Passive Income: Opportunity or Scam?
And the missing ingredient in investor education
When I click on YouTube videos, I often have to sit through ads telling me about investment opportunities before I can watch my videos. What disturbs me isn’t just that they’re usually lousy investments (they are). It’s that they sneer at my normal, assumed-to-be soulless 9-to-5 job.
“Look at you, a prole working day in and day out like a loser! You should invest in some passive income and become a winner!” That’s not what they say. That’s how it feels.
The logic goes like this: poor people work for money; rich people get money to work for them. Rich people’s income is passive. Shame creeps into the mind of the hard-working employee who is made to feel like a downtrodden wage slave and worse, a sucker. To prove you’re not a sucker, you can buy a subscription that promises easy money hacks. Then watch the money come rolling in. You deserve it because you’re smart, and everyone else isn’t.
Gambits like this are a great source of passive income…for the person who is making the video, but not you. How can we find the difference between these and real-life smart investment opportunities?
Let’s take an example of a real-life hustle. Not from a fly-by-night charlatan, but a famous restaurant chain.
A close friend of mine named Rick bought a restaurant. A Steak ‘n Shake. He did this in hopes of getting a passive income. Steak ‘n Shake attracted him by using all the promises of the passive income huckster, but without using the phrase itself. The Steak ‘n Shake corporation makes it easy to get started as a franchisee. The company boasts that the only up-front cost is a $10,000 buy-in, and they promise to renovate the dining room before you start. Once you get going, they said, the owner and the corporation just split the profits 50/50 – minus any incidental costs that happen to pop up, which they deduct from your profit. Hire a good manager, and you don’t even have to think about it any more.
But restaurants are famously difficult to start and to run. Why was this supposed to be passive? Well, this particular Steak ‘n Shake is the most famous one in Indiana, sitting right next to the Circle Center Mall in Indianapolis. Anyone who goes to Indianapolis without a clear itinerary automatically finds their way to this Steak ‘n Shake. The money just rolls in!
Except it doesn’t work like that all. At least it didn’t for Rick. First, let me say what Rick was after in the first place. He ran a Christian urban ministry in central Indianapolis. He was basically a pastor for at-risk youth. This is not a high-paying gig, so he was hoping to find a way to fund his ministry while staying active in it. With the restaurant, he was able to hire lots of young adults from the neighborhood, including people coming out of a halfway house or from jail. People who would usually have a very difficult time finding work. Rick was able to use the Steak ‘n Shake as a transitional work program, and even promoted several of his wards to management positions. The kids were learning important job and life skills and making money.
You know who wasn’t making money? Rick. Steak ‘n Shake corporation hid several large costs that he didn’t know about that he had to pay back. The restaurant required constant oversight, taking him away from his day job. And the company didn’t renovate the dining room before he started. When they finally got around to it, they added the cost – $1 million! – to expenses he owed before he could make any profit. It would have taken years. Rick did the only sane thing in this situation: he walked away. That particular Steak ‘n Shake is now run centrally from corporate. They used hidden costs to get a few years of entrepreneurial work out of Rick while keeping costs low for themselves.
Passive income is usually based on previous hard work. It’s not that you can’t get money to work for you. It’s that you can usually only get there by investing money that you saved, or by maintaining your investment with skill and time. Yes, people should invest in stocks, mutual funds, a house, their skills, and so forth. But the money for those came from saving and effort. Yes, people should start businesses, but they must understand that it will be an enormous investment of time and risk. There will be nothing passive about it.
Those of us who teach personal finance education often use the “Risk Pyramid” to show the tradeoff between risk and reward in investing. But we should add an additional element that the risk pyramid misses – effort. Checking the effort that something will take is like checking a math problem after you’ve done it. It’s possible to make money without effort, but it’s unlikely.
How can we teach this to young people? Here’s a few ways.
First, teach kids to be proud of their job.
Ask your kids the same questions you should ask yourself about pursuing passive income:
What is the risk?
What else could I do?
Why don’t you think everyone is doing this?
How is this valuable to others?
How much time will this take?
Ask “when does the hard work happen?” (It could be in saving up to invest, or in gathering information, or getting an education, or running a business. It’s unlikely the income will be truly “passive.”)
Show the Bluey episode “Ragdoll.” It shows that the hard work of pushing Dad to the car is what made the day fun, memorable, and more valuable than just getting ice cream.
Use this cool infographic and lesson plan from the Federal Reserve Bank of Atlanta, or this helpful blog post with lesson ideas from Next Gen Personal Finance.
Play “Investment Basketball” as devised by star Virginia teacher Christine Pedersen. Have kids toss a ball into the basket from farther and farther distances, showing the relationship between risk and reward. To show effort, make them do pushups if they want an additional throw. Give larger prizes the farther away they are.
Sign up to get a lesson plan for each Paper Robots article from the Foundation for Economic Education. They send them out the Friday after every post I do.
Everyone should plan to invest. But the value has to come from somewhere. We already know about empty “get rich quick” promises. We should also teach about “get rich easy” promises.
Teachers, come learn from each other at the Personal Finance Teacher Forum hosted by the Federal Reserve Bank of Richmond and the Virginia Council on Economic Education, April 25.
Quite a few years ago now, Senator George McGovern lost his presidential bid and retired from the Senate. He bought and managed a Connecticut hotel. He famously wrote a 1992 op ed piece for the Wall Street Journal stating how difficult it was to manage the hotel. In the article McGovern lamented that had he known the challenges of running a business he would not have promoted so many left-leaning policies that made running a business more difficult. Every time I go into a restaurant these days I try to appreciate the difficulty of managing that enterprise.