What’s passive income? It’s not what influencers say it is
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LUCA Alboretti was enticed by the thought of making money in his sleep.
He was looking to supplement his income as a real estate agent in 2018 when he created an online store selling golf products, an idea he had hatched after watching a YouTube video about how to earn US$150,000 a year in “passive” income selling salt-and-pepper shakers online.
“I thought I would wake up to a couple of hundred orders, fulfil them and collect my profit,” said Alboretti, 28, who lives in northern New Jersey in the US.
He spent about US$5,000 on sourcing and testing the golf products, developing a private-label product and paying website management fees. He put in about 10 hours setting up his online store, writing descriptions for each item, communicating with suppliers and marketing his site.
Yet a year later, Alboretti had made only US$300 in sales. He closed the store and began using the Instagram page he had created for it to share humorous real estate content he made instead. “I worked hard to get my couple of hundred followers and didn’t want them to go to waste,” he said.
That morphed into ActuallyAgents, a multiplatform social media brand that is known for its clever memes on Instagram and free educational resources for real estate professionals and lead generation services for brokers in the US and the UK.
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ActuallyAgents became Alboretti’s full-time job. “The courses, videos and social media content don’t create themselves,” he said. “None of this is passive.”
Search “passive income” on YouTube, TikTok or Reddit and you will find a wealth of videos by people claiming they make thousands of dollars each month this way – whether they sell courses, e-books or other products online; offer property on short-term rental platforms such as Airbnb and VRBO; or even buy and maintain vending machines in high-traffic buildings.
The allure: Theoretically, it is easier than a traditional 9-to-5 “job”.
“We live in a passive-income-obsessed culture,” said John Boyd, founder of MDRN Wealth, a financial planning firm in Arizona.
This preoccupation with making money effortlessly, he said, is fuelled by investors in their late 20s to early 40s, who are understandably frustrated that they are not in the same financial position their middle-class parents were at their age and are looking for easy ways to catch up.
But investing several thousand dollars to buy a vending machine that pays out just a few hundred a month, or overextending yourself by taking out a 10-year mortgage to buy a rental property, is not the best way to create long-term wealth or to save for retirement, Boyd said.
While many people claim to be making passive income, particularly on social media, only 20 per cent of American households earn such income – either through dividends, interest or rental properties, showed Census Bureau data. And the median amount that those households make from those sources is US$4,200 a year, showed bureau figures.
So, what is passive income? The IRS defines it as trade or business activity that you do not materially participate in, meaning you are not involved in its operations on a continual and significant basis. However, the IRS does consider rental real estate activities a source of passive income as long as the property owner is not a real estate professional.
Yet there is much confusion about what qualifies. What people often call “passive income” is income that is not dependent on a single pay cheque or employer, said Kevin Brady, a vice-president at Wealthspire Advisors in New York City.
In some cases, without understanding the difference, people are talking about leveraged income – putting in time and effort in advance to earn recurring profits from selling, say, an online course or an e-book – or additional revenue from a side hustle (that is, more work).
Extra income isn’t passive
Gina Vanegas and her husband have experience developing multiple income sources, including ones that generate leveraged income.
About 20 per cent of their total income derives from two rental properties they own in Atlanta. The couple each owned a home there before they moved to California in 2015. Because they initially planned to return to Atlanta, they rented the properties to long-term tenants.
“It helped to fund my life as a student for several years,” said Vanegas, 37, a psychologist.
The couple recently bought another property, in Mexico, that they hope to rent through Airbnb this year after they complete renovations, buy furniture and find a local manager. Vanegas estimates that they have invested several thousand dollars getting the property ready to rent.
“I hear a lot of people say, ‘Buy these properties and you don’t have to do a thing’,” she said. “People don’t realise how much work it takes.”
Compound interest creates passive income
Stacy Miller, a financial planner, said she believed that the pandemic had further fuelled workers’ desire to create passive income. Many Americans had more free time, and they started to question whether working a traditional job would provide them enough money.
“People want to earn extra money to save for retirement and to do fun things now, and that takes more time and energy than people have,” she said.
Miller’s two sons became interested in investing in January 2021 during the meme stock frenzy.
At the time, her sons were still doing virtual classes at Georgia Institute of Technology, and all campus activities had been cancelled. The headlines about amateur investors making money buying and selling GameStop stock on the Robinhood trading app grabbed their attention.
Every time GameStop’s stock rose, Miller’s sons called her to discuss how novice traders were making big bucks.
“It was a great learning experience,” said Miller, a vice-president at Bright Investments in Florida. She explained that the value of GameStop stock could easily plummet, and that if an investor sold the stock at its high, he would owe significant taxes.
“You could easily owe more than the money made on Robinhood when you factor in all the transaction fees,” she said.
Miller’s elder son, Jamie, 21, said the experience had “brought the idea of investing to my attention and doing things with your money rather than just put it in a saving account that won’t earn much interest.”
That lesson stayed with him, and during the summer of 2021 he decided to invest 20 per cent of his internship salary. After talking with his mother, Jamie Miller made those investments within a Roth IRA, which he opened when he was 19.
Last year, he contributed the maximum amount of US$6,000, earned from another internship. If he continues to max out his IRA contribution, he could have US$4 million in his account by age 65, assuming a healthy 10 per cent annualised return on his investment, Stacy Miller said. Even if he doesn’t contribute another dollar to his account, he could have US$650,000 by the time he turns 65.
“Compound interest is absolutely one of the keys to the success of passive income,” said Stacy Miller. NYTIMES
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