A couple of days ago, I responded to a guest post by Mr Credit Card from askmrcreditcard.com over at Fiscal Fizzle. His premise was that there really was no such thing as passive income. I disagreed and wrote a post taking the opposite argument. The articles caused quite a bit of debate both on this site and Fiscal Fizzle so Mr Credit Card has asked me to allow him to clarify his views, which I agreed to, so with no further ado Mr. Credit Card…
A few days ago, I wrote a post about why I thought that there was no such thing as passive income. There were lots of comments on the subject. Most seemed to disagree with me. It led me to reexamine my thoughts to see if I was wrong. But after further thoughts on this, I am even more convinced about what I said. Ryan has kindly allowed me to air my views here (or rather clarify them and make some more arguments to points that were brought up), so here it is.
What we agree on – I think we all generally agree that to build a successful business or asset that produces income requires hard work. And obviously, there is nothing passive about work. But where we diverge is that I think the assumption is that income streams can last forever and that it can be maintained with minimal work. There is also a disdain among advocates of passive income folks for being employees. In this post, I will argue why being an employee is not such a bad thing as well. While I do acknowledge that perhaps you can build passive income for a while, my main gripe is that it may not last. So below are some additional points that I would like to make to bolster my case.
So let’s begin at me dissecting the arguments against what I have said.
Permanency of Income Stream – One of the reasons why I have trouble with this whole concept about passive income is that there is no permanency to any income stream (or at least there is no guarantee for it). I’ve used several examples in my original guest post but I’ll reiterate them here. Let’s take rental real estate as an example. I stated in my previous post that while you can have a few rentals that bring in passive income, things like excessive buildings, economic situations can cause rent to plummet and vacancies to rise. No matter how passive the income may be, it may not last. Income from an internet site may disappear overnight as well. Nothing is permanent.
Lack of Permanency in Income implies the need to build more income producing asset – Because no one can guarantee that the income from an income producing asset will last forever, it implies that one has got to be constantly searching, building or acquiring new assets. That to me is not passive at all. Let’s use the real estate example again. So if you know that the rental properties you have will decline in value due to some external factors, then you have to sell it. Then 1035 exchange it. Now that is work and certainly not passive. Or you will have to keep buying more buildings to diversify. Researching and looking for properties is work.
Passive short term but not long term – If you really think there is true passive income, then perhaps that may be true in the short term. Heck, you could have passive income for even a few years. But in my experience, if you do not work strategically to grow your “passive income”, it will slowly dwindle. Perhaps the best examples is the web site that I run. When I started www.askmrcreditcard.com six years ago, there were many other credit card sites that were more prominent had much better visibility. For many of them, they really had a nice passive income that I can only admire back then. Fast forward six years, and only one or two of the those sites are still big and prominent. The rest have simply fallen away in terms of traffic and presence. I know that the day I stop giving a damn about my site is the day it will start to decline. Perhaps not immediately, but it will for sure. I could still probably take a months vacation, not touch it and still do ok. But it will be the start of an imminent decline. I set myself the goal to make the best credit card site (IMO anyway) and I’ll make sure it stays that way. But who knows what will the web look like in ten years time?
I am sure those of you who want to build “passive income” want it to last for decades, right? I’m pretty sure most readers of this blog and many other are young and not in their 80s! For passive income to last for decades, you have to work at making it grow. It may not involve day to day operations, but it sure is work and not passive.
Having Passive Income is a Result of Being Successful – Another issue I have with the concept of passive income and the way it is used is that it implies that only “certain types of business” is suitable for those who pursue “passive income”. But if you think about this logically, any business can be logically considered passive once it has achieved a level of success. That means a decent amount of revenue to hire staff to run the business. But then, this can apply to any business, not just real estate or “internet websites”. It applies to anything. But I guess nobody in the “passive income guru business” mentions starting a restaurant, starting a janitorial business or a hair salon! Hey, I know many successful business owners who take lots of vacation every year and they are not involved in real estate and internet web sites!
But rather, it is more appropriate to say that once you have built a successful business, you can take a back seat and be involved in “strategic matters” and leave the “day to day running” to a CEO or general manager. In that sense, maybe you can say you can achieve a point where the income is passive. But like I said earlier, the business or asset may produce income now and not later. You have to be consisting thinking “strategy” and “how to maintain and grow the business”. In my opinion, that could be an even harder task than initially building the business. Now that is not passive to me.
