Hey everyone, it’s Finance Fridays again. The past few posts were part of my “Let’s Gamble” segment about Crypotcurrency mostly with a short break to talk about “Why Do Doctors Buy Big Houses”. Today we’re going to talk about something a little different, “Passive Income doesn’t start Passively”.
First things first…
What is “Passive Income”?
Well, it is kind of what you expect. It’s income you get on a regular basis that doesn’t require you to do much of anything in terms of “work”.
When people normally think about income, they think about going to a job and getting a paycheck every 2 weeks, or every month, or so. However, for passive income, there is the idea that you have “something” in place which pays you every month without you being actively involved in it, ie, it’s not your “main job”.
Sounds pretty awesome, sign me up!
Everyone loves the idea of passive income. What’s not to love? You get paid outside the scope of your main job, it’s “free money” right?
Except… it’s not really.
Well, that’s kind of the point of my post today. If you google “passive income”, you’ll get a ton of results. “Ten great passive income ideas” or “5 passive income ideas you can start today” or something like that. However, what they don’t tell you is:
Passive Income doesn’t start Passively
What do I mean by that? Well, when people think about passive income, they jump to what I consider the prototypical passive income idea, which is a rental property.
Yea, Rental Properties are Great right?
Sure… I mean, what’s not to like? You buy a property and rent it out. Just make sure rent pays for the mortgage, and you’re golden. You’re making money every month, while building equity in a property. Ez Pz right?
However, it doesn’t start that way… or even that easily. Let’s look a little more closely, just using some round made up numbers:
You find a property you think will be great to rent for like $300,000. You do the normal 20% down payment of $60,000. Your mortgage is $240,000. To make the numbers easy, we’ll use a 30 year mortgage and 4% interest which makes your monthly mortgage payment around $1,146.
You’ve done your homework and decided a “fair” rental price would be around $1500.
So $1500-$1146 = $354 in monthly profit while you continue to build equity in the property.
This scenario is the “Ideal Passive Income” scenario. You are building equity in property and still getting a monthly net profit.
That’s the dream.
You do this for enough properties and you could potentially “not work” anymore, collecting a few hundred dollars in income from 10 or so properties each, or a few thousand in income from 4 or 5 properties each.
However, the above is assuming all the best case scenarios. You have to consider the possibility that your property may be vacant for a few months. In the above example, if your property is vacant for 3 months, you’re paying the mortgage for $1146 x 3 = $3438. That’s already 7 months of your “passive income” gone. Then you have to include other possibilities such as the property needing repairs, property tax, etc.
However, the more properties you own, the more heavily leveraged you are, and the risk increases. You can imagine a scenario where you are struggling to rent some of your properties out and therefore your “income” may be in the red for months at a time.
Not quite as easy as you thought right? Not a “sure thing” anyways.
However, the most important part of this whole ordeal is that getting to the Passive Income part doesn’t just magically happen. You need to have enough money in order to put down money for the down payment as well as to be able to pay the mortgage on this place for months at a time (if needed). You also need to do your own due diligence to insure that your rental market is strong, find good renters, and create a good rental agreement. Then you need to make sure you rent to good people who can pay the rent on time. Or you need to hire a management company to find renters for you who will take anywhere ~10% of the monthly rent (in fees). You also need to remember that you can’t deduct the mortgage interest on an investment property. There are a lot of things to consider.
You don’t just go from “I want an income property” to “passive income”. There are a lot of steps in between, and it’s not without risk… and definitely not “passive”.
The amount of risk you can take on will depend on your own level of responsibilities/liabilities and your own risk tolerance.
I see, well what else?
Well, let’s look at another example that’s a little closer to home. Blogs.
On the surface, a good blog is considered by many to be passive income, and it kind of is. You create content and develop a relationship with affiliates and sponsors and are paid on a regular (usually monthly) basis. Maybe you add in some other advertisements and get some more money on a conversion basis. Once your blog is successful, eventually your revenue is bigger than your costs and well, it’s “passive income”.
