Five Categories of Passive Income and How to Evaluate Them

Today we’re going to continue with some thoughts from Passive Income, Aggressive Retirement by Rachel Richards (which I highly recommend BTW).

If you missed part one of my thoughts on this book, check out Passive Income, Aggressive Retirement.

BTW, I think a better title for the book would be “How to Become Financially Independent by Creating Multiple Streams of Passive Income”. But that might be a bit too long…hahahaha!

In this post we’ll cover the five main categories of passive income, how the author recommends evaluating them, and how I like evaluating them.

We’ll also discuss how passive these ideas really are (or aren’t).

Let’s get started…

Five Categories of Passive Income

We begin with Richards listing the five main categories of passive income as follows:

  • Royalty Income
  • Portfolio Income
  • Coin-Operated Machines
  • Ads and E-commerce
  • Rental Income

She then describes each in detail. Here’s a quick summary:

The first type of royalty is a payment for the use of literary works, such as copyrights, trademarks, and patents. Another type is a trademark, which protects brand names and logos. Patents protect new inventions and designs. The other type of royalty has to do with mineral rights.

Portfolio income, which by the IRS is considered neither active income nor passive income, still fits the passive income definition by my books, since it’s earned with little to no work. Portfolio income comes from interest, dividends, and investments.

With coin-operated income, you have some type of machine, and the end-user pays you for the use of that machine—think vending machines, ATMs, arcades, and laundromats.

Next, you have advertising and e-commerce. You can earn income from ads, participate in affiliate marketing, or sell products passively with drop shipping.

Rental income can be indirect or direct. You indirectly earn money from a real estate investment trust (REIT), which is covered in the portfolio income section. Or, you can directly own and lease a property, room, or storage space.

Here are my thoughts on each of these:

  • I’m not a big fan of royalty income as 1) there’s a big upfront time commitment and 2) the chances of making any reasonable amount of money are slim. As we get into how I evaluate income opportunities it will become plain why I don’t spend a lot of time in this category.
  • Portfolio income is a different story. I receive dividends from my index funds (income isn’t the primary reason for investing in stock index funds but income is generated from them all the same), dividend stocks, and private real estate loans. This is one of my favorite categories.
  • Coin-operated machines have always intrigued me and I’d love to own some. I’ll chat more about my thoughts when we dive into the various options in this category.
  • The ads and e-commerce section is a bit fuzzy for me. Is she talking about blogs? If so, I’m all in. I think most people can make a decent side income with blogs if they apply themselves. That’s why I wrote Five Steps to Creating a Winning $25k Blog. If she’s talking about something else, I’m not sure what it would be (other than drop shipping which sounds so 1980 to me — I remember those offers were big in magazines I read back in the day).
  • I think you know what I think about rental income. I also like the idea of renting out your space and investing in storage companies. More on this to come.

Now of course these aren’t the only ways to create side incomes. But they are what the author says are the ways to create PASSIVE side incomes.

But you might be thinking “these aren’t passive!” Me too.

Well, the author addresses that issue as well…

Two Stages of Passive Income

Richards shares her thoughts on what defines passive income as well as admits it’s not all passive as follows:

I know some of you are thinking, “these aren’t passive! It takes time to manage tenants and fill vacancies.”

By no means will I mislead or make elaborate promises about what passive income is, so: You would be correct, friend.

All passive income streams require upfront time or capital to build in the first place, and saying that they’ll magically generate cash with zero work after that would be disingenuous. But once the income stream is created and going, the work you must put in to maintain that income is minimal. Cha-Ching!

Passive income has two stages:

Stage 1 consists of the time, work, or money you spend building the income stream. Make no mistake: it’s work. Stage 1 isn’t the “magical” part. If you decide to create and launch a course, for example, then Stage 1 includes all the time it takes to write, edit, record, publish, market, and launch the course.

Stage 2 is when it becomes passive. After you’ve created, built, or launched the income stream, it’s much more, if not entirely, hands-off. With a course, maybe you’re putting a couple of hours in each week on marketing activities to maintain the income. Maybe you outsource even that to make it more like a couple of hours per month. Compare that to the 9-5 job where you’ll be working 40 hours per week for the rest of your life. Passive income is maintained with little to no work; it’s not built with little to no work. Remember how I mentioned how hard I worked for those two years building my passive income streams? I put the time in up front to get them into place, and then I retired.

You may spend ten, twelve, or twenty months in Stage 1 building the passive income stream. After it’s launched in Stage 2, you put in minimal work to maintain the money coming in.

