Basics of Passive Income: Types, Ideas, and Benefits

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What is passive income?

Passive income refers to the earnings an individual derives from a rental property, limited partnership, or other enterprises in which they are not actively involved.

Passive is one of the most strategic ways to financial stability, you earn while you sleep. Your money works for you, it generates income for you.

It means rather than trading time for money, the passive income strategy revolves around creating sustainable systems that generate revenue with minimal active effort.

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Examples of passive income include receiving rental payments from properties you own, earning book royalties, receiving dividends from stocks, and generating income from investments.

In this comprehensive guide, you’ll learn how passive income works, the various types, how you can start building passive income streams, and passive income ideas that are worth trying.

Passive income in the U.S.

The median passive income in the United States is $4,200 per year, according to data from the U.S. Census Bureau, with small metros and midsize metros from California and Florida earning the most from passive income.

The data further shows that 20% of American households earn passive income from rental properties, dividends, and interest.

Passive vs Active Income

The primary difference between active and passive income lies in the relationship between work and pay.

Passive income is the opposite of active income. In active income, you trade your time directly for money, as seen in salaried or hourly jobs while passive is money earned with little to no daily effort.

In active income, you’re compensated based on the work you perform, meaning once you stopped working, your salary (income) stops too.

But in passive income, once you have a significant upfront investment either in the form of time, money or both, you continue to earn. So, “passive” doesn’t mean “effortless”, you need to make an upfront effort.

Benefits of passive income

Here are some benefits of passive income:

Financial freedom:

It can contribute to achieving your financial independence, where your passive income meets or exceeds your expenses.

Diversified income stream:

It provides an additional income source, reducing reliance on your primary income (typically active income).

Retirement security:

Passive income can supplement retirement funds, providing additional security in your golden years.

Time flexibility:

Since passive income isn’t tied to trading time for money, it allows for more flexibility in how you spend your time. All you need to do is to put in place upfront efforts to continually earn.

Types of Passive Income

The Internal Revenue Service (IRS) of the United States categorizes passive income into two main sources: rental property income and income from businesses in which the individual doesn’t actively participate.

Broadly speaking, there are four types of passive income:

  1. Investment Income
  2. Royalty income
  3. Business income
  4. Peer-to-peer income

Investment Income

Some examples of investments that can yield your income are:

Rental income:

Owning real estate properties and renting them out can provide a steady income stream. Investing in rental property appreciates over time if the property is well maintained and managed.

Dividends:

By purchasing shares of a dividend-paying company, you earn a portion of the company’s profits paid out periodically. You don’t need to actively get involved in the management of the company, your money works for you.

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Interest income:

Lending money to financial institutions through savings or fixed deposit accounts can earn you interest over time.

Business income

Income from businesses where you’re not actively involved is another form of passive income. Some examples include:

Limited partnerships: Being a limited partner in a business can provide income without the need for daily involvement.

eCommerce: Dropshipping, where you sell products online without holding inventory, can generate significant income once established.

Blogging & affiliate marketing: Creating a blog and earning through ads or affiliate marketing is a popular passive income stream.

Royalty income

If you’re a creative professional, there are ways to earn passive income from your work:

Patents: If you’ve invented a product, patenting it and licensing it to companies can bring in royalty income.

Copyrights: Authors, musicians, and other artists can earn royalties whenever their work is purchased, published, or used.

Stock photography: By selling your photos on stock photography websites, you can earn whenever someone purchases your image.

Peer-to-Peer lending

In peer-to-peer lending platforms, you can lend money to individuals or small businesses in return for interest payments. It’s a newer form of investment that can potentially yield higher returns than traditional savings accounts if you find a legit P2P lending platform.

How to start a passive income

Earning passive income doesn’t come easy, you have to learn practical steps and methods to create passive income streams and diversify your sources of earnings, from choosing the right passive income type to investing in time and effort, here are the steps and strategic process to get started:

Choose the right passive income type:

Your choice of passive income should align with your skills, interests, and financial goals. For example, if you have a knack for inventing, patent royalties could be a viable option. Alternatively, if you’re financially savvy, investing in stocks or peer-to-peer lending might suit you better.

