The Big Mistakes With Multiple Passive Income Streams

Generating multiple passive income streams sounds like the best and most secure way to reach financial independence. I have thought about the subject for quite a while now and also read a lot about it. Unfortunately, I kept coming across misconceptions and contradictions. Because when things sound too good in theory, they usually fail in practice. 


Readers key takeaway

  • In theory, generating multiple passive income streams sound like a fantastic and easy thing to accomplish.
  • However, two aspects always fall short for me when I look closely at the subject. It bothers me that no one is talking about proper risk correlation. Equity programs for workers are often seen as a great tool to increase pension savings. But from a risk perspective, it’s fatal. If the firm goes bankrupt, workers lose both active income and pension savings. It would be wiser to buy shares in the employer’s fiercest competitor.
  • Besides that, I don’t think the number of passive income streams is the decisive factor to generate the highest possible passive income. The decisive factor is the correct use of leverage. I can leverage not only the number of passive income streams but also the initial capital or the yield. The answer that works for me: I try to lever the capital, not the yield.
  • In any case, I must also create a basis for passive income through active work. And even on the active side, it’s not the number of income sources that matters, but the quality of my work, or my market value.
  • The nonsense of obsessively building up as many income streams as possible does not mean that pushing as many options as possible is a bad thing. With the latter, we provoke the “serendipity” phenomenon and I don’t wanna miss that.
  • Don’t expect a guide to wealth. All I want to do is to share some reflections on the topic. So take them with a grain of salt.

What’s wrong with multiple passive income streams? Nothing but…

Having multiple passive income streams sounds tempting. The words alone are promising. Multiple. Income. Streams. Passive. All have a positive connotation in an investor’s mindset. They also suggest independence. It even sounds a bit like sleeping under a tree and still having enough cash to live on.

Multiple Passive Income Streams Things seem to be as easy as fishing in a sea full of opportunities TEV Blog
Generating multiple passive income streams seems as easy as fishing in a sea full of hungry fish.

In theory, things are pretty straightforward:

It is like fishing in a sea full of opportunities or hungry fish. I write an eBook here. I run a blog there. Furthermore, I publish videos on YouTube every week. On top of that, I make sure that everything is full of affiliate links. Great.

But that is for beginners as I am already two steps beyond that. I don’t only invest in stocks but also in ETFs (what’s the difference?). I also bought an apartment and rent it, plus I give P2P loans. And last month, I have even started with put and call options.

The money comes from all sides, and some small springs become a flood on which I will sail peacefully towards financial freedom. It sounds simple. But is it? Mh, meh, maybe…  but honestly, I don’t think so.

In practice, there are some contradictions and misconceptions of this “multiple passive income streams” concept that are worth exploring. Primarily because all the videos and articles on the internet mostly hide them. I want to reflect a little on the aspects that I miss elsewhere. So don’t expect a guide to wealth, but a few reflections on the topic that will hopefully provoke some thought.

Take this with a grain of salt

A warning in advance. Like everything on the TEV Blog, this article is very subjective and reflects only my personal view and experience. What doesn’t work for me may be the perfect solution to your problems.

And indeed, I think it’s excellent when people try to generate cash flow and move their asses to pursue their happiness. So for the record: Passive income is great. Honestly, I feel connected to anyone who tries to generate one or another income stream. I also pursue this goal.

Nevertheless, I have some difficulties following the guidelines that you find on the internet. I don’t even think they are wrong, and I also see the altruistic intention. But when I read advice like “Build up xy income streams!”, there may be some misconceptions involved.

If I can do a lot of things a little bit, I am probably not good at anything

The first obvious problem is that I am not good at anything if I can do many things only a little bit. Behind this banal insight lies the fact that humans are not made to master many things perfectly.

If I can do a lot of things a little bit, I am probably not good at anything TEV Blog
If I can do many things a little bit, I am probably not good at anything.

We can’t run fast, we can’t see well, we freeze quickly, and we depend on others’ communities. In short: Humans can do everything a bit but hardly master anything. We are beings full of limitations. From an evolutionary point of view, this has definite advantages. Humans are antifragile as a species because we can adapt very well to nature and its changes.

This hunter and gatherer mentality says that the more income sources we build up, the better and safer it is. And this sounds reasonable. It suggests independence. If one income stream breaks away, other streams remain and can capture the loss.  

Since we have to act against our nature when it comes to standing out, our general impulse is gathering a lot of the average. But with this mindset, I see the risk that we will always remain average instead of concentrating on one thing and becoming exceptionally good at it.

As a result, we lose a solid lever to increase our passive income much faster and more effectively. I will dig into that in a moment. But first, I want to talk briefly about the problem of risk diversification.

More is not always better

The biggest problem is that the number of passive income sources doesn’t say anything about their quality or risk correlation/risk sensitivity. For me, the right risk profile would have the highest priority if I wanted to generate a passive income because constant risk review and monitoring would mean that things are no longer 100 percent passive.

More income streams do not automatically mean less risk

I think that the number of income streams does not necessarily correlate with the risk for your total assets. Moreover, it might be wrong to assume that the total wealth or total assets’ risk decreases with each new passive income source.

