It’s easy to think of passive income as money earned while sitting on a beach sipping mojitos, but there is lots of work involved, says financial coach and retired hedge fund manager Todd Tresidder.
If you’re worried about being able to save enough of your earnings to meet your retirement goals, building wealth through passive income is a strategy that might appeal to you.
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 two sources: rental property or a business in which one does not actively participate, such as being paid book royalties or stock dividends.
“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.”
10 passive income ideas for building wealth
If you’re thinking about creating a passive income stream, check out these 10 strategies and learn what it takes to be successful with them, while also understanding the risks associated with each idea.
1. Selling information products
Overview: One popular strategy for passive income is establishing an information product, such as an e-book, or an audio or video course, then kicking back while cash rolls in from the sale of your product. Courses can be distributed and sold through sites such as Udemy, SkillShare and Coursera.
Opportunity: Information products can deliver an excellent income stream, because you make money easily after the initial outlay of time.
Risk: “It takes a massive amount of effort to create the product,” Tresidder says. “And to make good money from it, it has to be great. There’s no room for trash out there.”
Tresidder says you must build a strong platform, market your products and plan for more products if you want to be successful.
“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.”
Once you master the business model, you can generate a good income stream, he says.
2. Rental income
Overview: Investing in rental properties is an effective way to earn passive income. But it often requires more work than people expect.
If you don’t take the time to learn how to make it a profitable venture, you could lose your investment and then some, says John H. Graves, an Accredited Investment Fiduciary (AIF) in the Los Angeles area and author of “The 7% Solution: You Can Afford a Comfortable Retirement.”
Opportunity: To earn passive income from rental properties, Graves says you must determine three things:
- How much return you want on the investment.
- The property’s total 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 has a monthly mortgage of $2,000 and costs another $300 a month for taxes and other expenses, you’d have to charge $3,133 in monthly rent to reach your goal.
Risk: There are a few questions to consider: Is there a market for your property? What if you get a tenant who pays late or damages your property? Any of these factors could put a big dent in your passive income.
3. Affiliate marketing
Overview: With affiliate marketing, website owners, social media “influencers” or bloggers promote a third party’s product by including a link to the product on their site or social media account. Amazon might be the most well-known affiliate partner, but eBay, Awin and ShareASale are among the larger names, too.
Opportunity: When a visitor clicks on the link and makes a purchase from the third-party affiliate, the site owner earns a commission.
Affiliate marketing is considered passive because, in theory, you can earn money just by adding a link to your site or social media account. In reality, you won’t earn anything if you can’t attract readers to your site to click on the link and buy something.
Risk: If you’re just starting out, you’ll have to take time to create content and build traffic.
4. Peer-to-peer lending
Overview: A peer-to-peer (P2P) loan is a personal loan made between you and a borrower, facilitated through a third-party intermediary such as Prosper.com or LendingClub.com.
Opportunity: 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. At Prosper.com, the minimum investment per loan is $25.
- Analyze historical data on the prospective borrowers to make informed picks.
Risk: It takes time to master the metrics of P2P lending, so it’s not entirely passive. Because you’re investing in multiple loans, you must pay close attention to payments received. Whatever you make in interest should be reinvested if you want to build income.
5. Dividend stocks
Overview: Shareholders in companies with dividend-yielding stocks receive a payment at regular intervals from the company. Companies pay cash dividends on a quarterly basis out of their profits, and all you need to do is own the stock. Dividends are paid per share of stock, so the more shares you own, the higher your payout.
Opportunity: Since the income 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.
Risk: The tricky part 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 a huge amount of time evaluating companies. 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.
Compare your investing options with Bankrate’s brokerage reviews.
6. Savings accounts
Overview: It doesn’t get any more passive than putting your money in a savings account at the bank or one of the many online financial sites offering high yields. Then sit back and watch the interest mount up.
Opportunity: Interest rates have risen to their highest levels in more than a decade. The Fed has said that it doesn’t expect to raise rates anymore in 2019, but if the economy strengthens, rates could rise in the future. So it’s an opportune time to take advantage.