Accumulate start-up capital:

Almost all passive income streams require an initial investment. Whether it’s purchasing a rental property, investing in stocks, or setting up an online store, you’ll likely need some start-up capital. This could come from savings, a loan, or profits from another business.

Diversify your income:

As with any investment, diversification is crucial. Don’t put all your eggs in one basket; instead, create multiple passive income streams. Diversification can help protect your income, ensuring that if one stream dries up, you have others to fall back on.

Invest time and effort:

Despite the term “passive”, setting up a passive income stream requires time, effort, and patience. Whether you’re creating a blog, building a rental property portfolio, or setting up an online store, you’ll need to devote time to get things off the ground. The payoff comes later when the income starts flowing in with minimal ongoing effort.

Risks of Passive Income

It’s sweet when you wake up and see your passive income earnings, however, it comes with its own set of risks and pitfalls. Here are some of them and how to mitigate potential setbacks:

Time investment:

Passive income requires upfront work which might take months or even years before your efforts start to pay off. Patience and perseverance are key to enjoy the benefits of passive income.

Financial risk:

There’s always a risk of losing your investment in investing in stocks, starting an online business, or buying rental properties.  Proper research, careful planning, and risk diversification can help mitigate this.

Sustainability:

Not all passive income sources are sustainable in the long run. Market trends can change, technologies can become obsolete, and what works today might not work tomorrow.

How to mitigate the risks of passive income

Perform thorough research before diving into any passive income venture. Understand the market trends, potential risks, and expected returns.

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Diversify your investments to spread the risk. Having multiple passive income streams can cushion the blow if one fails.

Regularly monitor and adjust your passive income sources. Stay informed about industry changes and be ready to adapt your strategies.

Passive Income Ideas

Apart from real estate investments, dividend stocks, and online businesses, here are 20 passive income ideas you may want to consider today:

Investments:

As we earlier pointed out, investments could include dividends from stocks, real estate, bonds, or mutual funds, and interest from savings accounts or certificates of deposit.

Real estate rentals:

If you own properties, you can rent them out for consistent income. This could include residential properties (like houses or apartments), commercial properties, or even vacation properties through platforms like Airbnb.

Peer-to-Peer lending:

Online platforms allow you to lend money to individuals or small businesses in return for interest payments, functioning like an online bank.

Businesses:

Owning a business or a portion of a business can provide income from its profits. This could be a brick-and-mortar business, an online business, or even a franchise.

Digital products:

There are more than 20 platforms where you can sell digital products like eBooks, courses, apps, and digital downloads. These can serve as passive income for you, the more people that purchase your products even while you sleep, the more your stream of income.

In case you want to start selling digital products online, here are the 10 best platforms to get started:

  1. SendOwl (to sell digital goods). The free plan attracts 5% transaction fee
  2. Sellfy (good for selling download products). It has a 14-day free trial for a starter
  3. Podia (for selling online courses). There is a free plan but it attracts 8% transaction fee for every payment you receive.
  4. Shopify (for eCommerce). You can start with the 14-day free trial before upgrading to the basic plan later as you grow.
  5. Creativemarket (to sell graphics)
  6. GumroadEasyDigitalDownloads (best for WordPress developers that want to sell plugins and other WordPress products)
  7. Thinkific (for selling online courses)
  8. ThemeForest by Envato (for selling WordPress Themes and templates)
  9. Teachable (for selling knowledge-based products online)
  10. DPD (for selling ebooks and software)

Online advertising:

Websites or blogs with high traffic can earn significant income through ad placements. Good content, and good traffic will earn you continual passive income because advertisers will keep coming back unless your blog isn’t hit by Google update.

Royalties:

Royalties are one of the passive income ideas with little money. If you are a musician, author, or inventor, you can earn royalties from your work. This can also apply to photographers who sell their photos on stock image websites.

For instance, the top 10 platforms to sell your photos on online which could fetch you passive income are:

  1. FotoMoto
  2. Etsy
  3. Shutterstock
  4. 500PX
  5. Adobe stock
  6. Getty images
  7. Alamy
  8. iStock photo
  9. Dreamstime
  10. Snapped4U
  11. SmugSmug Pro
  12. Unsplash (free but you can receive voluntary donations from people who use your photo)

Network marketing:

Network marketing involves selling a company’s products directly to consumers and earning a commission. You can also earn additional income by recruiting other people to sell the products.

