Passive Income and Other Money Myths

When’s the last time you saw a headline highlighting some young person making five figures of “passive income” a month?

Your news feed may not look like mine, but I see these stories on the regular, and I’ve clicked on them often enough to tell the algorithms that they should feed me more of that same nonsense. Shame on me for being fooled more than once, but each time I click, albeit with skepticism, my suspicions are confirmed. The person’s income is anything but passive.

The definition of passive income is about as loose as Al Roker’s old slacks, and that’s just one example of the numerous money myths that are pervasive in society today.

I also plan to dig on dividend investing, question budgeting and side hustling, attack travel hacking, and more while channeling my inner Andy Rooney.

About Passive Income

It’s not that passive income doesn’t exist. Investors earn passive income when their savings accounts and CDs pay them interest. When a real estate syndication or fund pays a distribution, that’s passive income too, as is the dividend payment that comes from ownership of a stock, bond, or mutual fund.

All of the above require capital, i.e. money. The more money invested, the more passive income received.

They all require something else to varying degrees, like acquiring at least a little bit of knowledge and doing some due diligence before selecting the investment. That initial bit of work can help ensure that a sound investment is chosen, and, if done well, should hopefully increase your potential return, lower the potential risk, or both.

Investment income of this kind, while it does require a small amount of knowledge or research initially, is about as passive as it gets.

Not-So-Passive Income

CNBC recently featured a 32-year-old mom who makes $143,000/month in passive income. She has a YouTube channel and creates and sells digital products. OK. I’m happy for her and her successful business, but what she’s earning is active income.

There’s also the 33-year-old mom makes $40,000 a month in passive income—and lives on a sailboat.  Now, the headline says she works just 2 hours a day, but she’s also written that she’s worked 60-hour weeks and burned out while building up her blog and online business.

I could have been featured myself as a 40-something Dad Earning $40,000 a month in passive income while traveling the world with his family. All of that was true a couple years ago, save for the “passive income” part, but I would not have allowed the deception. Blogging is work. It’s flexible and fun work, but I doubt there were many weeks where I didn’t spend at least 20 hours doing something at least peripherally related to Physician on FIRE.

This CNBC feature of a 34-year-old making $49,000 a month in passive income is a little more honest, even if the definition of the word “passive” escapes them. The featured side hustler, Ryan Hogue, says it’s a myth that you can earn passive income without putting in the work.

He says, “There is no shortcut to success. I worked many early mornings and late nights on my side hustles, especially early on. While I am still very involved in the day-to-day management of my businesses, I know many people who have been able to step away from day-to-day operations — after they hit an income threshold they were happy with — while continuing to benefit from their previous work.”

In other words, if you put in a lot of time and effort, perhaps mixed with some good timing and luck, you may end up with a business that provides solid ongoing income. I wouldn’t call it passive income; residual income is probably a better term, and that’s only after you remove yourself from running the business, which is not where the author of this particular passive income piece is at.

You know what else isn’t passive income? Buying properties, renovating said properties, finding and screening tenants for the properties, fielding complaints from the selected tenants, collecting rent from them, cleaning up after them, and finding their replacements when they move out.

Yes, it can be profitable, and some of the work can be outsourced (to people you need to find and screen and sometimes replace), but it’s way too much work for the word “passive” to be anywhere near it. I feel dirty just using that word in the same paragraph.

Dividends Increase Your Wealth

Educated investors understand this to be a false statement, but the myth persists, and the proliferation of dividend-focused financial influencers (finfluencers?) on social media is confounding.

When a dividend is paid out, the net asset value of the stock or fund decreases by the amount of the dividend. It’s a zero-sum event. Now, that fact can be difficult to see due to daily and minute-to-minute fluctuations of  stock prices, which can be influenced by the news of a dividend being more or less than anticipated, often accompanied by additional news about the company and its finances being made public.

In a tax-advantaged account, receiving a dividend has no consequences, and it’s essentially a neutral event. Your account balance doesn’t change, and you can reinvest the dividend. You could see it as a net positive if you need to do some rebalancing, and you seize the opportunity to take the dividend from one asset class to purchase shares in another.

In a taxable brokerage account, however, a savvy investor shuns dividends, especially in the high-earning years in which most physicians will pay both the base 15% and 3.8% NIIT surcharge, state income tax in most states, and possibly an additional 5% if overall income puts them in the top federal income tax bracket. When 25% to 35% of the dividend goes to the government (whether it’s reinvested or not), I’d rather leave that money invested.

There is a different question about whether or not dividend-payers outperform non-dividend-paying stocks, and these analyses are often fraught with selection bias and cherry-picking of data and timeframes.

It’s easy to show that companies that have increased their dividends for 20 years in a row have outperformed those that haven’t. Those are the survivors. That is the definition of survivorship bias. Zero people should be surprised by the fact that companies with strong balance sheets for 20 years are worth more than companies that have struggled.

I’ve shared my disdain for dividends on this website, and others have sung their praises. There are some debates to be had. What cannot be argued, however,  is the fact that the U.S. and state governments get their share of your dividends when you invest outside of tax-advantaged retirement accounts.

You Traveled for Free with Credit Card Points

No, you didn’t.