Several thoughts on the above:

  • I’m glad she recognized that there is a time and/or money commitment that can be pretty substantial. Most books on passive income (and websites for that matter) that I’ve read gloss over this fact or greatly minimize the actual cost.
  • I need to say this upfront: there are very few (if any) completely passive income opportunities. Even the ones that are mostly on auto-pilot require attention, administration, etc. now and then. So phrases like “entirely hands-off” and “no work” over-reach a bit IMO.
  • That said, her approach to the topic seems much more honest than almost anything else I’ve ever read on passive income. And it’s true that “after you’ve created, built, or launched the income stream, it’s much more hands-off.”
  • There’s really a range of passivity from little work to actively involved. This is one of the factors I use in evaluating what activities I pursue and which ones I ignore. We’ll explore these in my next post.

Before we leave this section, let me share this from the book:

Passive income has nothing to do with multi-level marketing (MLM) Companies. There will be no mention of MLMs in PIAR (this book). MLMs fall, without a doubt, into the active income category. It’s sales, it’s recruiting. Nothing about those activities are passive.

I see MLM included in many passive income lists which is a complete nonstarter for me. I wanted to be sure you knew that she was NOT including this in her lists.

How to Evaluate Passive Income Opportunities

Next the book gets into the five factors she uses to evaluate different passive income opportunities.

Her thoughts:

Not all passive income is created equal. Each type has pros and cons. Luckily for you, I did my homework and created a system for evaluating one passive income stream against another using five different factors. I call them the Factors of SCRIMP.

I love that they spell out a word that means being frugal and thrifty since you won’t have to do that once you build your passive income empire. Without further ado, here are the Factors of SCRIMP.

  • Scalability: Can it be produced or offered en masse?
  • Controllability & Regulation: How much control do you have over it?
  • Investment: What is the upfront time or capital investment in Stage 1?
  • Marketability: Is there a need for it?
  • Passivity: How much work must you do to maintain the income stream in Stage 2?

These are fine IMO and I look at the same sorts of things when I evaluate income opportunities, but I’d break mine down as follows:

  • Cost. What is this activity going to cost me in time and/or money? The answer to this is usually pretty straightforward.
  • Income. How much can I make on this? I generally like to pick a low to average number here just to be conservative.
  • Success. What are the odds of this project actually being successful?

That’s it.

Many of her factors are included mine — they just aren’t highlighted separately. For example her “marketability” is included in my “income” — if it’s marketable and with a large audience willing to pay a high price, it will generate a nice income.

To see how I evaluate opportunities, let’s take the example of creating and launching a course. This one works well since she mentioned it above and it’s one I’ve thought about for a long time.

Here’s how I look at the opportunity:

Cost

The cost is mostly in upfront time — researching, writing, and creating the course. The hours could be very long indeed — probably several hundred.

Once the course is created, the hours drop dramatically. There’s generally still maintenance, updating, order processing, and the like, some of which can be farmed out but some which would likely require my attention.

The monetary costs can be high (if you do custom video) but don’t have to be, so maybe $2,000 at most. IMO you do need a few bells and whistles if you want to charge a decent price and those come at a cost.

Income

If you hit on the right topic, you can make a very large amount. I know bloggers that earn $10,000 to $100,000 per month with their course(s).

Of course a lot of things have to go right — you must find the right topic, create an awesome product around it, and market it well.

To me the first is the hardest, picking a topic that’s new, exciting, and something people will pay for (not to mention a topic I know something about). The others are easy comparably IMO.

Success

Given how hard it is to find a great topic, I’m going to say that the odds of large success ($10k per month or more) are pretty low.

On the other hand, as long as you have an audience, can market well, and have a decent product, you could probably make $1,000 or so per month on almost anything (within reason).

In addition, I see people making money on all sorts of what I would consider to be bizarre topics, so maybe it’s easier than I think.

Evaluation

Given the above, do I want to invest a TON of time into creating a product?

As you know, I’m retired and don’t need the money. So I’m not really too excited about spending hundreds of hours on anything I don’t enjoy 100%. Especially if I have low odds of making a meaningful amount from it.

That said, I do have some knowledge I think could help people, I could create the product with my son and/or daughter helping me (which would make it more fun), and I would learn a lot and be challenged in the process, helping to keep my mind sharp. So there are non-monetary benefits to consider.

So far, I haven’t decided whether or not to proceed with this idea. I’m still on the fence.

That’s how I look at these opportunities. What do you think of my process? How do you do it? Do you think I should proceed in creating a course? 😉

To read more on this book and topic, check out 28 Ways to Create Extra, Passive Income.

 


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