Is Passive Income a Myth? No, and Yes — a Financial Planner Explains
A version of this article was originally written for and published on Business Insider
Passive income is the ultimate financial dream. And unfortunately, it’s often just that: a dream, not a reality.
As a financial planner, I have to be honest with you and say passive income is a bit of a myth.
If it were easy and realistic to create truly passive income, where money flows into your accounts with no effort on your part, we’d all be doing it!
That said, opportunities to create passive income do exist. There are some legitimate ideas you can pursue, but it’s important to acknowledge even these are not accessible to everyone.
I won’t say it’s impossible to create these kinds of income streams. But it is difficult to achive, often requires rare skills to establish, and helps to have a not-insignificant amount of luck on your side.
To pretend otherwise is harmful and misleading.
Buying into the myth of easily-accessible, anyone-can-have-it passive income can distract you from doing what you should focus on instead:
Wisely managing the income you actively earn rather than spending time and money chasing a ghost of an idea (or pursuing less-than-credible business ventures).
With these disclaimers, let’s look at 3 legitimate paths to building your own passive income stream.
1. Build a strong investment portfolio
The whole idea of contributing to investments during your working years is to create a portfolio of assets that eventually provides a livable income.
With a well-diversified, strategically-managed portfolio, you buy assets now that will increase in value over time. In the future, you can convert those higher-valued assets back to cash without doing additional work. You can also receive income from them directly, via dividends.
This is the only route to building passive income that I can classify as realistic, achievable, and accessible for most people.
Evens so, it still takes a lot of upfront time and effort to build the kind of investment portfolio that you can reliably convert into a high-enough income to sustain your lifestyle.
It also takes a significant amount of income to begin with! You need to earn a certain amount in order to have available cash flow to divert to savings and long-term investments to build wealth.
And, you must build your assets first before your portfolio can act as a passive income faucet for you.
That is why it’s so important to have a high savings rate while you’re actively working; it makes the passive income stream possible in the future.
Another benefit to this approach to passive income is you have a lot of control over the process. The more you save and the less you spend, the faster you will build up the required level of assets to convert them into a passive income stream.
2. Start a business (or invest in one)
You can create passive income if you can build a business that operates without you. Once you start a business, you need to hire employees who deliver your service or create your product without you having to do the work to produce value. Instead, you retain ownership (and therefore part of the profit).
Your service or product business can be in any industry or field and take on whatever specialty or target market you feel best equipped to serve. That gives you a lot of freedom to create in a way that aligns with your skillset or experience.
Of course, not all businesses make it. Even fewer successful businesses grow to the point that the owner can earn truly passive income from it.
That means scaling to a point where you no longer have to play an active role in keeping the business running and generating revenue.
Another avenue for passive income (without so much upfront work and risk) is investing in an existing business. You get an ownership stake in the company in exchange for a portion of revenues.
The benefit to this approach is that you could potentially create a passive income stream immediately. The downside is that the investment is still risky; the business could fail.
You also need to have sufficient capital upfront to make that investment in the first place.
Most people don’t have tens or even hundreds of thousands of dollars of available cash to use to buy a stake in a business, so even this needs to be part of a longer-term plan where you account for the time it takes to save enough cash to make a business investment.
3. Leverage your current work for future royalties
Selling the rights to a valuable asset can allow you to establish a passive income stream.
This could range from intellectual property, like a process or a system for a business to implement, or something like a story or script that a producer could turn into a film.
Publishing books, courses, or other resources people want to purchase would also allow you to turn a project you created once in the present into recurring future income in the form of royalties.
This path to passive income is one of the most narrowly available to a small group of people, though.
And some would reasonably argue that these earnings aren’t passive at all, but are leveraged income since they require a lot of time, effort, and work to initially create.
But if your goal is passive income, earning royalties provides an avenue to achieving that for your future self. It’s worth considering if your skills and experience align with this model of monetization.
Passive income exists — but there are no get-rich-quick guarantees
I think this article from Lifehacker puts it best:
Money rolls in a whole lot easier if you already have it. Otherwise, it’s going to take a lot of work to get other forms of passive income (real estate, creating content, re-selling goods) off the ground.
In other words, it’s easier to generate passive income from investments if you have the money to invest with in the first place — be it investing in a business, in financial markets, or any other kind of asset expected to increase in value.
Even then, that investment may only produce a return with a lot of care, attention, and hard work (as is usually the case with real estate, which is often billed as a way to earn “passive” income but is anything but for most people).
Instead of obsessing over how you can create passive income, most people would be better served by focusing their time, energy, and attention on a few fundamental practices of good money management:
- Keep your cash flow under control (keep your expenses reasonable and well within your means)
- Create a serious savings habit, and prioritize savings above spending
- Invest a significant portion of your annual income wisely, for long-term growth (we typically recommend putting 20–30% of annual household income to long-term investment vehicles, like retirement plans or taxable investment accounts you will keep invested for 10–30 years)
- Focus on your earnings power in order to increase your available cash flow (this is typically a very active, not passive, endeavor!)
If you can follow these steps, you’ll find you make strong progress toward building wealth in a way that you leave more up to chance by chasing the idea of passive income.
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