With the cost of living rising, one source of income often isn’t enough to support a comfortable lifestyle anymore. More than 25% of Americans now have a ‘side hustle’ such as running errands, driving for a ridesharing service or selling products online.
Side hustles can be a great way to increase your monthly earnings, but they generally require quite a bit of time and effort.
One way to increase your wealth over time is to earn money through passive income streams. If you earn enough through passive income, you could potentially quit your 9-to-5 job and have more money throughout your retirement.
The average millionaire in the U.S. has between three and seven sources of income. It’s rare to find a person who became wealthy through a regular paycheck alone.
However, creating and managing passive income isn’t a passive activity. It requires upfront work and sometimes investment to build up a source of passive income. Depending on what your passive income source is, it may require you to put in time each week to keep it earning you cash.
What is passive income?
Passive income is money that you earn without active involvement. In other words, it is income that isn’t attached to an hourly wage or annual salary. Passive income streams could include things like cash flow from rental properties, dividend-yielding stocks, sales of a product (that requires little or no effort), royalties and more.
If you own a business, such as an LLC, you could be earning money in your sleep through online sales, rising stock value or other sources. Jeff Bezos, for example, earns around $149,000 every minute.
Types of income
In addition to passive income, there are other types of income you can earn.
• Earned income: This is the most common type of income — money you make from a job. With earned income you are trading your time for money.
• Profit income: Profit income comes from the sale of a product after expenses have been deducted.
• Interest income: This can be money earned from one entity lending to another entity, such as a person, company or bank. This can also be referred to as interest from accounts such as savings accounts and CD’s (Certificate of Deposits) in which you receive a 1099-INT at the end of the year.
• Dividend income: Most dividend income is earned by the distribution of income from companies to shareholders owning stocks that pay dividends.
• Rental income: Rental income is earned when you rent or lease a house, car or other property you own to someone else.
• Capital gains: This generally refers to profit (or gain) that is subject to taxation when you sell an asset such as stock or real estate. There are both long- and short-term capital-gain tax rates depending upon how long you held the asset before sale.
• Royalty income: Royalty income is generated when you own the rights to a piece of art, music, literature, or another asset, or from extraction of oil, gas or minerals and it is licensed for other people to use.
The benefits of earning passive income
Everyone has only 24 hours in their day. If you go to a job each day which pays you a set amount of money, that is the maximum amount that you’ll ever make in a 24-hour period. That is called earned income.
By investing some of that earned income and creating sources of passive income, you may be able to increase your earnings. Also, you’ll likely have more financial security during hard times. Some of the main benefits of passive income are:
More free time
By earning money through passive income sources, you might be able to free up some of your schedule. You may choose to spend more time with your family, pursue a creative project or new business idea or travel the world.
Even if you still plan to keep your 9-to-5 job, having multiple sources of income could help increase your financial security. If you lose your job, get sick or injured, you may still have money coming in to cover expenses. This is especially important if you are supporting a family.
Depending on how you earn your passive income, you may qualify for more tax breaks than if you only earn through a 9-to-5 job. If you start your own business, you may be able to write off certain expenses such as equipment, business travel and software subscriptions. (Consult with your tax advisor on how to set up this business, LLC, etc.)
If you don’t have to go into an office each day, you’ll be free to move around and, possibly, live anywhere in the world. Many passive income streams can be managed from your phone or laptop.
Achieve financial independence
The definition of financial independence is having enough income to cover your expenses without having to actively work in order to cover living expenses. This could allow you to retire early and have more freedom to live your life the way you choose. Whether you’re interested in retiring early or not, passive income can be one way to help you reach financial independence.
Pay off debt
Passive income may help you to supplement your income so that you will have the opportunity to pay off any debts more quickly.
Potential downsides of passive income
Although it might sound like a dream come true to quit your job and travel the world, earning through passive income is not quite that simple.
Earning passive income is not a passive activity
Whether you earn passive income through a rental property, running a blog or in another way, you will still need to put in some time and effort. It takes time to get these income sources up and running and they don’t always work out as planned.
If, for example, you run an Airbnb, you need to find the right property to rent, maintain the property, make sure you’re getting positive reviews and will need to interface with your guests on a regular basis.
Passive income requires diversity
In order to earn enough passive income to quit your job and cover all your expenses, you would most likely need more than one source of income. It’s also wise not to put all your eggs in one basket.
Although you may no longer need to clock into a 9-to-5 job, you will likely still need to put time in to manage your multiple income streams.
It’s lonely at the top
It might sound great to never have to go to the office again and to have the freedom to travel, but earning money through passive income can become lonely.
Not having anyone to talk to during the day might make you stir crazy, and if you aren’t self-motivated, you may find it difficult to stay on task if you need to manage your passive income streams.
Getting started may require investment
Depending on how you plan to earn passive income, it may require an initial financial investment. You may need money for a down payment on a rental property, the development of a product you plan to sell or for investment into dividend-yielding stocks.
Types of passive income
There are many different ways you can start to earn passive income. Some are easier to get started than others. Here are a few of the most popular options for earning passive income:
Investing your money
Opening a high yield savings account: By simply putting your money in the bank, you may be able to start to earn passive income on it. If you invest in an FDIC insured account, the first $250,000 of your money is protected. There are both banks and online platforms which offer high yield savings accounts.
Buying a company: Although it may take more up-front investment, buying into a business and becoming a silent partner can be a great way to earn passive income. A business such as a car wash or laundromat has the potential to earn quite a bit of money each month.
Peer-to-peer (P2P) lending: Using a peer-to-peer or crowd-lending website, you can get matched to lend your money to individuals as an installment-type loan and earn interest on it. You might earn even more than from a bank, depending on the loan.
Buying a rental property or investing in crowdfunded real estate: One of the most popular forms of passive income comes from rental properties. You might want to purchase a home to rent out to an ongoing tenant or list a property on a short-term rental site like Airbnb. There are also platforms where you can invest a smaller amount of money into a crowdfunded real estate project.
Investing in index funds or dividend-paying stocks: There is no guarantee that investing in dividend-paying stocks will continue to earn you passive income, but some investors may enjoy the thrill of the ups and downs of the stock market. Dividend-paying stocks typically pay investors quarterly or annually, and often allow investors to reinvest the dividends.
Investing with an automated advisor: If you’re just getting started with investing, you may want to use automated investing tools to help you choose the best stocks for your goals.
If you want to invest time
Creating an online course: If you have a special skill or knowledge about a certain topic, you may be able to create a video course where you teach people about it and charge them to take the course.
Selling digital products: You may want to research online platforms where you can sell everything from computer backgrounds to e-books. Whether you’re an artist, graphic designer or writer, you can create digital products to sell online.
Licensing your photos: Many companies, bloggers and individuals use stock photos on a regular basis. You may be able to upload your best photos to stock photo sites and earn passive income on them.
Creating a mobile app: If you’ve been dreaming about an amazing phone app that you think a lot of other people would use, you may want to look into hiring a development team to create it.
Selling a product: You may be able to earn passive income through sales of a product that you create. This could be a book that you write or a physical product that you design and make. You might also list items you already own on sites like eBay and earn extra income through those sales.
Starting a blog: If you like to write and are passionate about a certain topic, you might want to start a blog and earn money through ads and affiliate links.
Managing passive income streams
No matter which form of passive income you choose to pursue, it’s important to keep track of your finances and both your short-term and long-term financial goals.
If you have multiple sources of income, it can be complex to track them all on top of your monthly budget.
You’ll likely need to pay attention to how much money you put into the maintenance of your passive income stream, such as property upkeep or monthly online services.
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