“Financial freedom is freedom from fear.”
– Robert Kiyosaki
A lot of people think passive income is a magic bullet.
They believe you can put money in a passive investment and it spits out cash.
You live happily ever after nothing else happens.
Anyone who’s been an investor will tell you that’s not the case.
Passive investing does take a fair amount of work.
It’s not fully passive because no one cares about your money the way you do.
That’s where it’s so important to educate yourself.
Learn about passive investing.
You’ll find that a lot of the work is on the front end.
Passive investing also involves a different type of judgment when compared to active investing according to this study.1
You find deals, evaluate them, and figure out what’s right for you.
Let’s talk about it!
1. The Passive Investing Myth
The big myth when it comes to passive investing is that you can throw money in an asset and it spits out cash forever.
Your feet are up and you’re drinking Mai Tais.
That might be your experience, but it hasn’t been mine.
The process of passive income is putting money into something after you’ve done the research.
You need to figure out if the asset can actually work for you.
Like I said before, all the work is usually on the front end.
But what passive income offers is a more passive experience.
You’re not the one managing the investment.
You’re not the one operating it.
You’re simply getting statements and getting cash flow.
2. Common Pitfalls and Risks
There are some common pitfalls with passive investing that we should talk about.
The first one is that passive income is not truly passive.
In my book, Fire Yourself, I talk about when I had a small single family rental portfolio.
It was great at the time!
I decided I wanted to go to Cleveland.
The numbers looked amazing.
You could buy homes up to $30,000, fix them up a bit, and rent them out for $1,000 a month.
Sounds like a home run, right?
Well, it was okay, until somebody stopped paying rent or until the 100-year-old house started falling apart.
Sometimes things can look great on paper, but they’re a lot more work than they seem.
For me, it was more time than I was willing to dedicate.
That’s pretty common with single family, even if you have a manager.
You also see the extra work in vacation rentals.
These types of properties are usually not fully passive.
If you have trouble spotting the extra work, I have a pretty easy test.
Ask yourself: Are you able to 10x what you’re doing?
If you have three rental houses, could you immediately go to 30 and manage them in the same way?
If the answer is no, then you’re not really doing a passive investment.
It’s more like a full-time job.
Stock trading is pretty similar.
They both require a lot of energy,
Another risk is overestimating returns.
If we can underestimate how much time an investment will take up, we can overestimate other aspects of the deal like its returns.
For example, if you’re a professional, your time has value.
This is true whether you make $40 an hour or $500 an hour.
If you’re doing calls on other sources of income, you have to take that into account.
The returns are probably not as good as what you’re thinking.
When compared to your first steam of income, is another job worth it?
Another risk is the lack of diversification.
A lot of people think if they put all their money into one deal, it’ll produce a huge return.
But there’s a lot of risk in that strategy.
It can be good to diversify into some different assets to avoid this.
Diversifying your investment portfolio has even been proven by studies like these to reduce volatility without sacrificing expected returns.2
Market volatility can be another pitfall.
Certain assets can be affected in different ways.
Do your research and use your own judgment.
3. The Positives of Passive Income
A huge positive to passively investing is the promise of time freedom.
I think time freedom is way more important than financial freedom.
Time freedom is what allowed me to quit my job and travel six times internationally last year.
Having the flexibility to do that was incredible.
I want that for you as well!
You should have time freedom so you can spend time on what matters most.
You can make more money, but you can’t make more time.
Another positive of passive income is scalability.
Unlike a job, you can grow exponentially by putting more resources toward assets that you like.
And, as a bonus, you don’t have to manage those assets like you might have to at a job.
If it’s truly scalable, it qualifies as scalable passive income.
The last positive of passive investing is long-term stability.
Even if you have some diversification, not everything will go perfectly.
There’s risk in every investment.
If you can’t afford to have a loss somewhere, you shouldn’t invest.
But if you have a certain amount of money in different places, you will see growth over time.
In conclusion, passive income is not a magic bullet.
It requires investment in yourself.
This is where networking and education are valuable.
(Even educational blogs like this!)
Networking is going to meetups and conferences to meet other people.
Ask them who they’re working with.
What investments have worked?
Which ones haven’t?
If you’re a passive investor, get connected with other passive investors.
That’s one of the most important things you can do.
We recently started a mastermind called The Wealth Forum.
It’s a group of all high-net-worth passive investors.
We talk about deals that are working, tax strategy and allocation, and mistakes we’ve made.
We’re also an investment group.
We want everybody to do our deals.
I generally want to help people, but we’re still biased.
Other passive investors usually don’t have a bias.
They simply want to find the best deals and help others find them as well.
Now I want to hear from you!
What risks and benefits are you looking at when it comes to passive investing?
Let us know in the comments.
Before you leave, make sure to check out our special report about inflation investing. It shares the best choices to invest during an inflationary environment.
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.
Works Cited
1. Trevor Daher and David J. Rapp. “An Austrian Critique of Passive Investing.” Quarterly Journal of Austrian Economics (2023). https://doi.org/10.35297/qjae.010159.
2. Nicholas Reinholtz, Philip M. Fernbach and B. D. Langhe. “Do People Understand the Benefit of Diversification?.” Financial Literacy eJournal (2016). https://doi.org/10.2139/ssrn.2719144.