Storage rentals:

If you have extra space in your home or own a large property, you can rent out storage space. In the United States, examples of storage rentals include:

  • Keystone Storage in Missouri,
  • Pro Box Portable Storage in Arizona, and
  • CubeSmart in Pennsylvania.

Renting out your car:

Platforms like Turo allow you to rent your car to others when it’s not in use. Other platforms/apps you can use to rent out your car when not in use are:

  1. carSHAiR
  2. Getaround App
  3. Lyft Rentals
  4. Alamo
  5. HyreCar
  6. Budget
  7. Uber Rent
  8. Zipcar
  9. Enterprise

Cash back rewards:

Credit cards or apps are another passive income idea that offers cash back on purchases can also generate passive income.

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Selling designs:

If you’re a graphic designer, you can sell your designs on platforms like CafePress or Redbubble.

YouTube channel:

If you create a successful YouTube channel, you can earn passive income from ad revenue from video views. You can check the most successful and highest YouTubers in the world, some of them and their stats at the time of publication include:

1) MrBeast owned by Jimmy Donaldson, which currently has 176 million subscribers with an estimated $54 million USD from his channel in 2022.

2) Jake Paul has an estimated earnings of USD$45 million (in 2022) with his ever-growing 20.4M subscribers.

3) Markiplier, Mark Edward’s 35.4M subscribers and still counting earns him passive income

4) Good Mythical Morning owned by Rhett James McLaughlin and Charles Lincoln Neal III known for its comic videos has 18.4M subscribers with estimated earnings of USD$30 million and many more are good examples of passive income earners on YouTube

Podcasts:

Similar to YouTube, successful podcasts can generate revenue through sponsorships and ads. Podcast platforms you can use and monetize your podcasts include:

  • Podbean
  • Blubrry
  • Libsyn
  • Captivate etc

Selling software:

If you have the skills to create software or apps, these can generate income every time someone downloads or subscribes to them.

Vending machines:

If you own and operate vending machines, they can earn income for you around the clock.

Domain flipping:

Domain flipping is one of the passive income ideas, it involves buying domains at a lower price and selling them at a higher price to generate profit.

Ready to start a domain flipping business? Here are the best places to sell domains:

  • NameCheap Marketplace
  • Sedo Domain Marketplace
  • EBay Marketplace
  • Domainstate
  • Flippa Domain Marketplace
  • Efty
  • Godaddy Auction
  • NamePros Forum
  • Afternic
  • SnapNames

Renting your space:

If you have an extra room or a property, you can rent it out through platforms like Airbnb.

Annuities:

These financial products sold by insurance companies are designed to provide a steady income stream during retirement.

Affiliate marketing:

If you have a blog or website, you can earn a commission by promoting other companies products or services. Anytime, anyone makes a purchase, your account will be credited and when you reach a set threshold, you can withdraw

How to successfully manage passive income

Have a clear plan:

Set clear, measurable goals for your passive income ventures. What kind of return are you expecting, and in what timeframe? Having a roadmap will guide your actions and help you assess your progress.

Monitor your investments:

Even though it’s “passive” income, regular monitoring is essential. Keep tabs on your investments, be aware of market trends, and adjust your strategies as needed.

Reinvest your earnings:

One of the best ways to grow your passive income is to reinvest your earnings. This could mean buying more stocks, purchasing another rental property, or upgrading your blog to reach a wider audience.

Is passive income taxable?

As such, passive income is taxable in the United States because it is an acquired income. If a passive income is long-term gains, 0% to 20% applies based on the investor’s annual taxable income, but if it is short-term, the marginal income tax rate applies (For more on tax in the U.S., data on IRS provide more insight).

Takeaways:

Passive income refers to earnings derived from sources other than active employment or direct involvement in a business.

Passive income streams allow you to generate revenue with relatively minimal ongoing effort once the initial setup has been completed.

Affiliate marketing, selling digital products online (e-books), and investments in stocks, bonds, real estate, or other financial instruments that generate returns over time are some of the sources of passive income or passive income ideas worth trying.

Passive income is taxable.

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