Have you heard the statistic that millionaires have an average of seven streams of income? That doesn’t mean seven jobs, rather they have multiple sources of passive income. But what is passive income?
Passive income can be an excellent way to generate more cash flow because it’s not trading time for money, meaning it’s not interfering with your day job or free time. Besides making more money, passive income can help you deal with inflation, grow your wealth, gain financial stability, and so much more.
But before you start making passive income, you first need to understand it!
What is passive income?
Passive income is a stream of revenue that’s earned without actively working for it. It’s a way to make money on autopilot, and according to IRS Publication 925, passive income is defined as:
- Business or trade activities that you don’t materially participate in
- Rental activities (even if you materially participate), except if you’re a real estate professional and are required to do fulfill those duties
Passive income can literally be money you make while you sleep. However, every passive income source requires an initial investment, and some streams of passive income require a little maintenance from time to time.
Think about your current job for a second. You work for X hours and get paid X dollars for that work. You are trading time for money — or earning an active income.
Passive income is not attached to the number of hours you spend in an office, driving for a rideshare company, or walking dogs. This is why passive income is money that you can earn while you literally sleep.
What passive income isn’t
Your day job, a part-time job, or side hustle generally isn’t passive income because your income is directly tied to the number of hours you work and performing specific tasks. Now, there are some passive side hustles, but that isn’t the norm.
Basically, if you have to show up to get paid, then it isn’t passive income.
Passive income also isn’t something that you can make overnight. Remember, it takes either time or money (or both) to set up and start running. But once you’ve invested in a passive income source, you should be able to do minimal work to maintain it.
Benefits of earning passive income
Where do we begin!? Finding ways to make passive income is one of the most impactful things you can do for your financial life. Not only are you making more money, you’re doing it while not taking time away from your family, work, interests, etc.
But if you want a quick list of the reasons passive income is so awesome, here you go:
- More financial stability: Making more money will help you pay off debt, grow your emergency fund, save for retirement, and more.
- Diversification: Not being reliant on a sole source of income is huge.
- Quickly meet your financial goals: Making more money helps you attain your goals even faster.
- Early retirement: This is the dream for many people, and passive income can help you retire early while still earning income.
- Location independence: What if you could make money while sailing the Caribbean? That sounds far-fetched, but the reality is that people making significant amounts of passive income spend their life like this.
- Financial freedom: This is truly the #1 benefit. Financial freedom means not feeling like your life is controlled by constantly worrying about money.
Types of passive income
What’s great about passive income is that there are several different types, and that means there are plenty of opportunities for nearly everyone. Below are three broad categories to help you understand how you get started.
- Buy: Think of these as investments you’re purchasing to earn income from. Stocks, ETFs, bonds, annuities — anything that produces dividends falls into this category. Rental properties or buying a business, as long as you’re not actively working at it, also qualify because they generate passive cash flow.
- Create: This is using your time and energy to develop a future source of passive income. Popular examples are starting a blog or creating an online course.
- Contribute: Investing in an existing business, making an asset you have available for sale or lease — these are both ways to contribute. An example is making space in your house available to rent for storage.
How is passive income taxed?
Passive income is taxable, just like income from any other job. It’s taxed when you sell your interest in a passive income activity, and a good example of this is thinking about paying taxes when you sell stocks. For sources of passive income like dividends or rental income, you will also pay taxes as they generate income.
How much you owe depends on factors such as the type of passive income and how much time you spent on the business. We highly recommend speaking with a tax professional if you have questions about your tax liability.
Does passive income really mean “no work”?
No, the reality is that every source of passive income takes a little work from time to time. Even sources that are created from a financial investment require some attention. Picture a stream: it flows on its own, but debris can get in the way and impact how smoothly or quickly the water flows. That's what it's like for your source of passive income. There's occasional maintenance, but it's mostly minimal and designed to keep things runny smoothly.
Here are some examples of the types of maintenance we’re talking about:
- Dividend producing stocks: Your portfolio will need to be balanced, and there’s tax loss harvesting to optimize for tax purposes.
- Blogging: Once your blog is up and successfully earning passive income from course sales and affiliate marketing, you still need to drive traffic to your site.
- Rental properties: Your tenants are paying their rent, but occasionally you’ll have to do repairs or possibly find new renters.
Best ways to earn passive income
Now that you understand what passive income is and why you definitely need to start making it, below are the best ways to get started. Check out our definitive list of passive income ideas for even more ideas.
1. Invest in the stock market
You’ll need to do some research to find out what are the best assets to invest in, but there are several very user-friendly trading platforms. Here are our two top picks:
- Betterment: This robo-advisor designs a portfolio that aligns with your financial goals and needs. There’s a $0 minimum investment, and Betterment Digital’s fees are 0.25% of assets under management (or AUM). Betterment is excellent for hands-off investors.
- M1 Finance: This well-designed trading platform is a great fit for hands-on investors. M1 Finance has $0 commissions, and there’s no fee to get started.
2. Real estate
There are many approaches to real estate investing, and here are two of the most popular ways to earn passive income through real estate:
- REITs (real estate investment trusts): REITs are similar to mutual funds in that it’s a company that owns and manages real estate. Investors earn passive income through dividends and appreciation when a property sells. You can purchase REITs through an online brokerage, or you can check out Fundrise — you can start investing in commercial real estate for as little as $10!
- Rental property: Our article Investing in Rental Property for Beginners can explain more and help you get started.
Blogging is our favorite passive side hustle because the income potential is virtually limitless. You should think about blogging as a long-game overall because your site will take a considerable time investment before you can make serious passive income. However, you are in total control of when you work and how you scale. It’s truly an incredible feeling. If you’re interested in getting started, here’s what we recommend:
- Start your blog using Bluehost: This is the exact hosting platform we built this blog on, and you can start a blog for less than $3/month. Bluehost offers an affordable way to design a professional looking website.
- Read this guide: Our in-depth How To Start A Blog Guide outlines every step of setting up your blog — this is a very detailed guide!
- Learn how bloggers make money: To get an idea of how you make passive income blogging, our post How to Make Blogging explains five realistic options for 2022.
4. Cash back apps
You will not get rich with cash back apps alone, but you can earn an extra $20-$100/month with them. Cash back apps will pay you real cash when you buy gas, groceries, shop online, and so on. Companies pay them to promote specific products and services, and they give you a portion of the sale as a thank-you. Here are two popular programs:
5. Rent out your stuff
Peer-to-peer rental has become a popular way for consumers to save money, but it’s also opened the door for a variety of passive income ideas, such as:
- Rent out storage space: Neighbor is a platform to list underutilized space in your house — think: attic, basement, closets, spare bedroom, garage, etc. — so people in your area can pay to store things there. You can make anywhere from $25-$600/month in passive income with Neighbor.
- Rent out your car: An excellent way to make passive income and offset the cost of car ownership is to list your car on HyreCar. You can rent your car to food delivery and rideshare drivers and earn an average of $700/month.
What is passive income? The final word
Passive income is the opposite of your day job where you’re trading time for money. Passive income helps you diversify your income, build wealth, provide financial stability, and much more.
There’s no trick to earning passive income, and you don’t have to be rich to start or have a ton of extra time to devote towards developing a source. There are opportunities out there for everyone, and there’s no time like the present to get started!
Passive income can include stock dividends, income generated from real estate, affiliate revenue from a blog, credit card rewards, online course sales, and more.
Investments that pay dividends or interest are considered passive income.
Yes, you will need to pay taxes on your passive income. However, there are several factors that determine your tax liability, such as type of passive income and how long you’ve owned it.