What is passive income?
Few investors can resist the allure of passive income, which promises the ability to earn money while you sleep. What is passive income? Broadly speaking, passive income refers to money you receive from investments or business activities that you’re not directly involved in.
To some, this sounds like easy money. But in reality, passive income ideas require a lot of planning and some initial hard work. This guide will help you understand the benefits of a passive income stream and give you some tips on how to get started.
Definition of passive income
It might help to contrast passive income with active income. Typically, you earn money through direct involvement in a particular job or business activity. That’s why you spend hours of your week punching a clock or earning a salary as part of your “day job.”
Income is considered passive when you generate income with little or no effort. Technically, the Internal Revenue Service has additional rules about your material involvement, but most people can simply think of passive income as the money they earn without an ongoing investment of time.
Common passive income ideas
What sort of passive activities can you use to generate income? Some of the most common passive income ideas include:
The most common way to earn passive income is through investing money in stocks, bonds, or other assets that appreciate in value over time. You’ll have to put up an upfront investment, but once you do, you have the potential to see your investment grow over time.
Most banks provide savings accounts that offer interest payments. Though the income generated by interest alone is relatively small, it requires the least amount of effort and carries the least risk. Alternatively, you can lend money to others and charge interest when they repay the loan.
If you own an apartment building or house, you can earn rental income from your tenants. You’ll have to put in some work to maintain the condition of your rental property, but this is largely minimal compared to the return on your investment.
A limited partnership (LP) can allow you to earn passive income from new business ventures. In this business model, the general partner runs the day-to-day business, while the limited partner simply makes an initial investment. The partnership agreement determines the amount that each partner earns from the business.
How to generate passive income
If you’re looking for specific passive income ideas, you might consider one of the following strategies:
Put your money in a high-yield savings account
This strategy might be one of the simplest passive income ideas. Just put your money into a high-yield savings account or money market fund. High-yield savings accounts are typically a bit safer since they’re located at banks and are FDIC-insured.
Interest rates are rising, which means that you’ll earn a stream of income based on the money you have in your savings account. The flip side, of course, is that the interest earned will be relatively minor and can keep your money tied up in a savings account instead of other investment strategies.
Invest in dividend stocks
What are dividend stocks? Some companies distribute a portion of their profits directly to their shareholders in the form of dividends. When you invest in dividend stocks, you’ll receive a dividend based on the number of shares you hold in the company, usually around 1%.
Keep in mind that dividends are only associated with particular stocks, and even then, not all dividend stocks pay dividends on a consistent basis. Plus, you’ll have to invest money in the stock market, and there’s never a guarantee that you’ll see a positive return.
Despite these risks, dividend stocks allow you to invest passively in the stock market and receive an income stream without having to do much after your initial investment.
Those already familiar with the stock market might also consider dividend exchange-traded funds (ETFs), which pair the advantages of an ETF with the passive income provided by dividend stocks.
Automatically invest in the stock market
If stock selecting isn’t your thing, you can always have someone else do it for you. There are many online brokerage services that you can rely on to invest in mutual funds, dividend stocks, and other income-producing securities.
These “robo advisors” simply require you to open a brokerage account and allow you to start investing right from your phone or computer. Keep in mind that each service provider has its own rules regarding your minimum investment, and there’s never a guarantee of positive returns.
The right fund can still allow you to build passive income that accumulates over the long term, which can be a good way to plan for retirement or save money for another investment.
Purchase a rental property
Another way to generate passive income is through rental properties. Naturally this will require an upfront investment, including the money you spend on the real estate property and the time you spend locating reliable tenants.
But once you find occupants, your only real responsibilities will be collecting rent money and maintaining the property. This simplicity is why rental properties are among the most common passive income ideas for investors.
Invest in real estate investment trusts (REITs)
If you’d prefer to avoid the upfront time investment or hefty down payment of owning real estate property, you might consider a real estate investment trust (REIT).
Real estate investment trusts allow you to invest money in a company that owns and manages real estate, usually commercial real estate such as offices or other commercial spaces.
REITs vary in complexity, so investors should do their homework before committing themselves. But many REITs are publicly traded on stock exchanges, making them simpler than other forms of real estate investing.
Lend money through peer-to-peer lending
Peer-to-peer lending platforms allow you to lend money to others, who will then make monthly payments to repay the loan, along with interest.
