In Defense of Active Income
In Defense of Active Income
We love to opine on passive income. Whether it be side hustles, investing in the market, or real estate, there is no bigger more audacious dream than reaping the benefits of effortless revenue streams. In fact, some define financial independence as the point when passive income streams meet monthly spending needs. We have become so exited about early retirement that the one more year phenomenon has become anathema. Yet, there are some clear benefits to the other side of the coin. Active income streams have several benefits that we often overlook because the idea of work chaps our hides.
Throughout my career, I have built up active income streams. I think of the W2 (or 1099) wages as its own asset class.
There are several advantages to being heavily invested in this asset class.
Capital Consumption
Building passive businesses, real estate, and investing in the market all have one thing in common. They are generally capital-intensive. You mostly have to invest money to make money. The whole idea is that your money is doing the work for you.
There is just one problem. The seed money used for these ventures is consumed in the investment. Once it is tied up, it can no longer be out there producing for you.
Active income, however, doesn’t require anything but a skill set or knowledge. While the educational process in the past might have been expensive, it costs nothing to do a hard days work. There is no capital consumed in showing up for your daily W2.
I can invest $20K into a down-payment on a rental property that may cash flow $5K a year. Sounds good, right? Or I could work a few hours a week and also earn $5K a year. I could take that $20K I was going to use as a down-payment and plunk it into an index fund which will also return an extra $1k (making 5%).
Which numbers look better to you?
Passive Income Pains
Another issue is the true passivity of passive income streams. While no one would argue that the stock market is relatively passive, often other activities lumped into this category don’t hold up to the sniff test.
I love real estate. But owning a real estate empire large enough to support oneself is anything but passive. Often it starts looking like active income after one considers time spent searching, financing, renting, and managing a group of properties. It may feel more luxurious than stumbling into a 9-5 everyday, but it does require effort.
Most businesses, blogs, podcasts, and amazon sellers face the same issue. You are going to work one way or another!
Diversification
And of course, our old friend diversification rears it’s pretty head. Active income streams add an important layer of diversification into any financial plan. Passive income streams are fragile, and can break at any time. Real estate can incur costs or a neighborhood can become less sought after. Amazon sellers are outperformed by the newest guy on the block and find no one buying their products. The stock market can crash.
Although not fully uncorrelated from passive streams (when the economy tanks all asset classes can be hurt), active income streams tend to be more resilient especially if one has a specialized skill.
Final Thoughts
I love passive income opportunities. They hold the dream of creating a perpetual money machine that requires very little maintenance or effort. In reality, however, active income streams provide a number of advantages. They not only avoid capital consumption but also add an important layer of diversification to any financial plan.
I may be ready to downsize and fade towards retirement in my medical career.
But I’m not giving up on active income streams just yet.
Plus I find there is a high level of fulfillment and accomplishment that comes along with a good day’s work. I agree, I’m all about the passive income, but I’m not looking to completely rid myself of active income anytime soon.
True. Work can be very satisfying.
The beauty of FI is that if you choose active income, you have the choice to pursue a fulfilling passion and not care as much about the money. Many times the money actually follows anyway. I was watching Tom Bilyeu on Impact Theory last night and his inspiration of making yourself better, pushing to find purpose and not necessarily following the money was inspiring. He definitely wasn’t discouraging W2 income though.
Don’t follow the money, let the money follow you!
Definitely first need active income (unless you are a trust fund baby, lottery winner, or inherit early) to start passive income.
There is a symbiotic relationship. My passive income owes its life to my active income but now is doing its part to help me reduce my active income and prolonging my career. There is no way on earth I will ever have a passive income stream match my active income stream but honestly I really don’t need it to. I just keep feeding the system and eventually active income will be an afterthought.
Symbiotic relationship. I like that!
Good stuff! Like the spend less/earn more debate, there’s room for both!
For sure. I guess it’s best to have a little bit of both.
Great balanced post! The main reason I stay out of real estate is that it is hugely time consuming, like owning a farm or restaurant. And delegating it to someone else risks disaster since they have no skin in the game. My day a week consulting is fun, low stress and meets a lot of needs in my life. Money isn’t one of them, but it is still fun to earn it.
I think consulting a day a week is the perfect mix.
I have understood the following and said this for some time. The easiest way to convert my effort into dollars is to go to work as a doc. Anything else requires investment or results in a lower dollar return per unit of effort.
Very true. We get paid well to be physicians.
I’ve never quite understood calling side hustles “passive income”. To me they sound like jobs. Maybe not 9-5 jobs maybe part time jobs but you still have to report income pay taxes SSI etc and still wear the responsibility and harness of seeing to it they don’t die. These profitability of side hustles may be exquisitely sensitive to the economy. Also not all W2 is stable even for very skilled workers. Many engineers will tell you about the perils of recession. We happen to be in a pretty recession proof biz. There is a whole class of “retiree” that now is 58, lost their retirement and home in the great recession, can’t get a W2 gig because they are old, and travel around living in their cars for 1099 money picking up gigs at places like Amazon fulfillment centers. A kind of economic gypsy. Active income is nice but not without its own risk.
I guess at sometime you realize that every asset class and every retirement plan has risk. Risk management is the name of the game.
Really enjoy that you pointed out the importance of the active income stream. When you think about the 4% rule, it takes a ton of capital to earn a pretty small amount. 5k a year of passive income from investments, for example, takes $125,000. That can take a long time for some people to build up that amount. In contrast, what’s it take to earn 5k a year – a mere $417 per month. A lot of people can do that!
I couldn’t have said it better myself!
The only passive income I have are my investments. My side-hustles are active, although my graphic arts could be passive if I stopped as the money would still come in.
But we gotta do stuff right? I’ll always have something active
Me too. I would go crazy without projects. Some of them happen to make money.
I believe a combination of both passive and active income is ideal. It takes a lot of mass to generate passive income at 4%. And to generate that mass takes active income. I will probably have some type of active income for as long as I can (physically and mentally). This would reduce the need for passive income as well. A two-pronged approach.
I think working both sides is worthwhile. It takes a lot of money to generate in passive income what is easy with active.