What is Passive Income?

Posted by admin on September 25, 2007 in Investment Strategy

Recently my friend Judi told me that she believed that the term “passive income” is the most over-used and mis-used term in personal investing. From what she told me, a lot of people she meets are working on producing “passive income” streams even if they are not. The fundamental source of her frustration was that people have confused the term passive income with streams of income. For example, someone who owns a business on the side which requires some time and attention does not have a passive income stream. They have another source of income- it is a big difference. Her challenge to me (and, by extension, the readers) was to list true sources of passive income.

Passive income, as the term indicates, is income you make without doing anything other than owing the cash flow stream itself. For example, dividend income is true passive income- you receive a dividend cheque every quarter for evidence of ownership. An inheritance or a trust for your benefit which pays you money on an interim basis for the rest of your life is passive income (if only we were so lucky). In these examples, you sit back and money comes to you. However, what about the grey zones?

Here is my take on what is and isn’t passive income for streams of income that fall in the grey zones- feel free to add your 2 cents since this list falls in the mushy middle of what is or isn’t passive income:

Real Estate Investing:If you own and manage investment real estate, you don’t have a passive income stream. You have an alternative source of income. What part of fixing the toilet, collecting rent cheques, advertising to fill rental vacancies and hiring trades is passive? However, this is where I will make the distinction. If you own commercial investment properties and/or hire a property manager, depending on how involved you are, it is passive income. Commercial premises and residential rental units with property managers are most likely professional managed. A commercial lease downloads almost all of the responsibility of managing the premise to the tenant other than major repairs and common area maintenance which is carried out by professional property managers. Thus, substantially all of the income flowing from these types of real estate investments are passive in nature. Granted, there are some minor responsibilities the property manager cannot do for you, such as renewing the mortgage, but this is some work spread out over time. What I would suggest is that real estate is an easier way to make income given you don’t have to be there for 9-5 but for most self-managed real estate investments, it is not passive income.
Licensing/Franchising: If you sell a license or franchise your business, it is only passive income if you have no obligation to the licensee or franchisee afterwards. For example, you license software with no obligation to provide patches or upgrades. Franchising cannot be considered a passive income stream- the franchise has obligations to provide sales/marketing and administrative support. Franchise is a great revenue source because someone else is paying you for copying your homework (sort of speak) but I would not define it as a passive income source.
Infopreneurship/Publishing: “Infopreneurship” is a relative new term to the business lexicon. It refers to the selling of information whether through seminars, training modules or blogs. Its the new economy’s version of traditional publishing. This is where things get really murky. Infopreneurship which involves the constant updating of information from the owner-manager (i.e. a blog) is not passive income. An aggregator site which publishes articles from other sources is passive income only if a program has been devised to find the articles and publish them-but it is only passive income after a lot of work has been putting into setting up the program. Despite the thousands of dollars Google can pay to a site, sites need constant updating so it cannot be strictly defined as passive income. However, if you develop a training module, seminar, e-book that can be sold many times over via e-commerce, it is passive income because you don’t have to do anything to get a sale- but again, it comes with the same limitation that you had to put a lot of work in beforehand.

These are just my opinions. It is definitive by any stretch of the definition. Let me know what you think what true passive income is.

3 Comments on What is Passive Income?

By HalOtis on September 25, 2007 at 1:55 pm

Good points. I think you have to consider that there are many different ways to make money that don’t require that much on going work. Some of them are truly passive in that you don’t have to lift a finger, money automatically arrives in the mail or is deposited in your accounts.

There are however many other opportunites to make money that don’t require that much work. Brian at Geniustypes.com takes one day per month to go collect the money and refill his bulk candy machines. Is that passive or not? I think there’s a range.

The other key point from my perspective is that passive income should pay when you’re not directly working on it. If you were a door to door salesman for one day a month, it’s not passive because you only make money while selling. But Brian’s candy machines are collecting money for the entire month.

By the Wealthy Canadian on September 25, 2007 at 2:53 pm

I agree that true passive income means that you do not have to actively do anything to earn that income. However, I think that all types of passive income do require some initial time (active) investment.
For example; dividends and interest income are truly passive once you’ve committed to the purchase of the income stream, but there is plenty of groundwork before that (which investment to buy, etc).

But you make great points, once the initial time investment is made you can turn many investments into passive income depending on how you structure it (hiring property managers for you real estate, etc).

By Customers Revenge on October 4, 2007 at 11:57 am

Passive income is where you make money without doing work. You leverage your ideas or your assets. In that way real estate is much more passive than an hourly job because you make money off the asset. But it is not as passive as being a slient partner in a business for example.