Passive income has become a buzzword these days: the idea that you can invest in assets or anything that allows you wake up in the morning and see payments on your bank account credited during your sleep.

There’s millions of trainings out there that stir up people’s enthusiasm about the idea of earning money while they sleep. But there’s really nothing special or magical about this idea and it’s happened to a lot of people for a very long time, way before the dawn of the internet.

Your bank earns money while you or most of its employees sleep. If you buy a property on a different time-zone and rent it out, you’re earning money when you sleep every time your tenant pays his rent. When you earn interests on your deposits, or rebates on your credit card, you’re also earning money while you sleep. And sure, if you have an internet business, a website that sells anything, people can buy online at any hour of the day, including when you sleep. But that’s also true of a brick and mortar store, if you hire employees and delegate the work. You may go take a nap while your business still earns money.

Now the question is: what happens if you nap a little too often?

Is passive income really passive?

A lot of people hold this silly notion that passive income is a bit like having a slot machine, where you just pull a lever and it spits out cash to support your lifestyle. That would be nice, although entirely unrealistic, because passive income is not so ‘passive’. And it’s not for two reasons: upfront investment and maintenance work.

1 – Upfront investment

All things that produce so-called ‘passive income’ need to be built or acquired first. And the higher passive income they can produce, the more labor they require to build or the higher is the price to acquire them.

A stock gives you dividends and dividends can be considered passive income. However, the higher the dividend expectation, the higher also the price of the stock, since the price itself is fundamentally the expectation of all future dividends at the net present value.

So, passive income doesn’t come for free. It requires money or labor upfront, and usually a mix of both.

Unlike a fixed-salary job where you’re trading time or labor for money at a steady pace, building a passive income stream usually requires a high upfront investment that doesn’t pay off until later. Maybe you work your tail off for years at your start-up before ever seeing your first profit. Maybe you take a mortgage and just use the rental proceeds to offset the payments for years, until you finally own the asset.

Whether it’s labor or money (and you can also use money to acquire labor), there’s usually a huge upfront investment to creating any stream of passive income.

2- Maintenance work

Stuff breaks a lot more often than you think. Things that seem easy on the surface present a lot of problems on the backhand. Even running this blog requires a lot of fixes, plugins, updates, just to post articles.

So imagine when a business gets just a little more complex and starts to include enquiries, refunds, handling, shipment, cybersecurity, taxes, intergrations etc. Surely, you can outsource a lot of that stuff, but it will still eat into your profits and require some level of supervision.

Besides, nothing stays the same: consumers change their preferences, new technologies enter the market, competitors catch up, you may be victim of scams, cyber-attacks, stuff breaks, updates are required and the list goes on.

You can’t expect to build something, never touch it again and let it produce cash for you. Even if you’re investing in real estate, you need maintenance work for the property, dealing with brokers, tenants, buyers, land departments, accountants, taxes etc.

If you’re invested in the stock market you still need to manage your portfolio to some extent, exit positions that may cause huge losses, hedge against risks that might suddenly emerge etc. Surely, you can have a very long term strategy that may not require too much rebalancing or hedging for example, but it’s not like you’re never going to look at your portfolio again. Especially if you want it to produce a regular stream of income to support your lifestyle (and even then you need a sizeable initial capital, which still begs the question of how did you build that to begin with).

Earning passive income: that little thing called initial capital

When people think of passive income they only tend to look at the brighter side. They compare passive income with working as an employee and view passive income as an escape from wage slavery.

However, the difference isn’t so clear cut. For example, let’s say you’re selling a digital product or earning royalties from songs or books, some of the most desirable and scalable options: your earning potential is unlimited (unlike your salary) and the work required on your part is virtually down to zero, true. These are some of the most optimistic cases (very few artists make a living from royalties out of the millions who play in a band, write a book, or perform in theaters, worldwide). However, you need to look at the downside risk too.

In general terms, we might say that being an employee has limited upward potential but also lower risk: you can either earn your salary or stop earning your salary.

But generating passive income, as we’ve seen, requires acquiring or building an asset first. You might pay a lot of money for the asset (or put in a lot of work to build it) and then see its value come all the way down to zero. You may buy a company that goes bankrupt and lose your entire initial capital, or buy an apartment that gets destroyed by a tsunami or lose 50% of its value because the market crashes.

Hence it’s crucial that you acquire the right asset, or build the asset the right way to stand the test of time and all market fluctuations: picking the right stock, choosing your property in the right location, buying insurance or other hedging mechanisms, so on and so forth.

But all these things, if you want to edge out the competition, still require due diligence. They require work and research on your part. Ultimately you’re not being so passive, once again. Most of all, they require capital to begin with!

Don’t forget that you’re risking your capital anytime you create a passive income stream. And if you build it from scratch, aside from the labor you’re putting in, there’s an opportunity cost to whatever you’re doing (the money you’re forfeiting by working on that thing as opposed to getting a salary or doing something else).

