Passive income can supplement the money you make from your job, compounding your finances and helping you build wealth more quickly. Or it can free up time in your schedule. On the other hand, it can chew up lots of your time and be one of the most difficult financial goals. Passive income in any meaningful quantity is usually difficult to earn. Whether you build something of value, buy income-generating property or set up a strong portfolio, this takes time and money. Consider working with a financial advisor as you seek to generate passive income.
Passive Income Defined
As we wrote in our guide to the subject, passive income is defined as income that is earned from an enterprise in which you aren’t “materially involved.” This means income that you earn with no activity, work or other involvement on your part. You might have worked for this money at one point, but it no longer involves significant ongoing effort.
If you receive interest or payments on a loan or other investments, that’s a common form of passive income. So are returns from a portfolio that you no longer actively manage.
There are two main differences between passive income and ordinary (earned) income. The first is that the IRS taxes these two forms of income differently. For the formal definition of passive vs. active income, you can see the IRS guidance here. When it comes time to file your taxes, knowing the precise difference between passive income and earned income matters.
More immediately, however, the main difference between passive and earned income is how you plan your time. From a personal finance sense, passive income is any money that you bring in without spending time on it.
Not all passive income is entirely without effort. Some of it involves up-front work, such as the royalties earned by writers. Other passive income involves minimal ongoing effort, such as rental properties or many investment portfolios. When it comes to personal finances this is a sliding scale. The real issue is how much time you have to spend on this income stream, and how it fits into the rest of your life.
Finding sources of passive income is difficult, but there are plenty of apps out there that can help as you start making your plans.
- M1 Finance
Income-oriented investing is an excellent way to generate passive income. This is particularly true when it comes to the relatively new field of robo-advisory services.
A robo-advisory manages money through algorithms and AI-generated trading. You invest your money, select how you want to direct your investments and then let the system take over from there. Investors looking for passive income can set up their portfolios around income-investing, collecting back dividends and interest payments that their portfolio generates. Ultimately, your only point of interaction will be choosing how much money to put in your portfolio on a regular basis.
The challenge when it comes to income investing is volume. Building an investment portfolio that returns significant earnings on a regular basis generally takes a very large nest egg. It will take time to invest enough money to make real income through this method, but particularly with a robo-advisory this is also generally a stable method of building long-term income.
Rental properties have long been one of the most popular forms of passive income. You buy a vacation condo, find someone to clean up after your guests and let the payments roll in. The upside to rental properties is their overall income potential. You can make a lot of money this way. A well-run property in a popular location can make hundreds of dollars per night, and many people make their entire living just renting cottages and vacation homes.
But absolutely do not ignore the downside: Risk. Rental properties might be the single most capital-intensive income stream you can generate. You have to buy the property itself, likely particularly expensive in an area where you’ll get regular guests. Then you have to pay for maintenance, taxes, anyone who helps you tend to the business and more.
Ultimately, your best approach to rental properties is to treat this as a speculative asset. Dive in if the money works, but wait until you’re spending money you can afford to lose. Here are three ways to pursue passive income through rentals:
We have added Turo as a special category here. In a very similar vein to renting out a spare bedroom through Airbnb, with Turo you can rent out time in your car. People pay you to rent your car when you’re not using it, then bring it back. Given that most cars spend almost all of their time idle, this can be an outstanding way to make use of a resource that you already have. Just make absolutely sure that you are properly insured in case anything goes wrong.
Peer-to-peer lending is a relatively new form of investment, but one with enormous potential. (Readers should note that not all of these services have apps. Some only have websites.)
In this form of finance, you invest in loans to other individuals and small businesses. People will approach P2P lending sites looking for any amount of money, from minor expenses to startup costs for a small business. Individual lenders can extend an entire loan or just part of one depending on their portfolio and risk tolerance. For example, say someone is looking for $5,000. You might extend $1,000 of that loan, which would finalize and go through if the borrower gets financing for the entire note. (In this way it is not dissimilar to a for-profit kickstarter.)
Here are three possibilities:
- Funding Circle
You make a profit based on the interest rates on these loans, earning back your money on a fixed payment schedule. This makes P2P lending a very engaging new way of building wealth, and a good passive income stream. Although it’s important to note that the risks involved with this form of investment are generally higher than the sites claim, so approach with suitable care.
This is probably the toughest category to cover. Creating your own blog, video channel, Instagram account or any other form of media presence might be the single most popular way out there for people who want passive income. And if you do this successfully, these are excellent ways to get it. A well-read blog post with plenty of affiliate links can generate steady money for years. The same can be said for any other significant media presence that has ads, links or other forms of revenue that operate on their own. (We have omitted TikTok because, despite its popularity, monetizing this app requires quite a bit of active involvement on your part.)
Here are four options:
Writing a book that sells has the same benefits. Do it successfully and your royalty checks will come in year after year. The key word is “successfully.” Creating media with an audience large enough to make real money is very difficult. Most people who try to do so fail. This isn’t to say that you shouldn’t try, however understanding the difficulties will inform how you should approach this form of passive income.
First and foremost, do not attempt to launch a blog/YouTube channel/etc. if you need the money. Media is neither a quick nor reliable source of income, so make sure that this is a side hustle. It might grow beyond that someday, but approach it carefully for now.
Second, make sure to pick something that you will want to pursue for a long time. Whether you’re filling out an Instagram or writing books, it takes a lot of material to generate an audience and a paycheck. Don’t start something you’ll be tired of in the next six months.
Finally, authors can focus on the work. Everyone else needs to think of this like a business. Whether you’re writing, filming, taking pictures or making music, your first thought should be how this venture will generate revenue and achieve stability in the long run. The most well-written blog in the world won’t do you any good if nobody reads it … or pays for it.
The Bottom Line
Passive income is money that you make with little or no additional effort on your part. While it is difficult to build in any significant quantities, the payoff is well worth it.
Tips for Income
- How can you build passive income? What’s the right approach for you, and are there any targets that you want to hit? How will this fit into your overall financial planning, and can passive income help you meet your goals? SmartAsset’s matching tool can help you find a financial professional near you to answer these questions and help you make passive income a key part of your financial strategy. If you’re ready, get started now.
- Among other challenges common to seeking passive income, there’s the challenge of getting a good estimate of how your assets will do over time. That’s where a free investmenet calculator can come in handy.
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