When you think of the word income, what comes to mind? For most people, income primarily refers to their paycheck, money they earn from a business they own, or money earned as an independent contractor. These are examples of earned income, but earned income is only one of two main categories of income. The other main type of income is known as passive income.
There’s an old saying that wealthy people don’t work hard for their money, but that wealthy people make their money work for them. And that’s where passive income comes in. This is income that doesn’t require the recipient to actively work for the money. In this article, we’ll explore the various types of passive income and a few ways that you can build passive income streams of your own.
What is passive income?
Passive income can be loosely defined as income that comes from a source other than a job or a business you own. It doesn’t require your active involvement to make money.
For example, if you buy shares of a stock that pays dividends, those dividends will arrive periodically without any need for you to perform any work. If you put your money in a savings account, the bank will pay you interest on your money without any need for you to do anything.
We’ll get into some common types of passive income in the next section. However, the types of income considered passive largely depend on who you ask. For example, the IRS doesn’t consider interest or dividend income to be passive, but most financial planners certainly do. Plus, certain types of income are passive for some people and active for others. Just to name one situation, income from rental real estate is generally considered passive for most people, but if you are a real estate professional, that’s not the case.
Common types of passive income
There are many different forms of passive income streams, but here are some of the most common:
- Dividends from stocks, mutual funds, or exchange-traded funds (ETFs)
- Interest income from savings accounts, CDs, bonds, etc.
- Business income from a business you don’t actively participate in.
- Royalties or residual income from intellectual property you created.
- Rental income from real estate.
It’s worth noting that some types of income could be considered passive income but aren’t often associated with the term. Social Security is an example. While you don’t have to work for your monthly Social Security checks, you did have to work to establish your Social Security benefit, so there’s a bit of gray area here. But in many ways, Social Security and other retirement income sources like pensions can be considered passive income for most practical purposes.
Ideas to build passive income streams of your own
Obviously, the best types of passive income streams for you depend on how much capital you have available, your skill sets, and other factors. With that in mind, here are some ideas to help you start thinking about building passive income streams for you and your family.
Buy a rental property
Investing in real estate isn’t for everyone, and to be fair, this isn’t a totally passive type of income in the sense that you’ll have to maintain the property, find tenants, etc. But rental real estate can be a great way to generate income and build wealth. There are several alternatives if owning a property directly isn’t for you, such as real estate investment trusts (REITs) or real estate crowdfunding.
Write a book
It’s easier than ever to publish an ebook these days, and this can create a stream of residual income if you write a book that people want to read.
Invest in the stock market
Many stocks, mutual funds, and ETFs pay dividends, which can be a great way to create a passive income stream. If you invest within certain types of retirement accounts, you can even defer or avoid any tax liability from this type of income. There are many dividend stocks that not only provide passive income, but have excellent track records of increasing their payouts year-after-year.
Invest in a business
Income from a business you own and operate is definitely not passive income. But if you invest in a business you don’t actively participate in, it can provide a passive income stream.
Open a CD or savings account
CDs and savings accounts can provide a passive income stream. If you focus on banks that primarily operate online, you should be able to find the most competitive yields for your money. One thing to keep in mind is that CD yields are guaranteed for a set time period, while savings account yields can rise and fall over time.
Make money online
With the emergence of new technologies, there are more potential passive income streams available than ever before. You could start a blog or website and make money from affiliate marketing, start a YouTube channel and produce residual income from advertising, or create an online course in your field of expertise. There are platforms that will allow you to rent out a room in your house, rent your swimming pool for an afternoon, or even rent your car to other people.
You may have noticed that most of these aren’t completely passive income streams. In other words, you have to do some work to set them up and maintain them. For example, writing an ebook is clearly considered work while you’re doing it – but once you publish it, a successful ebook can produce years of income without any active involvement from you.
The bottom line on passive income
Building passive income streams is a key component of achieving financial freedom and the good news is that there are many ways to do it. Some methods of passive income require certain skills and knowledge, while others, such as putting money into a CD, are easy and can be done quickly by anybody.