Either way, it’s not an entirely passive process.

Earning passive income: that little thing called competition…

Now let’s say that you structure your business in such a way that it produces passive income, meaning it doesn’t require you to actively work on it all the time.

One thing you need to account for, is competition. If you’ve created a business model that works, you can rest assured that a lot of people will jump in soon enough to get their piece of the pie, offering the same thing at a cheaper price until the profits for all are virtually down to zero. That’s just basic economic theory.

Don’t forget that you’re risking your capital anytime you build a passive income stream

That invariably happens unless… there is a barrier to entry. The barrier can be a patent, an exclusive license, a government restriction etc. All these things are pretty hard to acquire for you as an average Joe.

So, the most viable barrier you can create is: your business is complex enough that it’s not so easy to replicate. It means that what your business does, others can’t do so well. And that again requires skills and work!

Easy business model to create = low barriers to entry = easy for anyone to copy

You can’t be so naïve and expect to create something that’s both easy to build, easy to manage and earn big profits in the long term.

Earning passive income: the breakneck pace of technology

Everyone these days, dreams of having an internet business, because they think they can manage it from anywhere and just watch the payments flow into their bank account while lying under a palm tree in Costa Rica.

That’s entirely possible with the right strategies, some work and a dose of luck and many people have successfully done it, but – especially in the tech space- things change all the time, so you might be sitting under that palm tree for too long and find that your entire business is gone.

For example, new technologies come into the market all the time and if you’re not quick enough to adopt them, you’re going to be left behind. Also, algorithms change all the time. Whether your lead generation system is based on Google, Facebook ads or Youtube, whether it’s organic or paid, you can’t expect to do nothing and see your prospects flock to your website indefinitely.

There is a constant war to appear on the first page of Google for any keyword, there’s endless new players spending money in ads and competing for your customers’ attention and the list goes on.

If you want to get a sense of this, go to SEMrush and key in your favorite website. You can see how it’s doing in terms of SEO, what are the keywords it ranks best for and where it’s getting traffic from.

At the very top, you see a chart that shows its traffic over time. Well, that graph looks a lot like the stock price of a listed company!

You thought you didn’t want the life of a CEO who’s stressed about quarterly results and stock price? Or the fund manager who’s concerned about the daily trades? You thought you could sit under your palm tree while your online business produces passive income? Think twice. You might end up checking that SEMrush graph in fibrillation just like a CEO does with the stock price..

Earning passive income: the cost of delegating

Finally, we come to the real key to getting labor off your hands: outsourcing and delegating. Yes, that’s actually a straightforward way to stop working so many hours or needing to be in a certain place at all times.

You build something, put good people to manage it, and earn income in a ‘passive’ way. Sounds workable.

You can do it pretty much with everything. Buy properties and get an agency to rent them through Airbnb. Get someone to invest for you. Build a business and outsource all the technical work or hire a managing director, etc.

Again, unfortunately this process isn’t really that passive. First off, outsourcing and delegating still costs money and that will eat into your profits, to different extents. Doing it well is key to succeeding at business, but it doesn’t come without any effort on your part. Because you need good screening and selection, first. Or testing and trying different outsourcing options that many times will produce low-quality output. Then people need training. Sometimes they leave and you must work to replace them. Labor in countries where you outsource may increase too and the list goes on.

Also, the higher their skillset you need, the more they will presumably cost you. And if you train them up from scratch, at one point they’re going to demand more because they’ve increased their value. Competition may poach them too. And if you delegate so much because you want to be hands-off and carefree, then some of your key employees may become so indispensable that they will start to expect equity.

Sure there are still a lot of good-quality options for outsourcing in India, Pakistan and the list goes on, especially if you can handle stuff remotely. But depending how much you scale things up, you eventually may need management-level staff or partners etc, with all the costs associated. Also, some professionals will cost you no matter what: lawyers, tax advisers, brokers, bankers etc.

Either way, this isn’t such a passive process either, because just like technology, consumers’ preferences, laws and regulations do, also people change and evolve all the time. Surely hiring and nurturing the right talent or outsourcing properly can be a key to your competitive advantage, but it just doesn’t happen to be such an automatic or effortless process too.

So, is passive income possible?

The final verdict is… yes. Passive income is entirely possible and the advice of investing in assets that produce returns is a sound one. But it’s probably a much slower process than you’d think.  For most people that will mean working and regularly investing for the first half of one’s career to build that stream and then enjoy the benefits ten to thirty years later. Although this is a sound financial strategy, we must be clear on what ‘passive’ truly means.

Your income generation can be only as passive as you are willing to increase your risk, invest more capital or decrease your relative profits. You can have ‘passive’ income but there are different degrees of passive and different degrees of income. 

And for anything you get, there must be something you give. Because ultimately, in the market, there’s no free lunch.

Also published on Medium.