The idea of building wealth through passive income has understandable appeal, especially if you’re worried about being able to save enough from your work earnings to meet your retirement goals.
For example, to generate $1,000 a month in retirement income from a portfolio, you’d have to amass about $250,000, assuming a 5 percent withdrawal rate. Better to create a passive income stream to help you reach this goal.
What is passive income?
Passive income includes regular earnings from a source other than an employer or contractor. The IRS says passive income can come from just 2 sources: rental income or a business in which an individual does not actively participate. Examples include book royalties and dividend-paying stocks.
It’s easy to think as passive income as money you earn while sitting on a beach sipping mojitos, but there is lots of work involved, says financial coach and expert Todd Tresidder.
“Many people think that passive income is about getting something for nothing,” Tresidder says. “It has a ‘get rich quick’ appeal … but in the end, it still involves work. You just give the work upfront.”
If you’re thinking about creating a passive income stream, check out these five strategies and what it takes to be successful with them.
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Selling information products
One popular strategy for passive income is establishing some kind of information product — an e-book, audio course, DVD — then kicking back while cash from the sales of these products rolls in.
While information products can eventually yield an excellent income stream, Tresidder notes that it’s hardly a passive activity.
“It takes a massive amount of effort to create the product,” he says. “And to make good money from it, it has to be great. There’s no room for trash out there.”
Tresidder says to find financial success, you have to build a strong platform, market your products and plan for serialization.
“One product is not a business unless you get really lucky,” Tresidder says. “The best way to sell an existing product is to create more excellent products.” But once you master the business model, he adds, you can generate a good income stream.
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Investing in rental properties is an effective way to earn passive income. Nonetheless, it often requires more work than people expect. If you don’t spend the time learning how to make it a profitable venture, you could lose your investment and then some, says John Graves, author of “The 7% Solution: You Can Afford a Comfortable Retirement.”
To earn passive income from rental property, Graves says you must determine three things:
The return on investment you want to have.
The property’s costs and expenses.
The financial risks of owning the property.
For example, if your goal is to earn $10,000 a year in rental income and the property requires a $2,000 monthly mortgage plus an additional $300 a month in taxes and other expenses, you’d have to charge around $3,150 in rent monthly to reach your goal.
Now, the question becomes one of risk: Is there a market for your property? Might you get a deadbeat tenant? Will your tenant damage the property? All of these could result in a sizable dent in your passive income.
With affiliate marketing, website owners or bloggers promote a third party’s product by including a link to the product on their site. When a visitor clicks on the link and makes a purchase from the third party, the site owner earns a commission.
Affiliate marketing is considered passive because, in theory, you can earn money just by adding the link to your site. In reality, you won’t earn anything if you can’t attract readers to your site, click on the link and buy something. So if you’re just starting out, you’ll have spend time creating content and building traffic.
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A peer-to-peer loan is a personal loan made between you and a borrower, facilitated through a third-party intermediary such as Prosper.com or LendingClub.com. As a lender, you earn income via interest payments made on the loans. But because the loan is unsecured, you face the risk of default.
To cut that risk, you need to do two things:
Diversify your lending portfolio by investing smaller amounts over multiple loans (Prosper.com recommends more than 100).
Analyze the historical data on the borrowers to make the right picks.
The time it takes to master the metrics isn’t the only reason P2P lending isn’t entirely passive. Because you’re investing in multiple loans, you need to pay close attention to payments received. Whatever you make in interest should be reinvested if you want to accumulate interest.
Shareholders of dividend-yielding stocks receive a payment at regular intervals from the company’s profits or reserves. Since the income received from the stocks isn’t related to any activity other than the initial financial investment, owning dividend-yielding stocks can be one of the most passive forms of making money.
The tricky part, of course, is choosing the right stocks. Graves warns that too many novices jump into the market without thoroughly investigating the company issuing the stock. “You’ve got to investigate each company’s website and be comfortable with their financial statements,” Graves says. “You should spend two to three weeks investigating each company.”
That said, there are ways to invest in dividend-yielding stocks without spending too much of an initial time investment. Graves advises going with exchange-traded funds, or ETFs. ETFs are investment funds that hold assets such as stocks, commodities and bonds, but they trade like stocks.
“ETFs are an ideal choice for novices because they are easy to understand, highly liquid, inexpensive and have far better potential returns because of far lower costs than mutual funds,” Graves says.