Risk: If you invest in an account insured by the FDIC, you have no risk at all up to a $250,000 threshold per bank. The biggest risk is probably that interest rates tend to fall when the economy weakens, and in this case, you would have to endure lower payouts that potentially don’t earn enough to beat inflation. That means you’ll lose purchasing power over time.
Overview: A REIT is a real estate investment trust, which is a fancy name for a company that owns and manages real estate. REITs have a special legal structure so that they pay little or no corporate income tax if they pass along most of their income to shareholders.
Opportunity: You can purchase REITs on the stock market just like any other company or dividend stock. You’ll earn whatever the REIT pays out as a dividend, and the best REITs have a record of increasing their dividend on an annual basis, so you could have a growing stream of dividends over time.
Risk: Just like dividend stocks, you’ll have to be able to pick the good REITs, and that means you’ll need to analyze each of the businesses that you might buy — a time-consuming process. And while it’s a passive activity, you can lose a lot of money if you don’t know what you’re doing.
But like dividend stocks, you can buy an ETF or mutual fund that invests exclusively in REITs. That provides immediate diversification and is a lot safer than buying individual stocks — and you’ll still get a nice payout.
8. A bond ladder
Overview: A bond ladder is a series of bonds that mature at different times over a period of years. The staggered maturities allow you to decrease reinvestment risk, which is the risk of tying up your money when bonds offer too-low interest payments.
Opportunity: A bond ladder is a classic passive investment that has appealed to retirees and near-retirees for decades. You can sit back and collect your interest payments, and when the bond matures, you “extend the ladder,” rolling that principal into a new set of bonds. For example, you might start with bonds of one years, three years, five years and seven years. In one year, when the first bond matures, you have bonds remaining of two years, four years and six years. You can use the proceeds from the recently matured bond to buy another one year or roll out to a longer duration, for example, an eight-year.
Risk: A bond ladder eliminates one of the major risks of buying bonds – the risk that when your bond matures you have to buy a new bond when interest rates might not be favorable.
Bonds come with other risks, too. While Treasury bonds are backed by the federal government, corporate bonds are not, so you could lose your principal. And you’ll want to own many bonds to diversify your risk and eliminate the risk of any single bond hurting your overall portfolio.
Because of these concerns, many investors turn to bond ETFs, which provide a diversified fund of bonds that you can set up into a ladder, eliminating the risk of a single bond hurting your returns.
9. Rent out a room in your house
Overview: This straightforward strategy takes advantage of space that you’re probably not using anyway and turns it into a moneymaking opportunity.
Opportunity: You can list your space on any number of websites, such as Airbnb, and set the rental terms yourself. You’ll collect a check for your efforts with minimal extra work, especially if you’re renting to a longer-term tenant.
Risk: You don’t have a lot of financial downside here, though letting strangers stay in your house is a risk that’s atypical of most passive investments. Tenants may deface or even destroy your property, for example.
10. Advertise on your car
Overview: You may be able to earn some extra money by simply driving your car around town. Contact a specialized advertising agency, which will evaluate your driving habits, including where you drive and how many miles. If you’re a match with one of their advertisers, the agency will “wrap” your car with the ads at no cost to you. Agencies are looking for newer cars, and drivers should have a clean driving record.
Opportunity: While you do have to get out and drive, if you’re already putting in the mileage anyway, then this is a great way to earn hundreds per month with little or no extra cost. Drivers can be paid by the mile.
Risk: If this idea looks interesting, be extra careful to find a legitimate operation to partner with. Many fraudsters set up scams in this space to try and bilk you out of thousands.
How many streams of income should you have?
There is no “one size fits all” advice when it comes to generating income streams. How many sources of income you have should depend upon where you are financially, and what your financial goals for the future are. But having at least a few is a good start.
“You’ll catch more fish with multiple lines in the water,” says Greg McBride, CFA, chief financial analyst at Bankrate. “In addition to the earned income generated from your human capital, rental properties, income-producing securities and business ventures are a great way to diversify your income stream.”