When it comes to the amount of time necessary to acquire and manage an investment, there are two types; Active and Passive. There is a concept known as The Scale of Passivity; The less time required to maintain the asset, the higher it is on The Scale of Passivity. The more time required, the lower it is. There are also tax implications for, what the government considers, an active vs passive investment. The latter is taxed at a much lower rate and losses can be deducted from other forms of passive income.
What is active investing?
An active investment is an asset that you purchase and own outright or through a partnership, of some kind. The management of the asset lies solely on you or your team. If it is a depreciable asset, such as Real Estate, you are entitled to your equity % of ownership of the allowed depreciation for the current tax year. An example of an active investment would be a rental property you purchase and manage. Some would argue that rental properties are passive in nature. I would agree if the property is managed by a third party property manager and the management is completely hands off. In the eyes of the IRS, the revenue generated by a rental property is passive, not to confuse passive income with the “type” of investment (active/ passive). Contrast a rental property being an active investment vs investing in someone else’s deal, in a limited capacity, as a silent partner. More on that to come.
What is passive investing?
A passive investment is investing in an asset through an owner/ operator that will acquire and manage the deal. In terms of Real Estate, an example would be investing in a commercial syndication deal as a limited partner. A general partner (active) typically finds, underwrites, raises funds for a deal. The investors that put up the capital are owners in a limited partner entity that has ownership in the property. The limited partner is paid a return and sometimes participates in the upside of the sale of the property but does not make any management decisions or put forth any effort in the ongoing operations of the building(s). The limited partner simply collects a check based on the properties performance.
Is active or passive investing right for me?
The answer is, that depends. Everyone’s personal and financial situations are different. What’s right for you is how the investment fits into your lifestyle and how it fits your investing & lifestyle goals. The benefits of actively investing in an asset is that you control the performance and the eventual sale. Actively investing also tends to be more lucrative because you have full ownership. However, there is something to be said for letting experts do what they do best and allowing them to find and manage deals you invest in. Anytime I’m evaluating buying a new property or business, I ask myself, “where does it fall on the scale of passivity” and how does that fit into my life. If I’m already working 70-80 hours a week, that is going to put undue stress in my life and the benefits of the additional income probably aren’t worth the time. To this point, I’ve chosen to mostly invest actively because I wanted to grow my income and net worth as quickly as possible. There will come a time when I start to move more towards passive investing when I’m happy with my net worth or I can’t take it anymore. In summary, do what’s right for your lifestyle.
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