Takeaways
- Passive income is generated without actively working for a salary.
- Some passive incomes have special tax benefits.
- Building a portfolio of passive income streams takes financial planning.
- Buying cash-generating assets provides access to passive income.
- Passive income can let you travel and explore new career opportunities.
Want to earn money while you sleep? That is the dream of building and creating passive income streams. Passive income streams are cashflows generated outside of your formal employment and can be a great way to make more money in today’s economy.
You can generate passive income by starting your own business or investing in certain investments, such as real estate. These entities begin to generate income without considerable active management. The allure of earning money each month without lifting a finger is enticing.
Passive income streams can supplement your current income to help pay off credit card debt or achieve other financial goals. Generating a passive income stream isn’t necessarily easy, but it can pay off in the long run. Most avenues to create passive income require either an investment of capital or time (sometimes both).
What is Passive Income?
The IRS categorizes incomes into three different buckets: active income, portfolio income, and passive income. Passive income is a type of income defined as unearned income. As the name suggests, this type of income requires little to no labor to earn or maintain. Passive income is not income earned trading your time for a service, such as consulting or freelancing. Instead, it is income produced where your time is not materially required.
9 Ways to Earn Passive Income
Here are the nine best ways to earn passive income in 2023:
1. Dividend Stocks
If you are learning to invest for the first time or are a seasoned trader, investing in dividend-paying stocks can be an excellent source of passive income. Dividends, or cash payments to shareholders, are typically paid by mature publicly traded companies. This cash payment to you, the shareholder, is income earned simply by investing in shares (an investment).
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When you receive a cash dividend, you can spend it, save it, or use it to meet another financial goal. Alternatively, you can reinvest that cash into another stock or investment. By reinvesting your dividend (learn about Dividend Reinvestment Plans) you can increase your investments in stocks, mutual funds, or another type of investment over time.
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2. High-Yielding Savings Account
If you do not want to invest in stocks, putting your cash into a high-yielding savings account can be a great way to earn passive income. Opening a savings account only takes a couple of minutes. Whether you are typing to grow your emergency fund, increase your slush fund, or looking for a place to temporarily store your money, a high-yielding savings account could be perfect for your financial situation.
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A major advantage of high-yielding savings accounts is that most are FDIC-insured. This means that the FDIC will automatically ensure deposits of $250,000[1]. Since interest rates vary from bank to bank, shop around to get the highest bang for your buck.
Smart Tip:
Interest rates on savings accounts are at their highest rates in years. Take advantage of the rising rate environment, protect your savings against inflation, and earn more income while you do it with high-yielding savings accounts.
3. Invest in Certificates of Deposit
Another short- and longer-term investing option is to invest in a certificate of deposit (CD). A certificate of deposit is a deposit account with a bank for a guaranteed term, which can vary from as short as one month to upwards of 10 years.
The APY (Annual Percentage Yield) offered on CDs varies with term length. CDs are generally attractive because they are short-term in nature, and you can lock in a guaranteed return. Fixed returns help investors with portfolio allocation.
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You can think of a CD as a pool of money you weren’t going to touch. Because of that, you can earn interest while your funds are used by banks and credit unions. Certificates of deposits pay higher interest rates than checking or savings accounts to compensate for reduced access to your funds.
4. Real Estate Investing
Investing in real estate has always been a strategy to generate passive income. Buying rental properties, single or multi-family, can offer a steady and healthy stream of cash flow to you in the form of rent from your tenants. If you own rentals in popular and healthy markets, you can generate a return through your rental income and the appreciation of your real estate assets.
Investing in real estate also has its disadvantages. The highest hurdle for most investors is the upfront capital to purchase a real estate asset. In addition, you must manage properties, be liable for a mortgage, and manage property taxes.
5. Rent Out a House or Apartment
If you are not ready for the capital demands of investing in real estate properties, you can always rent out your apartment or car. Renting out a vacant single bedroom or your apartment when leave town can be an excellent way to monetize unused space and simultaneously generate passive income.
Companies like Airbnb or VRBO offer concierge-like services to quickly add excess capacity or list your entire apartment or house. These short-term rental options fluctuate in demand, depending upon your geography, and often aren’t a steady income because tenants typically don’t stay longer than a couple of days. And as the host, you still must manage the property and your visitor's stay, much like with a real estate property.
6. Create A Blog
Starting a website or blog can be a great way to generate passive income. Although founding a successful website is not easy, creating a website with affiliate links can produce passive income. By writing articles about topics that captivate readers and providing the highest caliber content, you can generate millions of views per month. This type of traffic can generate passive cash flow.
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While building a website or blog business is a long-term strategy for generating passive income, you might be able to put in a ton of work upfront and enjoy the fruits of cash flow months later. The flexibility of remotely managing a blog has enticed many entrepreneurs to start their businesses.
