I’m a huge fan of the idea of passive income.
I bet that you are, too. What’s not to love about the idea of earning money every day, every hour, without having to lift a finger? There’s no better feeling than sitting on a beach, eyes closed, not putting a single iota of effort into working — and knowing that money is flowing into your bank account.
Unfortunately, the idea of passive income is so seductive that it’s led to a wealth of internet clickbait articles, all claiming to hold the secret to lasting passive income. It’s not that the strategies in the articles are bad; it’s simply that most of them aren’t really passive.
Even on Medium, there are lots of articles about passive income. The “passive income” writing tag has more than a thousand followers. Here, for example, is the article that inspired me to write this response:
How To Create a Passive Income Machine
Even if you’re broke, clueless, and don’t know where to start
It’s not a bad article; it’s easy to read, and the principles laid out in it are mostly sound — but it’s not passive income.
True passive income is any income derived from an activity where the recipient is not actively involved.
The top methods of passive income that I’ve seen described are:
- Real estate
- Online business/drop-shipping
Out of these four, only one method is truly considered to be passive.
Real Estate — Usually Not Passive
Real estate is often considered one of the biggest passive money earners. The pitch sounds reasonable enough — you put your money into buying rental units (houses or apartments), and you get paid every month by the renters! Money rolling in, and you don’t have to lift a finger!
However, as anyone who’s had a negligent landlord can tell you, the hands-off strategy is not a great one. Who gets involved when…
- …tenants move out, leaving a mess behind that has to be cleaned up before the unit can be rented out again?
- …the unit is empty, and someone needs to screen prospective tenants and run background checks?
- …something breaks in the unit, and it needs to be fixed?
- …belligerent tenants become a nuisance and need to be evicted?
Estimates for the number of hours that landlords work ranges from four to ten hours per month, per rental property. This means that if you own three rental properties, you’ll spend around 15 hours per month devoted to maintaining that income stream.
I label real estate as usually not passive because it’s possible to pay a property management company to handle these listed issues for you, making you a true absentee landlord. However, the property management company usually collects a portion of the rent as its cut; if you buy a property with a mortgage, there’s usually very little money left each month after deducting both the mortgage cost and the cost of the property management company.
The truest form of passive rental income is probably investing in a real estate investment trust, or REIT. This overlaps with investing, where you’re buying a share of a large portfolio of real estate, managed by a property management company.
Online Business/Drop-Shipping — Not Passive
A few years ago, drop-shipping was all the rage in online entrepreneurial communities.
“Order wholesale items from China, sell them on Amazon, collect the profit!” raved promoters on blog posts, online articles, and Reddit. And at first glance, the idea makes sense. Companies like AliExpress sell a huge collection of different goods for incredibly low prices. Those same goods will often sell for a decent markup through online marketplaces like Amazon, or on a Shopify website. Just order from one company, add a markup, and sell to consumers.
Drop-shipping makes the idea even more attractive — you don’t buy stock from AliExpress until the consumer has placed an order. You essentially become the middleman; you never handle the product directly, just pass on orders and collect your cut.
Unfortunately, drop shipping is much easier in theory than in practice. In fact, these days, most drop shippers are only able to make significant money by doing one thing:
Selling a course on how to start drop-shipping.
The market has become saturated and it’s difficult to find a niche product to sell that isn’t already crowded with competitors. Since the barrier to entry is low, it’s difficult to build a “moat” (that is, it’s difficult to maintain a competitive advantage over other drop-shippers). Additionally, in the era of two-day free shipping, many consumers are not willing to wait the 6–8 weeks for a product to ship from China.
For more information on the challenges and pitfalls of drop-shipping, Reply All made an excellent podcast discussing their investigation into the difficult life of entrepreneurs in this space, focusing on selling watches:
#117 The World's Most Expensive Free Watch | Reply All
Intro Music] ALEX GOLDMAN: From Gimlet, this is a Reply All. I'm Alex Goldman. PJ VOGT: And I'm PJ Vogt. ALEX: So, PJ…
Regardless, selling a physical product online is not passive income by any sense of the word. It’s possible to get closer to passive income by selling a digital product (such as an ebook or recordings of a learning course), but that has its own challenges (see the next point, below).
Royalties — Technically Not Passive
Royalties are an interesting one. It seems passive, at first glance — put a creative work up for sale that can be resold an infinite number of times (ebooks, music, blueprints, videos on YouTube, online learning courses, or any other item or good that is digitally distributed), and collect a profit for each sale.
However, these technically aren’t passive, as you still need to create that digital good in the first place; the good simply has a long tail of selling, instead of selling one time for a preset price.
Most creative content producers are not able to “coast” on their previous products, either. The vast majority of self-published novels experience a sharp decline in sales after around 30 days (the point at which Amazon, the biggest marketplace of ebooks, no longer considers the book to be “new” and begins giving it less weight in its suggestion algorithms). The same thing happens for articles on Medium — while some articles continue to draw a few clicks per month, the majority of activity often happens when the article is first published.
This means that, to keep up profits, there needs to be a “churn” of constantly creating new content. If you create an online learning course, it must be updated. Fans of a musician demand new releases. Journalists and novelists alike need to keep writing.
And, of course, this is entirely ignoring other active activities, like buying ads, marketing through social media, or maintaining a mailing list. All of these activities demand time, and thus make earning royalties and income through online digital content an active activity — not a passive one.
Investing — One of the Few True Passive Income Sources
And now we come to, quite possibly, the only true source of passive income that is available to most people. Investing — buying stocks, bonds, or private shares of a company in order to share in its profits.
Investing requires no active involvement, aside from the initial provision of capital and the establishment of an account. Through dividends, yield, or a combination of both, money is earned simply by putting in money.
The only two downsides to investing? Many people are already doing it, and the yields are fairly low. Passive investing, such as buying a stock index, returns an average of 7% gains per year after accounting for inflation. For those with less taste for volatility, bonds return an average of 3–4% per year after inflation. That means that, even investing 100% in stocks, your money will double every 10 years.
Still, investing in stocks or bonds is a true method of earning passive income — although it’s not as glamorous as many other “new media” methods, such as selling skills or digital goods on the internet, so it sometimes attracts less attention.
Overall, this isn’t a dismissal of these methods of earning income, or a condemnation of pursuing these methods for creating an alternative income stream. It’s important to diversify, and have more than one way of earning money besides a 9–5 job.
However, the majority of methods listed in listicles and clickbait for “passive income” are, by no means, truly passive. If you plan on pursuing one of these methods for earning money, be sure to take the amount of time needed into account — will you earn enough to make it worth your time?
Additionally, don’t be fooled by any hucksters that insist that they can teach a foolproof method that’s guaranteed to never lose money — especially if they charge for the opportunity to learn this information. Do your own research, start small, and double-check information you find from others, especially if it sounds almost too good to be true.
Sam Westreich holds his PhD in genetics, focusing on methods for studying the gut-associated microbiome. He currently works at a bioinformatics-focused startup in Silicon Valley. Follow on Medium, or on Twitter at @swestreich.
Have a science-related question? Comment to suggest a topic for my next story. Or check out this related story: