The time, risk, and lifestyle factors just didn’t work for us. Plus, the skills needed to run these businesses did not align with our background expertise.
It’s easy to see in hindsight, but we didn’t know what we didn’t know, as the saying goes. This is what leads me to share our experience here with the humble goal that it may guide you.
Now we’re glad that the brick and mortar businesses didn’t work out. Here’s why. We ended up starting online businesses instead, as you’ll see below.
Passive Income from Online Business
The low capital high upside paradigm from small business was too intriguing to resist any longer. I was drawn to it for years but had no technology skills, so I resisted.
I knew that the internet was at the core of our economic functioning. It just made sense to explore creating an online business next. The fact that you can reach people globally, for no cost, with few skills, was irresistible.
I saw we could use our skills with zero risk, while living the lifestyle we wanted with an online business if we could figure it out. This felt big, but very low risk.
Creating a personal finance blog seemed a great way to learn about websites and online business, so I launched FinancialWoman.com, knowing nothing about online business.
After some resistance, a few years later, Larry made a few videos about trading options, based on his lifelong career expertise, and he shared the videos online.
There was immediate and extensive interest in Larry’s options trading videos. It was very exciting. Larry created an options trading course, while I got a website built for the business. Our son drew a logo which was had made into digital format. We used a Virtual Assistant to set up payment processing and manage customer service.
We were all scrambling. The courses sold well right from the start so we figured it out as we went.
If you think about it, there aren’t many traders who worked professionally for three decades that you can access with online programs. We just didn’t know going into it how unique this opportunity was.
The thing is, it didn’t matter whether the options trading online program worked or not, because the cost and time requirement were both extremely low. It was a test, and there was virtually no risk, but huge upside.
Since then, we have both generated online incomes is different areas, including virtual workshops for financial advisors, online information product sales, membership dues, financial marketing consulting, financial coaching, option trading consulting, affiliate sales, joint venture income, proprietary software and physical product sales.
While not disclosing our income, I’ll say that we have been able to live off these passive and semi passive income streams for over six years now, and we have a very nice lifestyle. And online business income has been the most rewarding and lucrative of all these activities while having the lowest risk.
All this income was the result of investing less than $200 to pay a student to build a website to see if online business would work for us in my mid 40’s. Click here if you want to read my article Is It Too Late to Start an Online Business?
From the beginning, the options trading courses were sold passively, meaning Larry created them and people who wanted to learn how to trade bought them. Now he does more interactive programs, which does require more time and energy. When testimonials pour in after a program, it is very fulfilling for Larry. This small online business replaced professional options consulting for a firm which required constant travel.
Real Passive Income from Online Business
I remember our first real experience of feeling like we could vacation while generating passive income. At new years’, we were skiing with our sons at the top of Wolf Creek in Colorado shortly after the recession. We stopped for lunch and our VA emailed that sales were doing great during our holiday sale.
As you can see, based on the number of products we now sell online, this income stream has not been completely passive! But some of the income streams are almost completely passive, such as affiliate income, software and online course sales.
Is Passive Income Risk Free?
As you can see, many forms of passive income have a high level of risk. Investments that provide a return higher than money market returns have a high risk of dropping in value at least temporarily.
What determines financial risk is how much money you can loose if you’re wrong.
Again, we spent about $ 200 to venture into online business. Even when we launched the options education site, we spent under $1,000 to get started.
Now, it cost even less to build a website. In fact, I built this very site myself for under $ 200. The low investment makes passive income from online business very, very low risk.
There was a 2011 Forbes article by Michael Ellsberg entitled The Top 4 Reasons Why ‘Passive Income’ Is A Dangerous Fantasy. Seriously? Does this mean that stock dividends are dangerous? Is investing $500 in creating an online business dangerous?
To me, danger is putting all your money into an investment that you cannot recover from if you are wrong. Enron comes to mind. Brick and mortar small businesses come to mind, especially restaurants. I suppose Ellsberg was addressing all the false hype around passive income these days, which I understand. A lot of people are promoting what worked five years ago and no longer works for passive income.
What Are the Best Passive Income Ideas?
As I have written before, the best passive income ideas for you depend on your level of capital, risk tolerance, skills and desired income and lifestyle. If you have high net worth and can live off investments, then investing in stocks and bonds may be all that is needed. If you want to limit the time you spend generating passive income, then traditional investing may be the best passive income idea for you. Click here to read my article How to Live Off Investments.
Or you may have plenty of wealth but feel a subtle calling to share your skills with others.
I have found financial coaching very rewarding. Helping my financial coaching clients look beyond stocks and bonds to discern the best income streams for them based on my experience is fulfilling.
If, like most of the population, you cannot live off investments, passive income from other sources can completely change your income level, and your lifestyle, for the better.
Passive Income Systems
Once you have success with your first passive income stream, you can expand on it with a similar venture. This allows you to create a little passive income system that leverages your knowledge and team across different but related income streams.
Does Passive Income Really Work?
So, does passive income really work? As someone who currently has 8 almost completely passive income streams, and 4 mostly passive income streams flowing in, I can say that passive income really works. The key is for you to assess what makes the most sense for you based on your own skills, risk, lifestyle and financial goals.