A perfect example is an employee (active income) who invests part of his salary in shares of his company. So now, his company pays a salary and juicy dividends four times a year (passive income).

We may even think that he has insight into the company. As he has all the insights, he should know precisely what excellent management is working there. And buying shares of the competitor would be out of the question for reasons of conscience alone.

Two income streams are not better than one income stream if both share the same risk

In the end, however, the employee’s risk has not been reduced at all. Yes, he has an additional passive income through dividends. But the problem in terms of risk allocation is this: If the company goes bankrupt, the employee loses both his active and passive income simultaneously. He didn’t split his risk. He gained nothing at all.

It is particularly dramatic if the dividends were supposed to support the pension. In the end, it would have been much more rational (and wiser) if he had bought shares in his employer’s fiercest competitor. That’s also why I think that employee equity programs may not be the best way to help people plan for retirement.

Different asset classes share the same risk profile/risk cluster

Another example is the allocation of income streams to several asset classes. Just take a look at the chart below. We can see that it is possible to achieve high returns and low returns with almost every asset class.

Multiple Passive Income Streams Risk Allocation & Diversification Image
Risk Allocation & Diversification: It doesn’t make much difference if you invest in two different assets with the same risk profile. Risk correlation is far more critical than multiple passive income streams. 

The decisive factor for an investment should not be the asset class or the type of income source attached to it but the individual risk profile. And although each asset class has different risk profiles, all risk profiles form risk clusters (low risk, medium risk, high risk) regardless of the underlying asset classes. Different asset classes can therefore share the same risk clusters.

So that’s why I am thinking like this: before I rashly shoot at anything that promises a return, I should gear my investments more closely to their risk profile. I don’t have to buy shares in my employer’s company if I receive a salary from it, as both have identical risk profiles.

It only makes kind of sense to look at the risk correlation

I think that the only theoretically sensible reason to buy different asset classes with a similar risk profile is if the risks do not correlate. A low correlation exists when one asset class performs poorly, and the performance of the other asset class remains positive. To show if and to what extent different asset classes correlate, I looked at the performance of the following asset classes since 1995:

  • Gold;
  • Crude Oil Price;
  • Cash;
  • US large caps;
  • US small caps;
  • International Stocks;
  • Emerging Markets Stocks;
  • REITs;
  • High Yield Bonds

In the chart below, we see a high correlation between most asset classes. Only two asset classes proved to be less correlative, and these were cash and high-grade bonds. However, these asset classes have not generated above-average returns in times other asset classes have crashed. Plainly speaking, they have merely mitigated the losses of the other asset classes.

The same applies to the returns these assets generated in good times. Interestingly, gold is not the winner in times of crisis either (in crises, everyone sells their gold to create liquidity). During the great recession in 2008, the gold price rose by just 3 percent.

Multiple Passive Income Streams Correlation between Asset Classes from 1995-2019 Image
Correlation between Asset Classes from 1995-2019, www.macrotrends.net

So the benefit that derives from distributing passive income across as many asset classes as possible is limited. Investing in many asset classes may give a feeling of safety. But that’s all. In practice, the risk for the total assets might easily remain more or less the same regardless of how many passive income streams I have.

In the end, it’s simple

I think that generating robust passive income is more promising if we strip out the theory of many passive income streams.

The better I am, the higher is my market value (in theory)

At the very beginning of any passive income is the concept of converting an active investment into passive income. An investment could be anything. Time, capital, and whatnot. Even a book that later becomes a bestseller (passive income) needs to be written.

Furthermore, our market-driven world has an interesting side effect. At least, in theory, things are like this: If I can do something better than the rest and stand out above the average, my market value (or human capital) increases in the fields where I am skilled. And a high market value, in most cases, also means more income.

So regardless of whether I’m trying to generate passive or active income, wouldn’t it be best if I got good at something first to increase my market value? And I surely also know that it takes a very long time until I become excellent at something because otherwise, it would be easy for everyone.

This problem applies to all sources of income. To become a lawyer with a good salary (active income), I had to study for an extremely long time. I took internships and saw millions of Excel spreadsheets. But there is no shortcut because it would also have taken me a long time to become a good writer and write a bestseller.

To wrap both aspects (1. I need an initial investment, 2. becoming experienced increases my market value) up: In the beginning, it’s not so much about how I earn my income (actively or passively). My market value and position in a capitalist-driven world have much more relevance.

A high market value in itself creates independence

A specific market value alone creates freedom and independence. Some may say that I have a somewhat high market value, and I won’t disagree. I noticed several times that I am already relatively independent. If I didn’t like my job, I would quit and simply join another firm.

A high market value ensures that no one can mistreat you, neither your colleagues nor your boss. You will always find a new job where people welcome you with open arms. By the way, this is also a form of leverage. I can use my human capital or my market value to get the job I want. But here, I want to talk about leveraging passive income and not about changing the job. So let’s get into that.

