Passivity of Income

Regular readers of this blog know that I employ various sources of passive income to achieve financial independence. Passive income is a powerful mechanism where I make my money work for me. Since there are various ways to generate passive income and there is always a question of passivity of the income source, this post delves deep into the methodologies and assigns a passivity index to each method.

This article was inspired by a post from FIFighter where he discussed the passivity of each income method and explored how much time needs to be dedicated per week. In this post, I build on that idea with more sources of passive income covered, and explore other details such as the relative risk and reward of each system. Note that these are the risk and reward numbers as per my personal opinion and may differ for each individual. I employ a scale of 0-10 for the risk-reward system, where 0 indicates no risk or no reward and 10 indicates max risk and max reward.

Keep in mind that the following discussion pertains only to passivity of income for each method. By that measure, Income Methods such as Internships & Volunteering and Active Jobs have no associated risk and reward when it comes to passive income and are thusly marked NA.

Income Method Passivity Index  Risk  Reward
Internships &
Volunteering
-1 NA NA
Active Job 0 NA NA
Royalties-1 1 7 9
Real Estate-1 2 7 8
Royalties-2 3 2 6
Trading 4 10 10
Active Investing 5 8 10
P2P Lending 6 9 7
Real Estate-2 7 7 7
GICs &
Bond Investing
8 3 5
Passive Investing 9 2 8
Savings 10 0 1

-1. Internships & Volunteering

This has a negative index on the scale of passivity for obvious reasons. Working as an intern or volunteering means that you not only not generating passive income, but are also not compensated for your time and effort. However, this does not mean that these are necessarily bad. Internships and volunteering can provide invaluable experience that can benefit you in future career or be beneficial in intangible ways.

Passivity Index: -1
Risk: NA
Reward: NA
0. Active Job
This is your regular run-of-the-mill active job for which you are compensated appropriately. The money you earn as income is directly proportional to the amount of time you put in and depends on various factors such as expertise, experience and negotiation skills.
Passivity Index: 0
Risk: NA
Reward: NA
1. Royalties-1
Royalties-1 is anything that requires immense amount of work upfront. Examples include a book or a patent. If we consider the case of a book, work here involves not only writing the book, but you have to work on negotiating a book deal with the publishers, work with designers, market it with book tours etc. It is for this reason that the passivity index is low on this income method. The risks are fairly high as your book has to compete with a lot of other material out there and can get lost in the noise. But the potential rewards are great. Many writers have been able to retire by simply relying on royalties collected from a best seller book.

Passivity Index: 1
Risk: 7
Reward: 9

2. Real Estate-1
Real Estate-1 includes buying real estate and becoming a landlord to rent and manage the property by yourself. This involves a bit of work as you have to screen the tenants, collect the cheques (the easy part :), act quickly if tenants are missing deadlines for rent cheques, address complaints about the property etc. The risk associated involves ending up with problem houses, having problem tenants, potential of missed income if vacant; but the rewards are great as it provides you with a monthly income and if done right, will result in positive cash flow.

Passivity Index: 2
Risk: 7
Reward: 8

3. Royalties-2
Royalties-2 includes earnings where publishing does not include as much of work upfront. Keep in mind that publishing still requires work, but what I refer to here is where you self-publish or e-publish such as online articles, e-books or blogging. The entry point and the hurdles at the beginning to get started are slightly lower here, but still requires marketing (SEO) and other efforts earlier discussed. In my case, blogging on this site brings me advertising revenue and writing content for third party websites provides me with passive income as well.

Passivity Index: 3
Risk: 2
Reward: 6

4. Trading
This income method involves actively trading on the financial markets, which could be trading stocks, bonds, options, futures etc. Traders buying and selling constantly requires work as time and effort has to be poured into understanding the trade. While not a completely passive method, the risks are extremely high as it requires the trader to time the market, an extremely difficult task, but the rewards are just as great if you are on the right side of the trade.

Passivity Index: 4
Risk: 10
Reward: 10

5. Active Investing
Active investing involves investing in companies that you want to own as a business. This usually involves investing in the company stock and holding it for the long run, with income coming through profit sharing via dividends and distributions. Picking the right companies that can perform well year-in and year-out is the risk involved. Holdings stocks for income can be very rewarding as the dividends start rolling in. As a dividend growth investor, this is one of my primary sources of passive income.

Passivity Index: 5
Risk: 8
Reward: 10

6. P2P Lending
P2P lending involves lending money to another person for a higher than market interest rate, which can be rewarding if the borrower pays back. However, the risk is higher as you have to trust that the person would pay the loan back, and on time.

Passivity Index: 6
Risk: 9
Reward: 7

7. Real Estate-2
Real Estate-2 is similar to Real Estate-1 except that a property manager takes care of all the hassles for a small fee. The property manager acts as a middle-man dealing with the tenant, providing the owner/investor with more free time making this option more passive. The risk stays the same between the two options, but the reward diminishes a bit due to added costs.