To get started, most peer-to-peer lending services require you to meet some basic income requirements and possibly even some state-level requirements depending on the service.
Once you’re approved, you can gain passive income through interest payments made by your creditors. Just be cautious with this strategy. It’s often wiser to offer multiple, small loans instead of few larger ones in this passive income strategy.
Sell your photos online
Do you have a creative side? If so, you can make passive income by selling your digital photos and artwork online.
Stock photo sites allow you to create an account and upload your content, which will then be placed in their digital inventory and organized by tag. Customers who are looking for photos of a dog, for example, can search the website and ideally land on one of your quality creations.
This approach means that every time someone downloads your photograph, you’ll receive a payment, though the website will usually take a percentage. Obviously, there’s a small upfront time investment to capturing the right images and managing your account, but once each image is uploaded, it will generate future income as long as the site is active.
Write a book
This approach might be one of the most-overlooked passive income ideas simply because many people assume that the process of writing a book is insurmountably difficult. That would be true if you were trying to publish the next bestseller, but the digital landscape has made it easier than ever to self-publish an e-book or even offer customers a print-on-demand option.
What are you passionate about? What skills and experience can you share with the world? Organizing and writing these ideas out can be a major upfront time investment, but once you’re done, you’ll have something to be proud of, not to mention a passive income stream.
You can promote your e-book through your website or even sell it through Amazon’s Kindle Direct service. If you do, you’ll receive residual income every time a customer purchases your book, guaranteeing cash flow as long as your book remains active.
Pursue affiliate marketing
Affiliate marketing refers to the practice of partnering with a larger company and then marketing its products or services to its target audience.
This strategy is ideal for those who already have a blog, website, or other online platform. But affiliate marketing isn’t entirely passive since there will be an upfront time investment for every blog you write or online post you make.
One advantage is that affiliate marketing is a growing field and allows bloggers to make passive income right from their own homes. The disadvantage is that it can be a bit more demanding than other passive income streams and can take time to develop enough content and connect with enough clients to achieve true financial freedom.
Sell advertising space on your car
Another way to create passive income is to sell advertising space on your car or truck. You’ll connect with companies that provide you with a vinyl decal, which can be easily removed later without damaging your paint.
In exchange for displaying these decals on your car for a predetermined length of time, you’ll earn passive income. The amount depends on the company itself and the length of time you agree to advertise.
The advantage to this approach is that there is no monetary investment required, nor is there any upfront time investment. Of course, if you use your vehicle as part of your small business, you won’t be able to slap another company’s logo on your car.
The right tools for less stress
Generating passive income isn’t a shortcut to financial independence, but these strategies can help you earn extra money with minimal effort.
If you’re a business owner, you might consider how to optimize your business with the right digital tools. Invoice2go can provide you with software to help you create and send digital invoices that can help you get paid faster and keep you focused on your core business.
These tools can be yours for free for 30 days by signing up for the free trial. You’ll see why our customers have come to rely on our innovative platform to help them manage their businesses and spend less time stressing over the details.
Frequently asked questions
There are many ways to build passive income, but there are also some things to consider before investing time and money into one of these strategies.
While you can earn passive income from various sources, it’s unlikely that you’ll ever earn enough passive income to let you quit your day job.
Technically, there’s no limit to the amount of passive income you can receive. But the interest you earn from your financial institution or dividends you earn from your stocks require a significant monetary investment to really generate significant returns.
Still, passive income can be a great way to supplement your income, and you might even use the revenue you generate for additional investments. Passive income can therefore help you save for retirement, a dream vacation, or your children’s education.
The passive income sources listed above all represent completely legitimate money-making opportunities. Therefore, it’s perfectly legal to earn passive income.
With that being said, you’ll have to ensure that you report this income appropriately when paying your income taxes. Additionally, some industries (such as real estate) have requirements that you’ll have to meet to remain in compliance.
Adding passive income streams will change your tax liability since you’ll be earning additional income.
However, the amount of taxes you pay and your specific tax treatment depend on your passive income source and the amount you earn. For example, real estate earnings are taxed differently than income from a business or trade.
Similarly, when you sell an asset (such as a stock, bond, or real estate property) for a profit, you’ll be subject to capital gains tax. If you receive passive income from multiple sources, it may be beneficial to consult a tax professional when you’re planning and filing your income taxes.