The leverage: The higher the active income, the more I can convert it into a passive income

“Leverage” is another reason why I find market value more important than the number of passive revenue streams. I consider “leverage” even the most critical tool to increase wealth. The only question is how I want to use it. And here is the thing. I can leverage not only the number of (passive) income streams but also the initial capital or the yield of my investments. And spoiler alert: I would always go for the “initial capital”!

Know your leverage
Know your leverage

Let me start with a somewhat bland consideration to show you why I would always choose the “initial capital” gate:

Passive income does not grow on a tree.

As I already said, even a passive income needs a fundament. To generate it, we need to work actively first. I need to write a book before I can sell it. I would need to feed the TEV Blog for many years if I wanted it to generate money. And I must earn money before I can invest it in stocks and ETF’s.

This banality has the following consequence: the higher my initial investment (time, capital, etc.), the better and less risky I can leverage my passive income. That is why, in the long run, the rich will get richer and richer. It is simple math since, in absolute terms, a 10 percent return on a billion is far more than a 10 percent return on a thousand.

Why the rich are getting richer and richer

Here is an example: Suppose I want to generate €5,000 per month by investing in dividend stocks with a dividend yield of 5 percent. To generate such a return, I would need invested capital of €1.2 million. Of course, I know that I can also save a lower amount through the compound interest effect. However, that is at the expense of time.

That said, if I wanted to generate €5,000 per month with dividends next year, I would have to invest €1.2 million in companies that have a dividend yield of 5 percent right now. Well, you probably already see that there are some difficulties. And the biggest challenge is where to get that amount of money.

So let me assume that I only have €600,000, which would already be pretty nice! But if I wanted to achieve the same monthly return of €5,000, I would need to look for a dividend yield of 10 percent now. What’s happening here is quite typical. I want to leverage the low initial capital with high returns. But the problem with this approach is evident as return always correlates with risk. And a company that provides a 10 percent dividend yield does not seem to be the safest dividend payer.

You need money to stop needing money

Once again, the initial capital is, in my view, the most important factor (or leverage) for achieving a high passive income (not the number of income sources).

By the way, the initial capital leverage is also the reason why the gap between rich and poor is widening. If a poor person and a rich person each achieve the same return, the rich person will increase his lead each year. Suppose the poor person invests €10,000 and the rich person invests €1 million and both achieve a return of 7 percent each year. Here are the results of two people having the same performance:

Multiple Passive Income Streams Why the rich are getting richer and richer
Why the rich are getting richer and richer. They have a higher initial amount of capital and not necessarily multiple passive income streams. 

In the first year, the return for the poor person is €700 and for the rich person €70,000. After 50 years, the annual return for the poor person will be €19,270, and for the rich person €19.2 million. The total return over the 50 years will then be €284,570 for the poor and €28 million for the rich.

As we have seen, it is a race that the poor man will never win unless he increases his yield (and thus the risk).

I think we can learn something from this example. It is a hell of a lot smarter and less risky to leverage the absolute return with high initial capital and not with the yield. And this is where the leverage of the initial income comes into play. And what makes more sense, trying to build up one passive income stream after another or by simply pushing the active income to the highest possible level?

The fine line between serendipity and squeezing multiple income streams

Finally, I would like to point out one subtlety. The nonsense of obsessively building up as many income streams as possible does not mean that pushing as many options as possible is a bad thing.

With the latter, we provoke the “serendipity” phenomenon. “Serendipity” is the ability or phenomenon of finding valuable or pleasurable things that one has not been looking for. People can provoke such fortunate discoveries. Curiosity and openness are proven means. But forcing “serendipity” is a consequence of increasing the market value/human capital. It’s not about squeezing multiple income streams.

I know someone who made research articles that he wrote in his free time available for free instead of hiding them behind a paywall. He had put an extreme amount of effort, work, passion, and care into the papers. It would be totally understandable if he had charged money for it. But he refused to do that. There was no need for him to prepare an additional video, podcast, and whatnot.

He just did a damn good job and put his passion into it. And now he writes statements and opinions for legal institutions in the country where he lives. Those institutions became aware of him simply by googling although he never aimed for that. It was serendipity (forced by quality).

Conclusion

Passive income is great, and I also pursue my passive income strategy. But I don’t think that I need many income streams. From my perspective, it is sufficient to increase the active income as much as I can. As a result, I focus on generating a high income that I can use as leverage.

And hey, I know some readers may see it differently. That’s a good thing! But so far, it’s working pretty well for me. While I’m trying to learn and develop in my full-time job, I’m building up passive income on the side through my investments.  That’s one reason I don’t monetize the TEV Blog. There are no ads, no pop-ups, no banners. Only content. It works, so let’s keep it that way for now!

All the best

TEV

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Denis
Denis
11 months ago

This is a great perspective and a good article! The best fresh idea standing apart from the sea of “multiple sources of income” waffle floating around.

Last edited 11 months ago by Denis
Damasky175
Damasky175
5 months ago

Found your blog through Seeking Alpha and I’m enjoying reading your work. I believe that an increasing amount of money is chasing a decreasing amount of real assets and so I agree with concentration of talents and effort instead of trying to be good at all investing. Thanks for the inspiration.

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