In my researches about p2p lending and investments in general I stumble sometimes on articles about passive income. But what is passive income?
Literally should mean a way to earn an income without making an active effort; this is the first misconception: to find and put in place the conditions to have a future stream of funds, coming from an investment or an entrepreneurial activity, needs a substantial effort of research (or an initial investment in that newsletter/YouTube channel guru -.-), for example, so what seems passive is simply a disconnection between the moment the effort is made and the payback. This is because we are influenced by the dynamics of the most common jobs: you work and at the end of the day/month you receive a salary for the work done. Reading a book about security analysis will not earn you any money at that of the day, but you will use the knowledge acquired to research this stock and that stock, today and tomorrow, so the payback of reading can be distributed in many future years.
The difference is between scalable and non-scalable efforts.
A dentist or a plumber is a non-scalable effort: whatever your skill level, to complete a task you need a certain amount of time and you can charge a certain amount of money. Being the best dentist in the world can make you millionaire but will never make you a billionaire: this is because you have a limited amount of hours to work in a day and a limit in what your clients are willing to pay for your service.
Writing this post is a scalable effort: to redact it takes me a finite amount of time but the earning potential, through ads for example, is limitless. The chance it will become the most read post on internet are quite slim but are not zero; The chance a dentist earns a billion in a day, performing a dentist job, ARE zero. The nature of a task dictates if it scalable or not. If you want to read more about this topic I suggest you this book by NN Taleb.
Investing is a scalable effort, and it is the tool that allows plumbers to retire richer than dentists.
Save, invest and let compounding grow your savings and investments so that one day you will be able to, for example, retire earlier. That is the passive income part, but arrives years after saving and compounding did the job for you.
The biggest mistake people preaching for passive income makes is the obsession with dividend-paying stocks. Stocks with a high dividend yield are simply value stocks with an inefficient tax treatment. I understand the psychological lure of seeing dividends accumulate on your account but as said before, the moment you will need that additional income is years away, you are simply diminishing your future income for a ‘brain candy’…and even in the future you will not need a dividend, you can simply sell part of your portfolio equivalent to the desired income. On the other side, to compound your gains you have to reinvest your dividends today, incurring in additional transaction costs.
Another mistake are the monthly portfolio updates. The more you check your portfolio, the higher the chance you will commit a mistake: your investment horizon is decades, monthly movements are only noise. US stocks are in a bull market that started more than ten years ago and volatility remained subdued for the most part of this cycle. I bet most of today p2p lending fans never saw a bear market in their life, unfortunately things get uglier and if you do not set your expectations in a realistic manner today you will have bad surprises.
Now you can insert here your favourite motivational quote…or better yet, go read a book and let your investments alone.
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