The 8 Levels Of Passive Income

2008 June 9
by Kyle Bumpus
from → Passive Income

The topic of passive income has been making the rounds lately.  More specifically,  the blogosphere has been debating the passivity of certain forms of income, such as blogging and real estate,  as opposed to dividends and interest payments.  To that end, I’ve devised a complex, sophisticated mathematical formula to divide all forms of income generation into 8 levels from lowest level of passivity to greatest.

Level One: Contracting and Self-Employment
Passive Component: 0%

Working as a contractor is trading time for money in its purest sense.  While contracting obviously has many advantages like flexibility, variety of work, and higher pay, it is also the least-passive form of income.  A contractor only gets paid for hours actually worked.  If you take the day off, you don’t get paid.  The same is true for self-employed individuals such as lawyers, plumbers, etc.

Level Two:  Full-time Employment
Passive Component: 2.573%

Full-time employment is still trading time for money, just like contracting.  Unlike contracting, however, full-time employees usually get paid vacation, sick days, and often even disability and life insurance to protect your family’s income in the event of tragedy.  These characteristics add a small passive component to income from your job, but only a very small one.
business with employees

Level Three:  Owning and Running a Small Business With Employees
Passive Component: 31.7%

Owning a small business is a lot of work and I doubt most small-business owners would consider it to be anything approaching “passive.”  And yet, delegating responsibilities to employees allows you to leverage the time of others to expand and maintain your income without dedicating any of  your own time to those tasks.  Once successful, many small business owners can slowly but surely extract themselves from the day-to-day running of the business and earn a full-time income working part time.

Level Four:  Real Estate Investing, Landlording, and On-line/Blogging Income
Passive Component: 67.97%

Blogging income certainly isn’t passive at first glance.  It takes a lot of time and a sustained effort over several years to become successful, but it does have a strong passive component.  Once your masterpiece has been written, attracted a few quality links, and gotten high rankings in the search engines, that particular post will continue to draw traffic and generate revenue for years to come.  While regular time and effort are required to generate new content to draw traffic and generate more revenue, a certain percentage of your blog’s income will persist indefinitely so long as your posts are remain in the search engines.  That is passive income.

Real estate investing also has a strong passive component.  Once you’ve bought and renovated your property, most properties (absent annoying trouble tenants) require only a few hours per month of your time to collect rent and do routine maintenance.  Serious maintenance problems can be farmed out to contractors.

Level Five: Individual Stocks, Bonds, and Income Trusts
Passive Component: 85.0001%

Dividend and interest payments from carefully-selected stock or bond investments are excellent sources of passive income.  They take significant due diligence in the beginning, but once purchased require very little intervention.  Of course, you do have to regularly monitor your investments to be reasonably certain your future income streams are secure.

Level Six:  Actively Managed Mutual Funds
Passive Component: 91.33%

This category, which includes hiring a competent financial advisor, is even more passive than individual income investments because they tend to be far more diversified and require less due diligence to buy.   You still have to monitor your investment manager’s performance to fend off persistent underperformance, but that takes little time.

Level Seven:  Broadly Diversified Index Funds and ETFs
Passive Component: 98.8%

Index funds, unlike actively-managed mutual funds, will never underperform the market by a significant margin and require almost no on-going effort.  You must still make asset allocation decisions and rebalance periodically, however.

Level Eight:  Target Retirement Mutual Funds
Passive Component: 99.9999999%

Target retirement funds are the gold standard of passive income, if you’ve got a large enough portfolio to generate a livable income from one.  You make only one decision:  what year you want to retire.  Once you’ve decided that, you just purchase the target fund that corresponds to your time horizon.  If you don’t care about growing your income in real terms but merely generating enough income to pay the bills, you can choose a target retirement income fund, which hold most of their assets in bonds and other income producing assets.

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14 Responses
  1. 2008 June 9

    Great post. I like the way you laid this out.

  2. 2008 June 9

    I really did enjoy the post and thought it definitely has some good numbers. My question is where is the money earning interest in a money market account? Could that be 100%?

  3. 2008 June 10

    Very cool analysis! I’m saving this for future reference.

  4. 2008 June 10

    thanx for the link!

  5. 2008 June 10

    What about P2P loans? I think they would fall somewhere around level 6.

  6. 2008 June 10

    Hmm, I guess I would put P2P loans somewhere between 5 and 6. Probably closer to 5, actually. Money market funds would fit in at level 8. They have been known to break the buck occassionally, so I don’t think you could call it 100% passive.

  7. 2008 June 25

    I like your analysis a lot. Where did you come up with the percentages? What about CDs? What about tax liens? In my opinion a CD is the most passive form of income (at least for me) as you buy it once and wait. Not the best return but unlike a stock or mutual fund you don’t have to monitor it.

  8. 2008 June 25

    I may not agree with all the percentages, but I like how you break it down and think that you got it right for the most part. Good job!

    Also, I would add company matching 401k contribution as a passive income component of your job.

  9. 2008 July 1

    Great post – I strongly disagree however with the passive percentage of the full time employment – as a full time employee my passive percentage is usually around 50%. :)


  10. 2008 July 26

    I don’t know a lot about real estate investing, but if you buy a property and hire a property manager to deal with all the stuff related to the property, while you only collect the rent, does that increase the passive percentage?

  11. 2008 July 26

    Yes indeed that would increase the passive percentage, but if you do that you can’t claim a passive loss on your taxes, which most new real estate investors would probably be entitled to. I could be wrong: I’m no CPA.

  12. 2008 September 5 permalink

    Great post. If you want to get in the nitty gritty – there’s a ton more ways of passive income. I know a guy who works in finance by day and sells high quality scenic photos he took every now and then. He makes a few hundred dollars a month from this. Another way is by building websites that require less maintenance than blogging does but attracts plenty of advertising revenue. Keep digging!

  13. 2008 November 17
    Anthony permalink

    Well done. My only advice is that I would have separate Real Estate Income and Blogging income as they usually attract two very different types of individuals. It is easy to convince a professional (i.e. doctor or lawyer) of the merits of real estate investing, but you would be hard pressed to find one that would want to commit to what it takes to build a profitable blog.

  14. 2009 March 16
    Chris permalink

    Good info!

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