There’s No Such Thing as Passive Income

April 4, 2011

Today’s post is from Mr. Credit Card of AskMrCreditCard.com (check out his credit cards offer list if you need a new card). Passive income is such a fascinating topic because there is endless debate about what constitutes “passive” vs. “active” income, and what strategies work best for creating passive income.

I briefly touched on the subject last September by comparing passive income to cows. That made for a fun post!  I hope you enjoy today’s counter-perspective and open up the discussion in the comments!

Many personal finance bloggers and the mainstream media have written reviews about the 4-Hour Workweek. There is also a whole industry out there touting the concept of how you have to build passive income. I want to make a counter argument that there is no such thing as a passive income.

This is not to say that I am totally against what is said in a book like the 4-Hour Workweek. In fact, I took a lot out of it. But I think many folks will read a book like this, read Rich Dad Poor Dad, and come to the conclusion that “building passive income” is the way to go, without realizing that building any sort of wealth requires really hard work, smart work and a little luck. I want to list some factors and reasons why income and wealth has to be maintained and that there is really no such thing as passive income. I will be using examples from some popular “passive income” strategies like real estate investing, network marketing, some knowledge from the credit card industry and even big Fortune 500 companies. But I really hope to illustrate my point that passive income is a myth.

There’s always competition – We’ve been always told that real estate investments are great because they are passive income, you get ridiculous tax write-offs, etc. But one thing the “gurus” who sell these courses miss is that an area can be overbuilt and result in falling rents. Oops! What happened to my passive income? Many folks have also been lured into “network marketing”. I guess years ago, when the market was not too saturated, folks had an easier time (though I wouldn’t use the word easy in an absolute sense). But with time, new firms with new products came to the market and marketing reps had to deal with that.

In 2006, many of the prominent personal finance blogs started. Since then, lots of other folks like Mint, and Credit Karma have sprouted out not just as blogs, but with new tools! There is always competition in whatever you do. Treat your business passively and you risk being made obsolete. Yahoo, Lycos and AOL used to be the kings of the search engine. You would think that they could rest on their laurels.

Changes in rules and regulations – The new CARD Act is going to take effect soon. New rules are being enforced on credit card issuers. Folks who issue credit cards for people with bad credit will see their whole economic model turn upside down. They now cannot charge ridiculous up front fees, but instead can only charge an upfront fee that is equal or not more than $25 of the credit limits given! Issuers of student credit cards cannot market to students at college campuses. In fact, if a student does not have any income and he or she is below 21 years old, they will need a co-signer. These are regulatory changes that have been forced onto credit card issuers.

Even in the blogging world, bloggers now have to disclose if they have any relationships with advertisers and if they are paid to review products. Automakers always have to contend with any new emission standards.

Technology changes and need for improvements – Can you imagine if Apple had the same product as they did five years ago? They would be dead by now if they did not come up with new products. How do you feel if your hotel room has no Internet connection? And by the way, a hotel has to make planned renovations once every few years (once again – no such thing as passive income). Would you rent a place if it did not have Verizon FIOS but only had DSL? See, even if you have rental properties, you have to always upgrade your apartment. Any business always has to upgrade their products with new features, better features. Here is another example: American Express has been coming up with new partners in the reward program and works constantly to make their existing partners happy. Discover has to continually add merchants to their online shopping portal to make it even more attractive. Your product offerings must always be improved.

On an individual level, you also have to be constantly upgrading yourself. Even for Tim Ferriss, he has to be aware of what is going on in the publishing world, in the world of the “self-help and improvement” market. He can’t just be resting on his laurels and his “present success”.

Maintenance Cost – So you have a few real estate rental properties–”passive income,” you say. But what happens when tenants complain that their heater broke down or their pipes burst? Passive income? No, no, no. You either have to get your hands dirty or simply outsource the maintenance of your property. But even then, you have to supervise who you outsource this task to, because you want to make sure they are not overspending on repairs or being too stingy as well (hey – got to keep the tenants happy).

Let’s use another example. Let’s take probably the best known personal finance blog, Get Rich Slowly. It appears that J.D. Roth, the founder and owner, has achieved a very good degree of success. He even now has writers for his blog as he focuses on his book publication. Does it mean he can switch off and let his blog earn passive income? Of course not. He has to continue to write great content (a high bar which he has set).

Another popular scheme that folks have gotten involved in is network marketing on the theory that you build up a “sufficient customer base” or “folks who work under you”. (Disclaimer: I have never gotten involved in this). But even if you are making a good income, you still have to recruit, you still have to attend “pep talk rallies”! In fact, it is anything by passive. Because if you are really passive, your business is simply going to die one day!

Cost of supervision – Like I mentioned earlier, even if you outsource your rental property maintenance to someone, you still have to supervise them! Let’s use the Get Rich Slowly example again. J.D. has hired a few writers for him. But guess who has to supervise the writers? Someone, of course. It could be J.D. But even if it was not and he “hired an editor”, he still has to supervise the editor! So here is the message to all business owners–you can’t just check your emails, work for a couple of hours and spend your whole day at the beach! You have to make sure things run smoothly! After all, it is your business!

There is always a cost of supervision even in what is seemingly a “passive business”.

Economics of Business Change – The economics of any business can change due to a variety of factors. 2008 will always be remembered as the year of the financial crisis. It was the year that credit became scarce. For many businesses that relied on credit, they saw the economics of their business change overnight. When your borrowing costs soar all of a sudden, what was once profitable becomes a money losing proposition just due to higher financing costs. Furniture shops and retailers who could not get adequate financing were closing down everywhere. This could happen to anyone.

Ending Thoughts – I could go on and on about this topic and give more examples of why, in my opinion, passive income is just a myth. The moral of the story is that there is no easy way to success or wealth, and there is certainly no such things as passive income. There are many folks who are out of work, or are frustrated with their work, and want to start something on the side that will earn them “passive income”. Don’t fall for pitches mentioning passive income, because the truth is that you need lots of hard and smart work to be successful in whatever you do. And even if you are successful, you must maintain your edge and be up-to-date on your industry, and stay on the cutting edge.

Rental property owners have to always update and upgrade their properties. Successful (and I’ve yet to meet one) network marketers have to keep “recruiting”! And for those of you who think having a few websites can make you passive income, think again. I run one, and it is certainly work. It ain’t no 4-hour work week for me. I’m sure it’s not for Wojo as well!

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