What Is Passive Income and Why Should I Care?
- Financial PlanningWhat's all this hoo-ha about passive income?
I’ve talked about passive income lately in a variety of contexts (here and here, for example), but so far I haven’t done a more exhaustive exploration of the topic. I thought some of you might be curious about it and want to know more. So here you go!
Fundamentally, you earn passive income without having to actively spend time on the money-generating activity. When you go to your regular job or do a consulting gig that pays you by the hour for your time, you’re earning active income. When you’re earning money while snorkeling in Zihuatanejo, that’s passive income. Sounds great, right?
You bet. But passive income does take planning, work, and sometimes even money to set up; it’s not entirely passive. Let’s go through some of the types of passive income so you can see what they entail, and which might be of interest to you. You may even get some of them by default, like Social Security.
Invest in an Asset: in this category of passive investments, you buy an asset that produces cash.
1. Business: you could buy a business and have someone else run it, or be a limited/silent partner in a business. Just be aware that the IRS has rules about what it means to participate actively (or not) in a business, and these rules affect taxation. Make sure you’re paying the right kind of tax.
2. Dividend-producing stocks or mutual funds: some stocks and mutual funds are focused on producing dividends for their shareholders, which can translate into passive income for you.
3. Interest: even with interest rates increasing, banks typically won’t give you much interest income for your money. You certainly won’t keep up with inflation. But US Treasury I Bonds or Treasury Inflation-Protected Securities (TIPS) might be an alternative way to earn interest and keep up with inflation to some extent. And yes, you can earn interest on cryptocurrency, but that’s WAY too complicated for me to go into here. Be sure you understand it before you invest.
4. Real Estate: you might buy commercial or residential real estate and rent it out to someone else. Alternatively, there are ways to buy real estate in cooperation with other people, via crowdfunding sites like RealtyMogul or Fundrise.
Real Estate Investment Trusts (REITs) are another real-estate-based way to earn passive income. A REIT is a company that owns, finances, and/or runs commercial or residential real estate. You can invest in these companies and earn dividends from the income they produce. This is a way of owning an interest in real estate without having to come up with all the investment money yourself.
5. Social Security: this is another kind of investment, although participation isn’t optional for most people. If you’re working in the US, you probably have to pay into the Social Security system. If you’re lucky, you might even get some or all of your investment back! OK, theoretically you should get out more than you put in, but the Social Security system isn’t entirely, well, secure. Anyway, once you hit retirement age, you can start taking payments from Social Security which will (hopefully) last until you die, and you’ve already done the work to receive them…so the income is passive in that sense.
6. Vending machines: if you can supply the funds to buy the machines and keep them stocked over time, this can be a decent way to earn money while you’re off doing something else. Just be aware that there is some risk involved if you’re selling perishables, or if you can’t find a location or lose a location. You’ll need a place to store your machines just in case.
Create an Asset: here, you create your own asset that produces cash.
1. Content: there are so many kinds of content you can create and sell again and again online, or use to generate advertising, sponsorship, or residual revenue. A few examples: eBooks, blogs, YouTube or other videos, sponsored posts on social media, voiceovers, templates, music, plug-ins, apps, photos, podcasts, and educational courses (e.g., for Udemy, Skillshare, Coursera). You might even set up your own print-on-demand store and sell designs (t-shirts, mugs, totes, anything!) that someone else prints out and ships.
2. Dropshipping store: with this type of online store, you are fundamentally acting as a curator. You set up a store in your area of expertise or interest, then you fill it with things from other stores. They produce the products, and you resell them after taking a cut of the profits. You can also buy wholesale products and sell them through your store.
3. Buy and flip websites: you might decide to create and then resell your own dropshipping store. You could also start a regular ecommerce store, earn a bit of income to prove it can work, and then resell it at a profit.
Share an Asset: in this category, you let others use an asset you own or control…for a fee, of course.
1. A room or your entire home: if you’re away part of the year or have an extra bedroom, suite, or annex, you can rent that space via a service like AirBnB. You could even have someone else manage the process for you…at a fee, of course. You could also rent out space to someone who doesn’t have their own office space.
2. Other space on your property: there are other ways to rent out your extra space. For example, if you have extra storage or parking space, others might want to rent it from you on a short-term or long-term basis.
3. Your possessions: yes, there are now peer-to-peer online programs for renting out your car, RV, boat, or just about anything else you’re not using all the time.
4. Your information: if you don’t mind sharing your data, you can earn a little extra cash by signing up with online data collectors like the Nielsen Computer and Mobile Panel.
5. Advertise on your vehicle: you’ve probably seen cars, trucks, and vans driving around with those vinyl advertising decals, but these people don’t necessarily own the businesses they’re advertising. You can agree to put the decals on your vehicle for a certain amount of time in exchange for some passive income. Just make sure you can satisfy the requirements of the deal.
Now, this isn’t an exhaustive list, but these are a few of the ways you can set up passive income streams for yourself. Only you can decide if they’re worth the time and/or money required to get them going and maintain them, and I suggest you investigate thoroughly if you’re interested in any of them. But I hope this has given you a few ideas.
Just be aware that ALL of this income is taxable in one way or another (with some possible exceptions for Social Security). These ideas might generate regular income tax or capital gains tax, but they WILL generate tax for most people. I suggest working with a tax pro to make sure you don’t make any mistakes when you report this income.
