What’s Passive Income? It’s Not What Influencers Say It Is. (2023)

Luca Alboretti was enticed by the thought of making money in his sleep.

He was looking to supplement his income as a real estate agent in 2018 when he created an online store selling golf products, an idea he had hatched after watching a YouTube video about how to earn $150,000 a year in “passive” income selling salt and pepper shakers online.

“I thought I would wake up to a couple of hundred orders, fulfill them and collect my profit,” said Mr. Alboretti, 28, who lives in northern New Jersey.

He spent about $5,000 on sourcing and testing the golf products, developing a private-label product and paying website management fees. He put in about 10 hours setting up his online store, writing descriptions for each item, communicating with suppliers and marketing his site.

Yet a year later, Mr. Alboretti had made only $300 in sales. He closed the store and began using the Instagram page he had created for it to share humorous real estate content he made instead. “I worked hard to get my couple of hundred followers and didn’t want them to go to waste,” he said.

That morphed into ActuallyAgents, a multiplatform social media brand that is known for its clever memes on Instagram and free educational resources for real estate professionals and lead generation services for brokers in the United States and Britain.

ActuallyAgents has become Mr. Alboretti’s full-time job. “The courses, videos and social media content don’t create themselves,” he said. “None of this is passive.”

Search “passive income” on YouTube, TikTok or Reddit and you’ll find a wealth of videos by people claiming they make thousands of dollars each month this way — whether they sell courses, e-books or other products online; offer property on short-term rental platforms like Airbnb and VRBO; or even buy and maintain vending machines in high-traffic buildings. The allure: Theoretically, it’s easier than a traditional 9-to-5 “job.”

“We live in a passive-income-obsessed culture,” said John Boyd, founder of MDRN Wealth, a financial planning firm in Scottsdale, Ariz.

This preoccupation with making money effortlessly, he said, is fueled by investors in their late 20s to early 40s, who are understandably frustrated that they aren’t in the same financial position their middle-class parents were at their age and are looking for easy ways to catch up. But investing several thousand dollars to buy a vending machine that pays out just a few hundred a month, or overextending yourself by taking out a 10-year mortgage to buy a rental property, isn’t the best way to create long-term wealth or to save for retirement, Mr. Boyd said.

While many people claim to be making passive income, particularly on social media, only 20 percent of American households earn such income — either through dividends, interest or rental properties, according to Census Bureau data. And the median amount that those households make from those sources is $4,200 a year, according to bureau figures.

So, what is passive income?

The Internal Revenue Service defines it as trade or business activity that you don’t materially participate in, meaning you aren’t involved in its operations on a continual and significant basis. However, the I.R.S. does consider rental real estate activities a source of passive income as long as the property owner isn’t a real estate professional.

Yet there is much confusion about what qualifies. What people often call “passive income” is income that isn’t dependent on a single paycheck or employer, said Kevin J. Brady, a vice president at Wealthspire Advisors in New York City. In some cases, without understanding the difference, people are talking about leveraged income — putting in time and effort in advance to earn recurring profits from selling, say, an online course or an e-book — or additional revenue from a side hustle (that is, more work).

Although the I.R.S. recognizes renting property as a way to create passive income, people often underestimate the time and money needed to buy and maintain that property. Unexpected repairs and expenses can eat into rental profits. As the property owner, you’re on the hook to pay property taxes and insurance costs, and if the property is in another state, you might need to pay someone to manage it.

“What will you do if you’re hoping that tenants will pay the monthly mortgage on your rental property, but you don’t have any tenants and you can’t pay the mortgage yourself?” Mr. Boyd said.

Extra income isn’t passive

About 20 percent of their total income derives from two rental properties they own in Atlanta. The couple each owned a home there before they moved to California in 2015. Because they initially planned to return to Atlanta, they rented the properties to long-term tenants.

“It helped to fund my life as a student for several years,” said Dr. Vanegas, 37, a psychologist.

Dr. Vanegas is adding another revenue stream by developing an online course, the BIPOC Survival Guide to Graduate School, with a colleague. She also earns income by livestreaming workshops on vicarious trauma and leading with intention and inclusivity. Mr. Velasquez, 37, has a full-time job in corporate finance.

“Our goal for that income is to provide financial flexibility for our family,” said Dr. Vanegas, who owns Health & Inclusivity, a consulting firm in Santa Barbara, Calif., that helps organizations create an inclusive culture through assessment, evaluation and professional development.

That work will also supplement her retirement savings. “I do have a small 401(k), but having been a student for most of my life, earning a Ph.D., I feel behind,” she said.

Dr. Vanegas said she had initially felt a bit ashamed of that extra money, especially when family and friends would refer to it as “passive income,” implying that she didn’t have to do any work to earn it.

“Thinking specifically as a Latina, it’s ingrained in our stories to really have to work hard to get ahead,” she said. “Somehow passive income doesn’t count as hard work, but that couldn’t be further from the truth.”

For instance, Dr. Vanegas said, it takes about 10 hours to develop a one-hour online workshop. And being a residential landlord is labor intensive. Finding a long-term tenant isn’t always easy, and when something breaks, it needs to be fixed or replaced immediately even though she and her husband live more than 2,000 miles from the property.

The couple recently bought another property, in Mexico, that they hope to rent through Airbnb this year after they complete renovations, buy furniture and find a local manager. Dr. Vanegas estimates that they’ve invested several thousand dollars getting the property ready to rent.

“I hear a lot of people say buy these properties and you don’t have to do a thing,” she said. “People don’t realize how much work it takes.”

Compound interest creates passive income

Stacy J. Miller, a financial planner, said she believed that the pandemic had further fueled workers’ desire to create passive income. Many Americans had more free time, and they started to question whether working a traditional job would provide them enough money.

“People want to earn extra money to save for retirement and to do fun things now, and that takes more time and energy than people have,” she said.

Ms. Miller’s two sons became interested in investing in January 2021 during the meme stock frenzy. At the time, her sons were still doing virtual classes at Georgia Tech, and all campus activities had been canceled. The headlines about amateur investors making money buying and selling GameStop stock on the Robinhood trading app grabbed their attention.

Every time GameStop’s stock rose, Ms. Miller’s sons called her to discuss how novice traders were making big bucks.

“It was a great learning experience,” said Ms. Miller, a vice president at Bright Investments in Tampa, Fla. She explained that the value of GameStop stock could easily plummet, and that if an investor sold the stock at its high, he would owe significant taxes.

“You could easily owe more than the money made on Robinhood when you factor in all the transaction fees,” she said.

Ms. Miller’s elder son, Jamie, 21, said the experience had “brought the idea of investing to my attention and doing things with your money rather than just put it in a saving account that won’t earn much interest.”

That lesson stayed with him, and during the summer of 2021 he decided to invest 20 percent of his internship salary. After talking with his mother, Mr. Miller made those investments within a Roth individual retirement account, which he opened when he was 19.

Last year, he contributed the maximum amount of $6,000, earned from another internship. If he continues to max out his I.R.A. contribution, he could have $4 million in his account by age 65, assuming a healthy 10 percent annualized return on his investment, Ms. Miller said. Even if he doesn’t contribute another dollar to his account, he could have $650,000 by age 65.

“Compound interest is absolutely one of the keys to the success of passive income,” Ms. Miller said.