Editor’s note: Today’s Post is from our PhREI Network partner, Jordan Frey MD, The Prudent Plastic Surgeon.
In this post The Prudent Plastic Surgeon outlines the difference between active, passive and leverage income. I especially like the line that passive income is leveraged income and I agree. Jordan also points out that all investments, even the passive ones, require some upfront time and effort. You need to take the time to learn about your “passive income” investments whether that be real estate or stock market investing. In the end, it comes down to how you view your time. Time spent on real estate seems to be a major limiting belief for many, especially when it comes to Short-term rental investing. I can see the point, if one does not enjoy the process then short-term rental investing may not be worth the time. However, if investing in real estate/short-term rentals is something you enjoy and consider a hobby then that time is probably time well spent and in the long run will increase your net worth.
Published by The Prudent Plastic Surgeon on January 12, 2021
Put another way, is passive income a real thing? This is the question that I will try to answer today.
It’s hotly debated. Many accused me many times of incorrectly calling some type of income passive. I’ve always had the same response…which I will share later on.
It really comes down to semantics. But semantics can be important. Someone hears about “passive income” and imagines a golden goose. It’s important that what we are describing is accurate to avoid misleading people.
So, can you actually achieve real passive income?
Or are we all just yanking your chain?
I decided to write a post on this topic while listening to Leti and Kenji’s podcast, Rich Doc, Poor Doc, on a drive home recently.
They spoke about a mastermind they have with Keith Cunningham who is the actual, real life rich dad from Robert Kiyosaki’s famous book, Rich Dad, Poor Dad, a must read in my opinion.
Keith reportedly says that there is no such thing as passive income. He’s a smart guy. I started to wonder if he was right…
Real passive income is really leveraged income
I left out a key qualifier. Keith says that there is no such thing as passive income. We are really after leveraged income.
And I could not agree more.
I fully believe that there is no such thing as real passive income. No investments are therefore truly passive. (Buying and winning a lottery ticket is gambling, not investing so don’t even try that one…)
If you are looking to grow wealth, you need to be ready to put in some work
I am new to the personal finance world, beginning to climb out of my self-made hole only 7-8 months before writing this post.
But with that being said, I’ve done my homework. I know what I’m talking about. I’ve put my money where my month is by investing in the vehicles that I think are best and recommend to my readers.
And, I have never come across any investment that does not require legwork to be successful
However, I have found many investments that weaken the link between my time/work and making money. As a plastic surgeon, my work/time:money ratio is roughly 1:1. But with my investments, it is much, much lower. But, it’s never been 0.
And this is how I answer the people calling me out for calling one of my investments passive
I tell them that passive income is really a misnomer. Nothing is truly passive. This term just means that the link between my time, work, and the money I make is weakened. I always point to my first investment property.
Selenid and I spent a couple weeks fixing up the property ourselves to save money and improve cash flow. Let me tell you, this wasn’t passive. But, now we collect over $2000/month on our duplex. Usually the money arrives in our account overnight when we are asleep. That’s pretty passive (Although I am told that I am an “active” sleeper…whatever that means).
Let’s look at some more case studies of real “passive” income
Investing in the stock market
Well, even if you invest in broadly diversified low cost index funds like you should, you need to put in some effort. You need to develop you asset allocation. This should include a full written financial plan. And you need to rebalance at least yearly to make sure you are always buying low and selling high. This is all effort.
However, once you put in this up front work, you really don’t even need to pay attention to your index funds. Expect for rebalancing once a year, you just let them ride knowing you are approximating the long term market, which is a pretty safe bet.
If you stock pick or try to time the market, you are doing more work. You also are likely underperforming the market. So just invest in index funds. Please. Seriously.
And don’t tell me you have a “money person,” so you really don’t need to put any active work in. In the best case scenario, you needed to put in work to vet this advisor and to gain the necessary knowledge to make sure they are giving you good advice. In the worst case scenario, you get killed with loaded funds and commissions and fees and poorly performing investments. Now you will need to actually work longer to build your nest egg large enough to safely retire.
Real Estate Investing (Make sure to read this primer first)
I already alluded to this above. “Active” real estate investing has active right in the name. Shouldn’t be fooled. But again, I argue that those semantics scare too many people away from actively investing in real estate.
It’s true, you need to screen and analyze properties. You need to go through the process of buying them. And you need to manage them, either by yourself or with a property manager. This is all work. I know because I’m doing it. But the reality is that our 3 doors (duplex + shed) average us much less than 1 hour of work a week. And we self manage.
So again, we weaken the bond between work and money.
And then there are “passive” real estate investments. Again, the semantics are a bit tricky here. People get really excited about these opportunities, like private funds and syndications.
They hear that it is passive and see pro forma returns like 12% and their eyes get big dollar signs. They gloss over the rest. The reality of these investments is that you are handing your money to someone and trusting them to do a good job investing it. If they lose your money, they have no fiscal responsibility to you. You’re just screwed.
So what does this mean? It means you damn well better do your due diligence on who and what you are investing with in these “passive” endeavors. And that my friends, requires work. Do it well and choose wisely and your investment will be relatively passive eventually. But not 100%.
I honestly am a noob with Bitcoin. I don’t own any and that does not mean I never will.
But it has been hugely volatile. And there is no long term data. So that has dismayed me from buying any.
Some people call Bitcoin passive. But like any investment, you need to do your research. You also need an iron stomach not to sell low. And antacids cost money. And effort to go to the store and buy. So there’s your active effort.
What I don’t want to happen as a result of you reading this post
What I don’t want is for you to read this and think, “Crap…I really wanted a passive investment but that doesn’t exist. I guess I won’t invest in [insert investment vehicle].”
Just because a truly 100% passive investment that works doesn’t exist doesn’t mean you shouldn’t invest wisely in these vehicles.
I am a huge advocate of investing the right way in the stock market. And I really believe in active real estate investing. That’s how I increased my net worth by 6 figures in the first 6 months out of training. And in the future I plan to invest in passive real estate investments. The work is really (I mean really) well worth it.
This is why I think that we should be as dogmatic about labelling something as “active” as we do about labelling things as “passive.”
Just because some work is required does not mean it is not worth it. I’m always confused when a physician will tell me that they don’t want to invest in real estate because it is “too much work.” Then they will turn around a work 5-10 extra years instead of retiring because they never paid attention to their investments portfolio and don’t have a big enough nest egg. They traded hours for years.
And time is still undefeated.
Now that you understand my philosophy on leveraged income, you should really think hard about starting to create some leveraged streams of income
Start here with my comprehensive post detailing possible (and realistic) side gigs for physicians!
What do you think? Is passive income a real thing? Have you invested in anything “passive” only to be supposed at the real work required? Have you ever wished you put more active time and effort into an investment? Share with us in the comment below!