The idea of passive income — earning money without having to work for it — sounds ideal. If you’re saving up for a specific goal, like buying a home, or just want more security in retirement, passive income is a great way to increase your wealth.
But it’s not as straightforward as it may sound.
“Passive income has been a hot topic lately, but a lot of people are confused on what exactly it is,” said Jacqueline Schadeck, certified financial planner and advisor at Sherrill & Hutchins Financial Advisory. “There’s a new wave of people that think, ‘I need passive income to fulfill my income to quit my job.’ They don’t think about the startup costs.”
What is passive income?
Passive income is income that requires minimal to no effort to maintain. But it’s not a get-rich-quick scheme. It often takes work to get off the ground.
Examples of passive income include:
- Rent out your home for the summer. (Make sure you have homeowners insurance to cover guests.)
- Rent out parking space. Drivers in popular metropolitan areas may pay top dollar to rent a spot near their home or work. Here’s how to get started.
- Invest. Starting to invest as soon as possible will net you the greatest possible returns, thanks to compounding interest. If you’re new to the investing world, here’s a guide.
- Try a high-yield savings account. If you want to grow your money safely, consider a high-yield savings account, which offers higher interest rates than their traditional counterparts. Another option is the CD ladder, which locks your money into higher rates without losing too much liquidity.
- Sell an Ebook online. Are you an expert in a certain topic? Consider writing an online guidebook — your expertise may appeal to readers and can turn a profit.
The biggest advantage is the future freedom you’ll earn once passive income starts rolling in. The extra money can help you retire early, increase your wealth and can protect you in the event of job loss.
“It’s about building that foundation and then not doing anything to manage it,” said Schadeck.
While many may be able to live off passive income, returns aren’t guaranteed. If your income stream runs out or your investments take a dive, you may find yourself in the red.
“In many cases passive income tends to have less diversification and less liquidity than traditional investments,” said Scott Bishop, certified financial planner and vice president at STA Wealth Management.
Those relying on passive income should beef up their emergency fund to prepare for slow months. If you become disabled and unable to work, disability insurance may still cover your passive income, depending on the situation. Learn more here.
Types of passive income
Passive income sources include dividends or interest from investments like stocks. It also includes pensions, royalties, annuities or alimony. Another form of passive income is renting out real estate.
Taxpayers can deduct passive income losses from other income they have. It’s best to consult a tax professional to understand the tax implications of passive income.
How to begin earning passive income
First, find your niche. Do you have real estate to rent out? Do you have an online resource or tool you could sell online?
Decide how much work you’re willing to put in, how much liquidity you’re willing to take on and a target amount of income you hope to bring in, said Bishop.
Once you’ve listed your home or posted your online tool, remember it often takes time to see results.
“Remain patient,” said Schadeck. “[Passive income] is never a fast track to wealth or quitting your job.”
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Image: Nastia Kobzarenko