Typically income can be divided into two categories: active and passive. Active income is the money you earn from working. For most people this is their salary at their 9-5 job. On the flip side, passive income is income you earn from things unrelated to your job, such as investments, real estate, or even writing a blog. But hold on, there’s more to it than that.
Does having passive income sound too good to be true? According to the U.S. Census Bureau, 20% of households do in fact earn passive income from either dividends, interest, or rental properties. While the median amount of income per household is $4250, the ability to earn increases with total income. If you’re looking for a passive income opportunity, read on to first fully understand what that truly means and the questions you’ll need to ask to make the right decisions.
The First Step is Understanding the Passive-Active Income Spectrum
Ideally, passive income is just that — passive. The goal is to have money flowing into your bank account even while you’re not “at work.” But usually, there is some degree of time or labor spent even with passive income. For this reason, active and passive income should be viewed more as a spectrum than just two categories.
While it’s true that active and passive income represent opposite ends of the scale, there are a lot of gray areas in between that render some passive income more active, and some active income more passive. Instead of looking at passive income as a “set it and forget it” model, it makes more sense to redefine it as a form of income that isn’t directly relative to the amount of time and effort you put into it. Still, there are different levels of time and effort that can be put into an income stream that will yield different results.
What Should You Look For in a Passive Income Opportunity
First of all, there are numerous opportunities out there if you are looking for new streams of revenue. Those that are usually going to be closer to the passive end of the spectrum we just discussed include investing in rental properties, real estate syndications, and traded REITS. But remember, it’s important to know what you are getting into.
Here are four questions to consider before investing in a passive income opportunity:
1. Does the opportunity match your values and expertise?
It’s impossible in this day and age to make a decision on whether or not to make an investment without exploring if the opportunity is in line with your values, matches or compliments your other investments and if you think it’s one that will not only generate passive income, but also increase in value over time.
To go along with this, you should be able to understand the investment you are making. Make sure you have the knowledge to fully understand the opportunity. Taking someone else’s word for it isn’t going to cut it. When you invest with your eyes wide open, completely understanding what you are doing, you make better decisions.
2. Does the level of passive investment match the potential return?
If we think of the spectrum, does the level of work you need to put in for the passive incomes match the expected level of return? Usually, the more active you are, the higher the return should be exponentially. With an investment that takes less actual work, the return is usually lower. Both are fine, but make sure they match up.
For example, if you are interested in investing in real estate, there are many levels to consider. If you are investing in traded REITs, they are 100% passive. You aren’t doing anything besides buying real estate stock. But the return will usually be a lot lower than if you are investing in a private fund. When investing in a private fund, you have to find the fund, which takes more work but there is a higher return for your trouble.
Then the next level might be giving someone money to buy real estate. In this case, you might want to evaluate the property and help make decisions, which is even more active. Then on the far end of the spectrum, if you were to buy a single family home and rent it out on your own, it’s not going to be passive at all. It will be a lot of work but that investment has the potential for higher returns.
3. Does the level of passive income match the risk?
Risk also needs to be a factor you take into account when investing. For example, Crypto staking is a way to generate passive income. It’s basically the crypto world’s equivalent of earning income or dividends while retaining your underlying assets. The returns are usually higher than what you would earn in a savings account, but there is risk involved. Generally speaking, the higher the risk, the greater the return. Before you invest, you need to consider the risk level and then also consider your personal risk tolerance to decide if that particular investment will be a good fit.
4. What are the tax implications?
Taxes are something that a surprising amount of people don’t think about before they make an investment. But you absolutely need to take tax implications into account. They can make a huge difference in your passive income stream.
For example, you might generate a 25% cash flow in one revenue stream, and 20% in another. But if the 25% cash flow actually incurs 25% tax, and the other one is only 10% tax, the second one is going to be the better option. Make sure you chat with your tax advisors or CPA to clarify taxes before you invest.
As you can see, passive and active investments aren’t two sides of a coin, and there are few fully passive investment opportunities out there. Considering the possibilities of income on a spectrum and asking yourself these four questions will help you manage your time and wealth more efficiently and purposefully.
Litan Yahav is a former officer in the Iraeli Navy and the CEO of Vyzer, a solution for investors with multiple streams of income who find themselves spending too much time managing, tracking and monitoring their portfolios. Yahav and business partner Vyzer COO Tomer Salvi were previously co-founders of Segoma, a revolutionary diamond display technology, established and successfully sold.