Let’s clear up some confusion about active and passive income. I’ve been writing about this topic since 2009, and it seems there’s still a lot of misunderstanding. Earning passive income isn’t a walk in the park. It took me from 1999 to 2012 to make enough passive income to quit my investment banking job. And then another five years to support a family of four in pricey San Francisco.
Even though I made enough passive income in 2017 to not work, I still generate active income to increase my passive income. Why? About 60% of the reason is to keep up with inflation. Costs for housing, healthcare, and tuition are skyrocketing, especially when you have kids. The other 40% is a mix of habit, greed, purpose, fun, and the comfort of financial security.
Active income is any income that demands your constant time and energy. It’s the money you get for performing a service. You can’t have permanent active income without investing time and energy. Sure, you can earn active income temporarily without any effort, like getting a salary while you’re sick or on a paid sabbatical. But in the long run, you need to put in the time and energy to generate active income.
Common examples of active income include salary and bonus, stock options, consulting, tips and commission, and gambling (which is a terrible way to make money long term).
People often ask me why I don’t count blog income as part of my passive income. The simple answer is that writing these posts takes time and energy! They don’t write themselves. I spend around two hours writing a post, then another 30 minutes to an hour editing it. I also spend time updating my archive of about 2,500 posts with new relevant information. When I’m not doing that, I’m responding to emails from readers, journalists, and business development employees. All these activities take up 15-20 hours a week of my time and energy. So, blogging and podcasting income can’t be considered passive income.
Passive income, on the other hand, is any income that doesn’t require your time and energy. You earn money while you’re sleeping, playing, or relaxing in the hot tub. There are only two ways to increase passive income. One is by investing more in the asset class. The other is if the asset class increases its returns on its own. You can’t generate passive income without first making active income. Your capital has to come from active income savings to then reinvest in passive income generating assets.
Common examples of passive income include stock dividends, bond coupon payments, certificates of deposits, savings at a bank, private real estate investments, venture capital returns, social security, lending money, royalties from books, music, and art, and lifetime pension.
Semi-passive income is any income that requires some of your time and energy, but not as much as active income. I define semi-passive income as requiring no more than 10% of the hours required to generate the same amount from working (active income).
Common examples of semi-passive income include rent from rental properties, eBooks, online courses, old posts, old videos, and drop shipping.
The main reason why people get confused about the difference between active income and passive income is due to crafty marketing. Someone might be selling you an online course about how to make more passive income without having to do any work. If so, they’re selling you a pipe dream.
You should always wonder: If someone can get so rich from their investments, why bother selling courses? Just keep getting richer by investing!
Contrary to popular opinion, the ideal total income composition is not 100% passive income. If 100% of your income comes from passive income, you will likely feel lost. It means you are not doing something you love, what you’re good at, and what the world needs. In other words, you have not found your ikigai.
Without ikigai, your life feels less meaningful. Without meaning, it’s easy to fall into a pit of despair. A 100% passive income composition is a dangerous situation to be in! You want to feel the constant reward of active income because you want to feel recognized for your efforts.
The key is to generate enough passive income to cover your basic living expenses and then only do the things you love to earn active income. If you do these two things, you will always feel like you’re winning.
In order to generate enough passive income to do what I want, I first had to work 60 hours a week for 13 years. Three of those years were comprised of going to business school part time. After 13 years, I proceeded to work another 10 years on Financial Samurai.
After reading this article, I hope everybody knows the difference between active income and passive income. If you come across those who are still confused, please send them my way!
