How to create a passive income stream

If you’re worried your salary is not enough to help you save a deposit for your first property or prepare you for retirement, building wealth through passive income is a strategy that might appeal to you.

What is passive income?

Passive income is a source of revenue that continues even after the work is complete, for example, royalties from a book or film.

We’re not suggesting you go out and write a book (not very passive) or make a blockbuster movie (not very savvy), but some of the below options do require a little effort in the beginning to then pay you in the long-term without you needing to lift another finger.

What we’ve tried to highlight here is how to make your money (that you’ve already earned) make more money (without you having to do much), so they do rely on you having some initial capital already behind you.

Some of these strategies involve an element of risk. If you are not fully comfortable with that, it might be more advisable to go down the slightly more labour intensive route of selling your stuff on eBay, setting up a side business or writing that bestseller after all.

What ways can I earn a passive income?

Here are eight strategies for creating a passive income stream:

    1. Switch your bank account
    2. Earn interest on savings
    3. Use a cashback or rewards credit card
    4. Buy via cashback websites
    5. Try out robo-investing
    6. Rent out a room (or parking space)
    7. Invest with peer-to-peer lending
    8. Purchase dividend-yielding stocks

1. Switch your bank account

Loyalty to your bank is a thing of the past, and banks know it. That’s why so many offer cash switching incentives (the current highest is £200 from HSBC) for current accounts, many of which link with savings accounts, some with interest as high as 5%.

Not all banks are part of the switching scheme, but those that are guarantee all direct debits and standing orders are transferred to your new account within seven days.

If they fail to do this and you wind up with a late payment charge from your old account, your new bank should cover it.

Most bank accounts have a minimum pay-in and a two direct debits requirement – make sure you meet them to reap the full benefits of the switching rewards.

Some charge a monthly fee, so watch out for that when you switch over as you do not want to pay out more than you earn.

2. Earn interest on savings

In today’s low interest climate, the best rates on savings are often reserved for fixed-rate accounts or bonds. These are savings accounts that lock away your money for a set period of time. Generally speaking, the longer it’s locked away, the higher the rate.

Only use these if you are comfortable with not having access to your money. If you suddenly realise you need it before the bond is up, you will most likely have to pay an early withdrawal fee.

One way to avoid this is to get a current account with a high interest rate as we mentioned above.

Today, the best returns on savings are from Lifetime and Help to Buy ISAs where the government pays you a 25% bonus on your funds. The Help to Buy ISA pays this on withdrawal, whereas the Lifetime ISA pays in the bonus annually.

3. Use a cashback or rewards credit card

If you are going to spend on a credit card anyway (which you may need to do to build up your credit history), you might as well get one that gives you cash bonuses to do so.

There are a few cards out there that offer cashback or that operate reward schemes that could give you discounts in certain stores or earn you air miles.

However, always approach credit cards with caution – they are a debt product after all. If you do not think you will be able to pay it back in full every month, your interest repayments will very quickly outpace any cashback or rewards.

4. Buy via cashback websites

Cashback websites are essentially third party portals that you visit before clicking through to a website from which you were already going to buy something.

Using the cashback site’s link rewards them with money, some of which they pass on to you. How much you could get is usually shown as a percentage of the total amount you spend, but you are not always guaranteed to get that amount.

Like with a cashback credit card, only use a cashback site if you were planning to spend that money anyway – that way, you really could be getting something for nothing.

5. Try out robo-investing

Robo-investing is one of the slightly riskier ways to make a passive income, especially as you cannot specify where your funds get invested.

Unlike with traditional savings accounts where your money just sits there earning (or not earning much) interest, here it gets invested so you could reap bigger financial rewards. Remember, you could also experience a loss, so proceed with caution.

Robo-investing, open banking apps like Moneybox round up your spending and invest the difference.

For example, if you bought something costing £2.80, Moneybox rounds it up to £3 and invests the spare 20p. You can pick from three levels of risk: cautious, balanced, or adventurous.

The idea is, the amounts are so nominal you do not notice them not being there – it’s like putting your spare change in a piggy bank rather than having it jangle around in your pocket.

However, if you are someone who likes to keep an eye on every penny, this may not be the best way for you to earn a passive income.

6. Rent out a room (or parking space)

Buying and then renting out an entire property is a good way to earn a passive income, but it’s an expensive one and requires a lot of work.

For starters, you’ll have to pay an extra 3% in stamp duty (if it’s your second home, otherwise you pay the normal stamp duty rates), need a 25% deposit and – if you’ve already exceeded the tax-free income threshold (£12,500 in 2019/2020) – you’ll have to pay income tax on any earnings.

However, if you have a spare room in your current property or have an empty parking space in an area where parking is an absolute premium, you can rent it out.

Again, this is something you will need to report to the tax man, but if you are not using the space, it could be a great way to earn passive income.

7. Invest with peer-to-peer lending

Peer-to-peer (P2P) lending consists of a personal loan made between you and a borrower, facilitated through a third-party intermediary such as Zopa or Funding Circle.

As a lender, you earn income via interest payments made on the loans. But because the loan is unsecured, you face the risk of the borrower defaulting on payments.

To minimise that risk, you should do two things:

  • Diversify your lending portfolio by investing smaller amounts over multiple loans
  • Analyse the historical data on the borrowers to make informed picks

It takes time to master the metrics of P2P lending, so it’s not entirely passive and because you’re investing in multiple loans, you’ll need to pay close attention to payments received.

Whatever you make in interest should be reinvested if you want to build income.

8. Purchase dividend-yielding stocks

A dividend is a sum of money paid to shareholders out of a company’s profits. Shareholders in companies with dividend-yielding stocks receive payments at regular intervals from the company.

Since the income from the stocks is not 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 is choosing the right stocks. To try and minimise loss, thoroughly investigate the company you’re thinking of investing in. Do not rush into anything!

If you are unsure of what to do, it might be worth speaking to a financial advisor. They will explain the risks meaning you can make an informed decision about the best course of action.

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Last updated: 8 July, 2019

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