Credit card rewards are fantastic, and I’ve saved myself many thousands of dollars by utilizing them well. I’ve “earned” all those rewards points and miles by charging the vast majority of our spending to various credit cards that offer juicy rewards.  I wouldn’t be at all surprised if I’ve charged over a million dollars to plastic over the years.

The banks that issue these cards are profitable companies. They charge retailers about 3% of what the consumer pays for goods and services. Retailers, also wanting to be profitable, bake that 3% cost into what they charge for goods and services. If we’re smart consumers, we get 1% to 2% back in the form of credit card rewards. It’s not 3%, but it’s better than a poke in the butt with a sharp stick.

It’s just not a great deal for the consumer. We can assume things cost close to 3% more than they would if credit card fees didn’t exist on retailers’ balance sheets, and we’re typically not getting 3% back from the card issuers. Yes, you can find certain redemptions of miles or points that exceed that value, but the best hassle-free cash back cards offer 2% back on all spending.

If, instead of getting cash back on all credit card purchases, you redeem them for travel, you can find some great deals, and, as mentioned, win the game by getting better than a 3% value with the redemption. But let’s not confuse rewards travel with free travel.

Did you read my thoughts on opportunity cost?

Let’s say you used 50,000 points or miles to book two round-trip flights. Depending on the airline and the destination, that may be next to impossible, but I’m giving you the benefit of the doubt. You might be inclined to consider these flights as “free travel,” but the truth is that you could have $500 cash in your pocket instead. Or, perhaps if you had used a different card, you might have earned $1,000 worth of points with the same amount of spending.

Where the rewards get extra-juicy is when you get the welcome bonuses for multiple cards in short order, but that’s straying far from the point I’m making. With all credit card rewards, including welcome bonuses, you can typically opt for cash or travel by either choosing different cards to open and use or by choosing a different redemption option from the same card.

You can spend your points on travel or you can spend your points on cash or cash equivalents like statement credits, but don’t forget that the person who actually paid for those points is you.

You Need a Budget

This statement is more of a marketing plan than a money myth. Jesse Meachem’s app, YNAB –guess what it stands for —  purportedly has hundreds of thousands of users who use it to get their budgets under control and reach their financial goals.

I haven’t looked closely at the service, and a few of our interviewees swear by it, but budgeting is not something I’ve ever done. I’ve never needed a budget, and I like to think that most high-income professionals don’t need one, either.

When I talk about budgeting, I mean preemptively determining how much money you plan to spend in various categories and sticking to the plan. For me, it’s too prescriptive and unnecessary.

I do believe that some people truly do need a pre-determined budget, and those who spend excessively in a way that is harming their ability to reach long-term financial goals should give budgeting a try, even if temporarily. It could help instill thrifty money-saving habits that may come naturally to others.

I do believe in intentional spending and being a good steward of money, paying yourself first by maxing out retirement accounts, and those sorts of budgeting-adjacent activities that lead to long-term wealth. However, for most of us, I think a true budget is too restrictive and should only be implemented when other money-saving methods have failed.

You Need a Side Gig

I had a side gig; you’re looking at it. There was a time when it paid me as much as my doctor job once did, but side gigs like this are a rarity. If you’re a professional earning multiple six-figures a year, the odds that you’ll come close to earning that same hourly rate or more by doing something different are small.

Side gigs can be great for non-financial reasons, also, and I’m not going to discourage anyone from starting one of their own. Picking up new skills and knowledge while exercising different parts of your brain that don’t get as much use in your career can be deeply rewarding.

You can also do some side hustling within your profession, leveraging your skillset and experience in new ways or simply in a different setting. Locum tenens work and other moonlighting opportunities can provide a solid income boost.

However, none of this is necessary if you’ve got a good job that pays well. Your social media feed may be full of side-gigging doctors singing their praises, but a main gig ought to be enough to support you and your family financially. If it’s not filling your cup in other ways, you may have other issues to address, but don’t feel like you need a side gig. You don’t.

Earning More is as Good as Spending Less

Foes of frugality are quick to point out that there’s no need to focus on spending less when you can just earn more!

They do make a good argument in that there’s a limit to how much you can cut spending, but there is no limit to how much one can earn.

There are issues with that line of thinking, though. One is that there is a limit as to how much one can make while working as an employee within a health system. Earning more might mean taking more risk (and possibly earning less) or uprooting your family and moving somewhere else for a better job. If making more money was easy, everyone would do it.

Furthermore, a dollar saved is better than a dollar earned. Every $1.00 that you don’t spend is about $1.60 that you don’t have to earn. Why? Taxes.

To look at the benefit of earning more, you need to factor in your marginal tax rate. That is, the tax paid on each additional dollar earned on top of what you already earn. This is higher than your overall average effective tax rate.

If your household income puts you in the 32% federal income tax bracket and you pay a middle-of-the-road 5% state income tax, your marginal tax rate is 37% (assuming no local income taxes). When you earn a dollar, you keep 63 cents.

To keep a dollar, you need to earn 1/0.63 = $1.59.

With a marginal tax rate of 37%, reducing annual spending by $10,000 improves your bottom line by same as earning an additional $15,900. In some locales and at higher incomes, marginal tax rates can reach 50% or more. In that case, you’d need to earn $20,000 extra to match the benefit of spending $10,000 less. You may want to think twice before your next credit card swipe!

 

What money myths do you see that persist? Tell us what gets your goat in the comment box below!