Except… it wasn’t really.
I don’t think it’s very common to start a blog and then the next month you’re making money, unless of course you’re a genius or lucky… or both. Most bloggers take months or years to find their “niche” before they even are able to make any revenue at all. Some (many) blogs never find their niche and never become profitable. However, let’s look at my blog just for a prototype.
I started this blog “for real” back in April 2016. So I’ve had this blog for more than a year. I’ve written a lot of posts since then. I must confess that this blog is more of a hobby than a second job. Writing is something I enjoy but I needed something to “push” me to write on a regular basis.
So how did it go…?
For the first few months, my blog had virtually no traffic, other than me checking on it to make sure it worked. Then I slowly got a few readers, and a few more. Now I have a small core group of readers who I think enjoy my blog. That makes me happy. I even get emails now from people who are interested in writing guest posts or providing sponsored content. However, I don’t think I’m ready for that yet. I have a few other things going on and am barely able to keep up with my 3x/weekly posts.
I must also confess that I don’t do all the things I should be doing like reading other blogs and commenting or writing guest posts. Although I did get a lot of views on my Quora post. I would love to be able to get a few guest posts for kevinmd or md magazine for more exposure, but I like I said, I’ve barely been able to keep up with my 3x/weekly posts.
All said and done, I am just not ready to monetize just yet, even though the costs of upkeep have been increasing. Other people in my position would probably think I’m crazy, but I think I’m just not ready yet. I guess I do have a small fear that I may mess something up and end up killing this blog I worked so hard to create. However, I think 2018 may be the year I try to make a push.
I guess what I’m trying to say is that while a blog is potentially passive income, it doesn’t start that way. It’s more like working for free for a period of time until the value you provide warrants enough money to cover your costs, and then more.
Let’s look at a more successful (and interesting) example:
White Coat Investor (WCI) in his State of the Blog Post 2017
Here’s an excerpt:
“Summing it up, $862,687 of income minus $177,263 of expenses gives us a total profit of $685,424. That’s an increase of about 81% over last year. Where did that all go? Well, about 1/3 of it went to taxes, $106K of it went to our individual 401(k)s, and the rest was given away, spent, used to pay down our mortgage, or invested in a taxable account. Mostly the mortgage to be honest, but we’ll address that more in a post later this year.” (emphasis mine)
$685,424 in profit
That’s… amazing. However, you can’t look at the end point and just say “wow, look at that passive income“. WCI was the original “physician financial blogger” when he started back in 2011 or so. However, you need to look at all the content he has created since starting:
“This year, I wrote 119 posts and guest posters contributed another 57 posts this year. The site is now composed of 973 posts and 74 pages.” (emphasis mine)
That is a ton of content and it didn’t just come out of nowhere. That is hours and hours of research and writing. He also has a very successful book, which he made $168,861.10 from just last year. Now, writing a book isn’t easy, and making it successful is even more difficult. However, once the book is finished and it’s successful, that’s truly passive income from royalties.
See what I mean? You don’t just go from “I want a blog” to “passive income”, there is a lot that happens in between.
Take home message?
Passive Income doesn’t start Passively.
You have to go out and make it happen.
There is a reason that people who are seeking out “passive income” call them “side hustles”. Other people even call “passive income” as “lagged income” because you put up money, time, and/or effort all up front with an expectation for return later.
Basically, if you’re putting up money up front, it’s “leveraged income” and if you’re putting up “time/effort” up front then it’s “lagged income”.
Or, if you’re putting up both, then I guess it’s leveraged/lagged income.
Passive Income doesn’t start Passively.
You have to go out and make it happen.
Rental properties require money up front, and is considered leveraged income.
Blogs require time/effort to write and find a niche, and is considered lagged income (if you ever become profitable)
Leveraged income and lagged income can become passive income… but like I said, it doesn’t start that way.
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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