Passivity Index: 7
Risk: 7
Reward: 7

8. GICs and Bond Investing
Investing in GICs and bonds can be quite passive and have a passivity index of 8. However, investors have to keep an eye out for macro economic measures and where the interest rates are going. Since the Fed and/or central banks around the world do not change interest rates on a monthly or quarterly basis (even though they meet frequently), the investment horizons are generally in years and decades. The risks are low as it is guaranteed income for the period, but there are risks involved nonetheless. If the interest rates rise, the face value of the bonds can fall. Similarly, GICs locked-in for years can erode your wealth if there is rampant inflation.

Passivity Index: 8
Risk: 3
Reward: 5

9. Passive Investing
Passive investing is where you simply invest in the financial markets using a fund on a periodic basis. Investors using the passive investing method seldom pay attention to what is happening on a day to day basis in the market and prefer buying broad funds that invest in indexes. This is one of the most common methods of investing, be it for beginners or seasoned investors who do not have the time to follow the markets and monitor closely. The risks are mitigated when using broad index funds and the rewards can be great as long as the expenses are kept in check.

Passivity Index: 9
Risk: 2
Reward: 8

10. Savings
Savings accounts provide the most passivity, but also have the least reward. Over a short period of time, the interest generated by savings accounts can be rewarding, but over time the cash loses value as inflation erodes the buying power. The interest paid by savings accounts seldom keep up with inflation. However, there is no risk associated with savings accounts as they are usually insured by a federal agency.

Passivity Index: 10
Risk: 0
Reward: 1

So there you have it. That should provide you with an idea of how to generate passive income and understand the risks and rewards associated with each. I would love to hear your thoughts, comments and/or questions. Feel free to start a conversation below.

18 thoughts on “Passivity of Income

  1. That’s an interesting approach R2R, but I can’t fault your logic. My goal is also to stay as far away from the center of that chart as possible. By the way, I really like the simple/elegant aesthetics of that chart. As I talk about in my free monthly newsletter, the risk/reward balance rarely stays static for a given asset! We need to find situations where they are skewed in our favor.
    -Bryan

    • Glad you liked it, Bryan. You are right…the trick is to find investments of assets where the risk/reward balance is skewed in our favor.
      Yeah moving away from the center of the chart, provides more passivity, but a lot of them also come with increased risk/reward….it depends on each person’s appetite to pick the method to use.

      regards
      R2R

  2. Interesting post…I imagine this would be very helpful for someone ready to invest but not sure which risk reward level they want to be. You even included P2P lending. Our family has been investing in P2P notes for a couple of years now and we love having them as part of our overall investment strategy. Thanks for sharing.

    Wishing you continued success in your journey!

    • Thanks for stopping by and the comment, AFFJ.
      Yes, this was supposed to be an overview of different methods of earning passive income – esp targeted towards people who are unfamiliar with the concept.
      Im glad to hear that you are using P2P and the strategy is working for you – Ive never tried it as we lack the services in Canada.

      regards
      R2R

  3. R2R,

    Thanks for the mention! I like how you took the passivity index and expanded the idea further. It’s definitely a challenge finding the right balance between passivity, risk, and reward. I guess if there was just one size fits all then everyone would be doing it 😉

    • Thanks for the inspiration, FIFighter. Yup, there is no one-size fits all and everyone needs to find what works for them. Im enthralled by your build up in real estate assets and want to use that partly as a strategy….but that’ll probably come in the future.

      regards
      R2R

  4. Hi R2R,

    Really like the post, because only recently I had a discussion with a friend regarding the passivity of my new DGI adventure. Picking the right investments and keeping up-to-date with all news regarding my portfolio is indeed taking quite some time, while from a financial perspective I would have been better of just using these hours for a second job! So according to him, my DGI adventure was anything but leading to passive income. In fact comparing the hours spend to the income received it was one of the worst paying jobs I have ever had :-). Of course I see it a bit differently, and while the initial buildup of the nest-egg will take a considerable amount of time from my side, in the end it will lead to a serious passive income stream that will need only limited upkeep. As such I think DGI has two phases with different levels of passivity. During the initial accumulation the passivity is low, as it requires a lot of time to build a proper portfolio, however all this invested time will in the end lead to a portfolio from which one can live with only limited time invested. Ergo high passivity!

    Best,

    DW

    • D&W,
      I agree with your viewpoint. While you are building your nest egg, you do need to spend a lot of time and effort into filtering out the bad ones while choosing the right company. But once you’ve chosen, you simply have to stick with it, follow up maybe on a quarterly basis to see if things are ok. That is a very small price to pay for a continued income stream, which grows year after year. And most dividend growth investors can achieve all the diversification they need with 40-50 stocks. So once you are there, you just cycle through them and keep reinvesting in the same companies.

      When investors start out, they watch things like a hawk. Watching the move every single day, which is unnecessary, but I think as time passes by, you start to learn that you dont need to watch your stock ticker symbols every minute.

      regards
      R2R

    • Im glad you liked it Asset-Grinder. As I mentioned earlier, this chart is more for people unaware of various methods of generating passive income and the associated risks-rewards that come with each.

      Best wishes
      R2R

  5. This is such a great concept. I am really grateful you shared it. While I always realized degrees of passivity existed, I never really considered how they all fit together. This is a great starting point for me to think about my own investing, working and savings to see how they each contribute to the bottom line.

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