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The Active-Passive Income Spectrum

Alicia Schneider
February 8th, 2022

Passive and active income aren’t just two opposite points of a scale, but rather a spectrum of different income possibilities. Do you know where on the spectrum your income falls?

Typically, we’ve learned to divide income into two categories: active and passive. Active income is the money you earn from work, such as a 9-5 job, and passive is income you earn from things unrelated to your job, such as investments, real estate, or even running a blog.

While it’s true that active and passive income represent opposite ends of the scale, there are grey areas in between that render some passive income more active and some active income more passive. Considering the possibilities of income on a spectrum will enable us to manage our time and our wealth more efficiently and purposefully.

Why Do Active and Passive Income Exist on a Spectrum?

For income to be truly passive, that would imply we’re putting in little to no effort to earn it, which isn’t always the case. Let’s take real estate as an example. When you purchase a property with the intention of turning it into an investment property, you likely first need to renovate it, post it for rent, interview prospective tenants, and handle repairs and maintenance. Even if you hire a property manager to handle all the day-to-day responsibilities for you, you’re still putting in time and effort to find that manager and ensure everything runs smoothly. Investments, too, can be more active than passive if you’re constantly spending time rearranging your portfolio or buying and selling stocks.

When we think of passive income, the goal is to have money flowing into your bank account even while you’re not “at work.” But, instead of looking at passive income as a “set it and forget it” model, we might need to consider redefining what it means: passive income is a form of income that isn’t 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 Do Different Types of Passive Income Look Like?

Think of a real estate investor, Sam, whose ultimate goal is to relax on a tropical beach, unbothered, while watching the numbers in her bank account go up and up. With certain types of passive income, Sam might not get to relax as much as she’d like. Let’s take a look at why that might be.

Self-managed Rental Properties

Sam has several rental properties that she manages. While this doesn’t take up all her time, she often gets calls from tenants. Sometimes things in the apartments break, or tenants move out and need to be replaced. These issues don’t come up every day, and her rental properties still provide her with a good amount of income without working a traditional 9-5. Still, she likely won’t be able to go on vacation completely uninterrupted without something coming up that requires her immediate attention.

Managed Rental Properties

Sam decides to hire a property manager to handle all the day-to-day tasks with her tenants. With a property manager, Sam is now looking forward to laying on the beach all day with a stack of books and enjoying the benefits of passive income. But, during her vacation, one of her rental properties completely floods. The unit now needs thorough inspection, insurance companies need to get involved, and major repairs need to be done. This is something outside of the property manager’s control since it requires Sam’s involvement to sign off on major financial decisions.

Real Estate Syndications

Having experienced both self-managed and managed properties, Sam decides to shift her real estate investments into real estate syndications as a limited partner. With a real estate syndication, Sam can reap the benefits of passive income with almost no intervention on her part. She no longer has to worry about her tenants or property managers as that’s the syndication’s general partners’ duty. That being said, she did have to put considerable time and effort into vetting the syndication to ensure the managers were trustworthy and that her investment was likely to grow.

Traded REITs

Alongside her real estate syndication, Sam also decides to invest in traded REITs. She looks into different types of REITs that will allow her to invest in various kinds of properties, all while enjoying a daiquiri on her beach lounger. REITs are typically a reliable source of passive income in that they usually generate high returns with low risk and little to no involvement from the investor. So, Sam can rest easy knowing that her traded REITs are backed by real properties and offer the liquidity she’s looking for.

Considerations for Truly Passive Income

In a perfect world, how much you’re able to relax on a beach would be the only gauge for the best format of passive income streams. However, in reality, there are a few other factors that need to be taken into consideration. When choosing your passive income streams, whether they’re self-managed properties or REITs, consider your goals and preferences for this source of income. Here are some factors you want to keep in mind:

  1. Tax Implications
    Each type of passive income has its own tax implications. The tax implications on passive income can be more intricate, especially if you own multiple properties, and can end up eating into your profits. However, real estate investments generally offer greater tax benefits than other sources of passive income, like investing in stocks, which is why many investors opt for passive income stemming from real estate.
  2. Liquidity
    Some investors prefer having higher liquidity, which might mean opting for passive income streams with higher risk or low returns just to have access to liquid assets. For example, publicly-traded REITs tend to provide liquidity for investors, whereas non-traded REITs and syndications are often illiquid for long periods of time.
  3. Market Correlation
    Like liquidity, market correlation also comes down to personal preferences. Some people want their investment to move at a positive rate compared to the public market to ensure steady growth. However, others might look for negative correlations to help reduce risk without jeopardizing their returns.
  4. Ability to Leverage
    Leveraging cheap debt to finance an investment is one of the most common ways to substantially increase wealth, but not all investments can be leveraged or it might be too risky. For example, a directly-owned real estate property can be mortgaged, leveraging the property and putting little to no cash down. However, a publicly-traded REIT, which is more passive than an investment property, cannot be leveraged in the same way, therefore the cash on cash profit potential is a lot lower.

Final Word

We’ve traditionally looked at active and passive income as two opposites, fitting income streams into each category. However, we should consider looking at them as two ends of a spectrum with many income opportunities in between. Vyzer enables you to stay on the more passive side of the spectrum, providing you with a quick and reliable way to oversee your passive investments (and even your more active ones).