Passive Income Vs Active Income for Location Independence

June 16, 2016.TomM.1 Like.1 Comment

Passive Versus Active Incomefor Location Independence

If you’re trying to achieve full time location independence, should you strive for that online marketing Holy Grail – completely automated, 100% passive income?

Or are you better off focusing on “hustle income” – work that still involves trading time for money, but without the element of being tied to an office?

In seven years of earning a full time living from the web, I’ve probed this question from many angles and tried many different methods of making money location-independently.

The answer, as you’ll see, is both. The order in which you do them, and the strategy involved, depends.

Depends on what?

In every case, it depends on how much you can actually earn from each method in general, and how much you’re likely to earn from any given project, be it passive or active.

In this post I’m going to break down the pros and cons of each method of deriving online income and dispel a few of the most common illusions about passive income being the only way to fly.

Why Passive Income Is NOT Always Better

One of the biggest misconceptions I see is that passive income is, by definition, better than active income if you want to become location independent.

The widespread belief in this idea seems to originate from that classic personal finance book, Rich Dad, Poor Dad.

In general, it’s sound advice: you should aim to build up a portfolio of passive, income-generating assets over time – in addition to your active income.

The problem occurs when you start holding your nose at the idea of “time for money” – before you’ve learned the necessary skills and invested the necessary time to build passive income assets.

Remember – Robert Kiyosaki spent two years selling Xerox machines door to door, learning how to sell, before he started his business.

When you’re new to online marketing, your attempts to build passive income are typically going to be pretty unsuccessful and low-yield.

There are a lot of subtle distinctions to getting it right, and it takes time and experience to make those distinctions.

In other words, your chances of hitting a passive income home run on the first try are not super high if you have no previous business and marketing experience.

(And especially if you’re not following the right training materials – and there is a lot of useless training material out there).

Assessing Risk and Reward

Earning an active income through freelancing or services, on the other hand, is a relatively safe bet in most cases.

There tend to be fewer risks involved because in that scenario, you can take payment before you commence work.

You also don’t have to put a large time and financial investment into product development before you start selling, if you’re doing custom work on a client-by-client basis.

Each client also tends to be worth more, which means you need to find fewer customers before you hit a comfortable full-time income.

Building passive assets is much more akin to launching a startup with a new product – there’s often a big time (and potentially financial) investment before you earn that first dollar.

And you may never earn that first dollar. Some projects fail.

More time and money laid out before you start earning money from your venture means more risk.

To keep risk low, you want to focus on projects where you will reach your income goals and recoup any investment in the shortest possible timeframe. In my experience, this is much easier to do with active income than passive.

Passive income assets tend to be more of a long run investment.

So if you’re putting your own time into building them, you need to weigh up whether it’s worth sacrificing money now for more money later.

More to the point, how much more money would you need to earn “later” to justify the time input, and how much later? Over what time period?

Breaking Down the Mathematics of Active Versus Passive Income

Let’s imagine for a second that you can earn $50/hour as a freelancer, doing projects from anywhere in the world.

This is not just your billable rate – it’s the average amount you earn even after factoring in all the time you spend on marketing and finding clients.

Now let’s say you have an idea for a simple passive income content website.

Its traffic will come from search engines, and it will be monetized with advertising and affiliate products – totally hands free.

If the site will take you 100 hours to build to the point where you can “set it on autopilot,” how much do you need to earn from it to justify building it?

For instance, if you put in that 100 hours and made $100/month from the site, would you be happy?

You now have passive income, true – but in the first 12 months, that 100 hours you put in only translates to $1200 in revenue.

Not great, considering you might have made $5000 as a freelancer with the same effort.

Now, true – the site may continue to make you $100/month for the next five years, yielding a total of $6000.

But that’s a long time to wait to earn an extra $1000, instead of taking the $5000 right now from freelancing – especially when you consider you may be able to save and invest some of that freelancing money in order to grow it over the next five years anyway.

The equation changes if you factor in the sale value of the asset. A website earning $100/month fully passive might yield a $1200-2400 sale price.

If you could sell it for $2400 at the end of five years, it’d earn a total of $7400.

That’s a gamble though – you might not sell it, or it might not be earning that much in five years. Again, due to the timeline involved there is more risk.

The dilemma in a nutshell: The higher your potential hourly rate is, the less sense it makes to build passive income assets using your own time unless they will yield a very large return.

In other words if you’ve cultivated skills that allow you to earn a high hourly rate without cultivating the skills to build high-yield passive income assets, you’re likely better off just saving money from active income sources and outsourcing your digital asset-building altogether.

The other option is to develop skills that will allow you to build much more wildly profitable passive income assets.

In this case, the balance would shift again to where it makes more sense for you to put your time into those types of projects.

Now of course, the case may be that you only have a limited number of $50 hours available from client work, and you want to work more than that. In this case, it’d make sense to spend those extra hours building passive assets.

But What About When You’re Travelling?

The logic often goes that passive income is automatically better for location independence because you don’t have to actually do the work while on the road.

This is not exactly true though. Again, if you run the calculations above and you’re going to earn the same amount from 100 hours of freelancing as 100 hours working to build a passive income site, “money now” still wins. It’s better to have that cash saved in a lump sum.

(Of course, ideally, you want both: lump sums saved from high hourly-rate active income, plus passive income ticking in every month – more on that soon).

The big difference is if you have no way to earn “per hour” income location-independently and you’re tied to an office – then passive income looks a lot more attractive. (Then again, you may already have a skill you can sell online from anywhere).

Investing Money to Build Digital Passive Income Assets

Now, what if instead of investing 100 hours of your time to build that site, you used money?

Slightly different rules apply here, and this is more of a straightforward return-on-investment situation.

The questions that matter are how much will the site cost to build, how long will it take to “pay for itself,” and how much will it earn, for how long, after that?

Again, assuming it’s a $100/month site, let’s pretend it costs $600 to build. Your investment is repaid in 6 months, and it continues to earn $100/month for another four and a half years.

That’s a good deal. You turned $600 into $6000 over the course of five years.

The caveat here again, though, is that you don’t know in advance how much the site will make.

It might make $500/month or $1000/month instead of $100/month. Or it might make nothing, if you made a mistake somewhere.

Your Active and Passive Income Strategies Should Complement Each Other

The ideal scenario is to have both a “hustle income” and a passive income strategy working in unison.

Take, for instance, what I did with my client SEO business.

This was not “trading time for money” per se, as I owned the company and had workers delivering much of the actual service, but it certainly wasn’t passive income.

Because the effective per-hour rate of running this company was much higher than the yield I could see on most of the potential passive income projects I had in front of me, it made more sense to grow this company and save as much as I could from it.

I then used money from my “hustle income” savings to start building passive assets, and I also used the SEO infrastructure of my private blog network, built using revenue from my client business, to rank these passive income websites.

For example, even a year after I began scaling down on SEO clients to free up more of my time for a big travel adventure, I still have a completely passive website that earns $200-300 per month on autopilot with zero maintenance which I ranked using my private blog network.

This site cost about $600 in outsourced content writing to build. In other words it pays for itself over again every 2-3 months, has been doing so for over 18 months, and requires no work to maintain.

This is how you transform hustle income into passive income for the long run.

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