In Defense of Active Income

We love to opine on passive income. Whether it be side hustles, investing in the market, or real estate, there is no bigger more audacious dream than reaping the benefits of effortless revenue streams. In fact, some define financial independence as the point when passive income streams meet monthly spending needs. We have become so exited about early retirement that the one more year phenomenon has become anathema. Yet, there are some clear benefits to the other side of the coin. Active income streams have several benefits that we often overlook because the idea of work chaps our hides.

Throughout my career, I have built up active income streams. I think of the W2 (or 1099) wages as its own asset class.

There are several advantages to being heavily invested in this asset class.

Capital Consumption

Building passive businesses, real estate, and investing in the market all have one thing in common. They are generally capital-intensive. You mostly have to invest money to make money. The whole idea is that your money is doing the work for you.

There is just one problem. The seed money used for these ventures is consumed in the investment. Once it is tied up, it can no longer be out there producing for you.

Active income, however, doesn’t require anything but a skill set or knowledge. While the educational process in the past might have been expensive, it costs nothing to do a hard days work. There is no capital consumed in showing up for your daily W2.

I can invest $20K into a down-payment on a rental property that may cash flow $5K a year. Sounds good, right? Or I could work a few hours a week and also earn $5K a year. I could take that $20K I was going to use as a down-payment and plunk it into an index fund which will also return an extra $1k (making 5%).

Which numbers look better to you?

Passive Income Pains

Another issue is the true passivity of passive income streams. While no one would argue that the stock market is relatively passive, often other activities lumped into this category don’t hold up to the sniff test.

I love real estate. But owning a real estate empire large enough to support oneself is anything but passive. Often it starts looking like active income after one considers time spent searching, financing, renting, and managing a group of properties. It may feel more luxurious than stumbling into a 9-5 everyday, but it does require effort.

Most businesses, blogs, podcasts, and amazon sellers face the same issue. You are going to work one way or another!

Diversification

And of course, our old friend diversification rears it’s pretty head. Active income streams add an important layer of diversification into any financial plan. Passive income streams are fragile, and can break at any time. Real estate can incur costs or a neighborhood can become less sought after. Amazon sellers are outperformed by the newest guy on the block and find no one buying their products. The stock market can crash.

Although not fully uncorrelated from passive streams (when the economy tanks all asset classes can be hurt), active income streams tend to be more resilient especially if one has a specialized skill.

Final Thoughts

I love passive income opportunities. They hold the dream of creating a perpetual money machine that requires very little maintenance or effort. In reality, however, active income streams provide a number of advantages. They not only avoid capital consumption but also add an important layer of diversification to any financial plan.

I may be ready to downsize and fade towards retirement in my medical career.

But I’m not giving up on active income streams just yet.