7. Buy A Bond Ladder
Predicting the movement of interest rates is extremely difficult. A bond ladder can help you participate at today’s interest rates and provides flexibility to capture newer rates in the future. A bond ladder is a portfolio of bonds with different terms and yields, maturing on progressive dates. A bond ladder can provide the necessary liquidity to ensure you keep capturing current bond yields.
For example, you can build a five-year bond ladder, with the bond maturing at the end of each year. As the bonds mature, you can keep your principal and interest or reinvest the proceeds into another bond to extend your investment ladder. Bond ladders are great for timing cash flows and allow you to manage liquidity in a changing interest rate environment.
8. Rent Out Your Car
Have you ever considered renting out your vehicle to make an income? If you have idle time or capacity, you can rent your car and earn cash sitting on your couch.
Car-sharing marketplaces, like Turo, let you rent out one or more cars. Turo functions similarly to VRBO or AirBnb, just with your car instead of your apartment. Your car renter even picks up and drops off your vehicle.
Another alternative is to check out the car rental service Getaround, which allows you to rent and share your car. All you need to do is list your vehicle, charge an hourly rate, and have someone rent your car.
Renting out your vehicle when you aren’t using your vehicle can help offset the costs of car ownership like – car payment, maintenance, insurance, and gasoline.
9. Invest in REITs
If you don’t have the upfront capital to invest in a rental property, you can still get the benefits of investing in real estate by investing in a Real Estate Investment Trust, or REIT. A REIT is a company that owns or finances income-producing real estate investments. REITs can trade on stock exchanges (like the NASDAQ or NYSE) and offer many benefits to investors.
There are also REIT platforms, such as Fundrise, that provide investors the opportunity to earn passive income and accrue asset appreciation.
Investing in real estate can be a fantastic long-term investing strategy and should be considered part of any well-formed portfolio. Gaining exposure to real estate can be accomplished by owning an investment property or buying stock in a REIT.
Benefits of Passive Income
The benefits of earning passive income are life changing. Passive income can provide cash flow to accomplish your financial goals and the kindling to make more income over your career.
1. Increased Income
Earning more income has its benefits. If you have concrete financial goals, more cash can help you reach them faster. You can treat your passive income as “extra” income not to be utilized for anything besides meeting your long-term financial goals.
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Here are three ways passive income can help your financial life:
Pay off Debts
Passive income could help you put more cash towards paying off your credit cards, finally paying off your student loans, or getting rid of your car note. Once you are debt-free, you can put even more income to work and start saving or investing.
Save More
The extra income you earn from passive income can help you save more cash. It could be the additional boost you need to fill up your emergency fund, slush fund, or start your investment account.
Achieve Financial Independence
Passive income streams are the financial apex for those trying to achieve financial independence. To achieve financial independence, you need to have your income streams exceed your costs. Whether buying dividend-paying stocks or owning multiple businesses that send you a check each month, financial independence can be accomplished with smart financial planning.
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2. Location Agnostic
A massive benefit of earning passive income is that you do not have to live in one location to make multiple income streams. You can start your business and work virtually anywhere, allowing you the benefit of travel year-round. If jet setting isn’t your thing, you can gain the flexibility to live almost anywhere.
3. Tax Treatment
Does the IRS tax passive income? Unfortunately, the answer is yes. The IRS taxes passive income at your ordinary tax bracket or the same as your income from earning a salary. However, the IRS does allow you to use passive income-based deductions against passive income. This can help reduce your tax liability.
We list the tax treatment as an advantage to passive income because you do not receive additional taxes even though you are not actively earning this income. We see this as a huge advantage.
Managing Multiple Passive Income Streams
Do you want to be a millionaire? In a recent survey, roughly 65% of millionaires had at least three income streams. Building a portfolio of passive income streams can increase your wealth drastically. If you are trying to earn more money with passive income, managing your income streams is essential.
Managing these income streams can be time-consuming, but websites like Personal Capital can help you manage your accounts by keeping all your information in one location. Regularly monitoring your passive income will help you manage the cadence, amounts, and robustness of your cash flows.
Smart Summary
Passive income has many definitions. As defined by the IRS, passive income is income generated from a business that does not require active participation or from rental property. In the personal finance space, it has come to mean income you do not actively have to generate.
In today’s economy, passive income has never been easier to create. Thanks to the ubiquitous nature of the internet, you can start yielding passive income at any time. Passive income can boost your earnings to help you reach your financial goals. Depending on how much you pursue passive income, it can provide achieve true financial independence.
[1] Federal Deposit Insurance Corporation. Understanding Deposit Insurance. Accessed August 28, 2023.