Being An Employee Can Be Sweat Equity – Another thing that “passive income” proponents claim is that it is better to build a business because even though it requires lots of hard work, once you are successful, you can be less involved in day to day running of the business and the income is “passive”. They claim that it is silly to be an employee because if you do not work, the money stops rolling in. That is correct. But being an employee is just the same stage as building a business. If your business is not built to a sufficient size yet, then stop working on it and it will soon die. But rather than looking at being an employee as a dead end road, we should look at it from the perspective of building the foundations for what you all like to call “passive income” in the future.
Being an employee is often necessary to
- be an apprentice and learn the tricks of your profession
- to build your reputation among your peers in the marketplace
- for many high paying jobs, it is the ticket to accumulate wealth so that you can retire just portfolio income
If you are a high paying doctor, a successful attorney, a very good portfolio manager, hedge fund manager, sports manager, high level corporate executive, an employee in a start up you believe in, then that is a ticket to great wealthy and perhaps to a level where you can live off your portfolio income. For these folks, their lives as an employee is actually the building or asset building process of folks looking to “build passive incomes”.
Is Portfolio Income Passive Income? – Financial Samurai is one who believes that portfolio income is perhaps the closest definition to a passive income. And I would agree to a certain extent. After all, great wealth has been passed through generations and if well managed could last a long time. But I also know of instances where wealth has been lost overnight. A church mate of mine lost his and his family entire wealth through the Forte Ponzi scheme. That was probably eight figure wealth we are talking about. Kids and grandkids education funds gone overnight – poof! This is probably eight figure wealth we are talking about. You could argue that they could have been wiser, but this just goes to show that even portfolio income can disappear overnight.
Can we make a scale to measure businesses or profession with regards to how “passive” it can potentially be? – Another point brought up in this discussion is that perhaps we can have a scale of say 1 to 10 where 10 represents businesses where you can really be hands off once it becomes successful. I say this is a flawed argument. The scale (if there is any) should be based on how successful and how large the income is. If you happen to be the founders of google, then yes, you can sell all your stock, pay your taxes, set up your trusts and foundations and because the wealth created is so large, you can live off the from the wealth you have created simply because of its size. You can lose 50% on portfolio value in 2008 and 2009 and still be OK.
But just imagine you have 10 websites each massive $1,000 a month for a total of $10,000 a month. And you claim they are static sites or you have writers writing your blogs. And you claim it is passive! But because the amount you make is “relatively small”, a slightly drop in your monthly income can wreck havoc in your finances. Just imagine if google adsense clicks and payouts decline by 40% (and they have happened before), your $10,000 drops to $6,000! Or advertisers for your banner ad space dwindles. Bet you will be “actively” working on building more “passive sites”! Hmmm..
Final Thoughts – Sobering Truth – Here’s the truth about “passive income”. There is no such thing. Perhaps you could have passive income for a while (and that could be a long while) if the asset was producing huge income to start. Perhaps it was a huge inheritance or a successful IPO of your company. And sometimes, you could live off the income it generates for the rest of your life. But these instances are really the result of being successful in your career, whether as a business owner or as an employee.
The danger of thinking about simply building passive income is that you get lured into “businesses that are supposed to produce passive income” – like real estate, network marketing, and recently blogging! Instead, what you should be thinking about is looking at your skill sets, doing market research in an area which you think is under served by existing players and build either a much better or totally new mouse trap which is difficult to replicate. If you really thought this way, you will be much more likely to succeed in your quest for wealth. But if all you do is to read about gurus telling you what is passive income, you will be lured into the same things other wannabes are following and your chances of success are much less. Or you could simply work at getting promotions and rising up the corporate ladder because the bulk of the wealth is distributed right at the top. There is nothing wrong with being an employee.
Perhaps I can best sum up my thoughts by saying that it is hard enough to be a world champion and rising to the top. But staying at the top is even harder! And the simple reason is that any passive income is never permanent and needs work to make it grow and last. It is never permanent because of capitalism. Someone else is always going after what you have. Bing is going after Google, retailers are constantly fighting each other for market share. In some industries where there is no copyright protection, competitors simply copy your ideas (look at all the proliferation of personal finance sites!). In my space, chase credit cards were recently revamped to resemble and directly compete with Amex! So if you have achieve what appears to be “passive income”, then congratulations. But do not rest on your laurels, work hard to maintain and even grow it cos someone else is always after your lunch.
Readers – what do you think?