What is Passive Income?

creating passive income
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Recently a friend of mine told me that she believed that the term “passive income” is the most over-used and misused in personal investing. From what she told me, a lot of people she meets are working on producing “passive income” streams even if they are not.

The fundamental source of her frustration was that people had confused the term passive income with streams of income.  For example, someone who owns a business on the side, which requires some time and attention does not have a passive income stream. They have another source of income- it is a big difference.

Her challenge to me (and, by extension, the readers) was to list valid sources of passive income.

Passive income, as the term indicates, is income you make without doing anything other than owing the cash flow stream itself.  For example, dividend income is truly passive income- you receive a dividend cheque every quarter for evidence of ownership. An inheritance or a trust for your benefit, which pays you money on an interim basis for the rest of your life, is passive income (if only we were so lucky).

In these examples, you sit back, and money comes to you. However, what about the grey zones?

Here is my take on what is and isn’t passive income for streams of income that fall in the grey zones- feel free to add your 2 cents since this list falls in the mushy middle of what is or isn’t passive income:

Real Estate Investing:

If you own and manage investment real estate, you don’t have a passive income stream. You have an alternative source of income. What part of fixing the toilet, collecting rent cheques, advertising to fill rental vacancies and to hire trades is passive?

However, this is where I will make the distinction. If you own commercial investment properties and hire a property manager, depending on how involved you are, it is passive income. Business premises and residential rental units with property managers are most likely professionally managed. A commercial lease downloads almost all of the responsibility of managing the premise to the tenant other than significant repairs and common area maintenance, which is carried out by professional property managers. Thus, substantially all of the income flowing from these types of real estate investments are passive.

Granted, there are some minor responsibilities the property manager cannot do for you, such as renewing the mortgage, but this is some work spread out over time. What I would suggest is that real estate is a more natural way to make income given you don’t have to be there for 9-5, but for most self-managed real estate investments, it is not passive income.

Licensing/Franchising:

If you sell a license or franchise your business, it is only passive income if you have no obligation to the licensee or franchisee afterward. For example, you license software with no obligation to provide patches or upgrades. Franchising cannot be considered a passive income stream- the franchise has obligations to provide sales/marketing and administrative support. The franchise is a great revenue source because someone else is paying you for copying your homework (sort of speak), but I would not define it as a passive income source.

Infopreneurship/Publishing:

“Infopreneurship” is a relatively new term to the business lexicon. It refers to the selling of information, whether through seminars, training modules, or blogs. Its the new economy’s version of traditional publishing. This is where things get really murky. Infopreneurship, which involves the constant updating of information from the owner-manager (i.e., a blog), is not passive income.

An aggregator site that publishes articles from other sources is passive income only if a program has been devised to find the articles and post them-but it is only passive income after a lot of work has been putting into setting up the program.

Despite the thousands of dollars, Google can pay to a site; sites need constant updating, so it cannot be strictly defined as passive income.  However, if you develop a training module, seminar, e-book that can be sold many times over via e-commerce, it is passive income because you don’t have to do anything to get a sale- but again, it comes with the same limitation that you had to put a lot of work in beforehand.

These are just my opinions. It is definitive by any stretch of the definition. Let me know what you think about what real passive income is.