Wikipedia has a rather tortured entry on passive income. The entry begins by categorizing all income as either earned (wages), portfolio (income from market instruments such as shares) and passive (income from rental properties, royalties, etc.). I think a clearer definition might be to define all income as either earned or passive. Earned income is income arising from a continuing exchange of labor or time for money. Passive income is income arising from an exchange of money for the same unit of labor or time. That’s a confusing way of saying earned income is when you must continue the activity to keep getting money, and passive income is when you do the activity once and then keep getting money. So if I work for wages, I have to show up 8 hours a day to get paid 8 hours’ worth of wages. That is earned income. If I have passive income, I show up and do some work for 8 hours and then get paid that day, and the next day for the prior days’ work, and so on.
My definitions are fairly vague but the general idea is that earned income requires continuing work and passive doesn’t. If you buy a house, fix it up and rent it out, theoretically it could earn rent for the lifetime of the house, making it passive income. If you buy a house, fix it up and sell it, you are earning money for the time spent buying, fixing and reselling, so it’s earned income.
So why doesn’t everyone just forget earned income? Earned income is much easier to come by, for starters. I sell my time at a very specific rate to clients to perform consulting services, and in doing this I’m only doing the same thing 200 million other Americans do. If they have an 8 month project, they pay me my rate times 8 hours a day times 5 days a week times 4 weeks per month times 8 months. They don’t pay me any more after that. However, if I wrote a blog post, and someone comes to my page via a search engine and I get an ‘impression’ from Google Adsense, then the initial hour spent writing that post could potentially generate income for 8 months if people keep visiting the page. But it is hard to imagine that I could ever get to the point where the one hour spent writing a post might equal one hour spent doling out my consulting wisdom, earned through 15 years of experience and a master’s degree. That would be the goal, though.
I do have a fair amount of passive income which I have purchased with my earned income: stocks and mutual funds. Once I buy a stock, the dividends continue to come even though the earned income used to purchase that investment was capped out. If I worked enough hours to earn $100, then bought one share of a stock that earned me $1 per year in dividends, that passive income would (in theory) truly start after 100 years. Up until then it was just a deferral of my earned income in a sense.
I have given a good deal of thought as to what a ‘normal’ person like me, a wage earner, can do for passive income. I only come up with a few areas that are realistic:
- Owning dividend-paying stocks, interest-bearing cash accounts or other market-related investments.
- Owning and renting property.
- Creating original content (writing, art, music, etc.) and selling it.
The first two present the problem that you need at least some earned income to ‘kick off’ the passive income stream. You have to buy a stock or a house. Sure, there’s leverage, but still, some sort of earned income has to be there to initiate things. The third item is where the possibilities are.
This blog is original content. It may not be good original content, but it’s definitely my own work. Selling an original MP3 would be, too. If I can create good enough content, people will want to read/listen/acquire it, and they will pay for it, either passively through advertising or directly by paying me for it.
The goal, therefore, is probably to work on increasing your creativity, which is free of cost but can generate income. Of course the time spent in generating creative thoughts has to be retroactively paid for once the income comes in, but at some point – like the stock example above – you reach a break even point and move into true passive income territory. Once you have reached that point, the need for earned income decreases and you can stop selling your time for money.
This is nothing new to readers of Kiyosaki or Steve Pavlina or Lazy Man and Money or dozens of other blogs, who have covered the same ground in more depth and precision than I. But I think the challenge for many people is how exactly to recognize passive income generators. Owning and renting property and stocks is far and away the easiest way, but still require an initial payment of earned income (and again, many people would argue you can borrow money to generate that, but no-one will lend you money if you don’t have some sort of earned income ‘background’). Creative content, however, does not require an intitial payment of earned income, but a retroactive payment once it is created. So I continue to try to think of things to create, so I can generate more passive income and quit selling so much of my time (a limited commodity) to other people rather than using it myself.