With more than half (54%) of U.S. workers taking on a side hustle in 2023, it's clear that many of us are looking for opportunities to bring in additional streams of income. But there's another way to do so that many Americans aren't making use of: passive income.
The idea of earning money passively—with minimal ongoing effort—has become a hot topic among social media influencers. But, contrary to their claims, passive income isn't a get-rich-quick scheme or a ticket to instant financial freedom. When done right, however, passive income can provide a valuable boost to your financial health, helping you reach your goals faster and build long-term wealth.
What Is Passive Income?
Passive income generally refers to any earnings that do not come from active work. Think savings account yields, investment income such as dividends, rent you collect on real estate properties, or anything else that earns you money while you're busy living your best life.
Note that the IRS's definition of passive income is much more narrow. For tax filing purposes, it only considers earnings from rental activities or from businesses in which you don't materially participate (i.e., silent partnerships) as passive income. However, for this article, we're using the broader definition.
Passive income can be a powerful tool for building wealth, saving for big goals or simply creating a more comfortable financial cushion. It's about making your money work for you instead of you always working for your money.
According to Census Bureau data, just 20% of American households earn passive income through dividends, interest or rental properties. If you're among those who have not yet tapped into any sources of passive income, below are a few possibilities to consider.
6 Ideas To Generate Passive Income
“Passive" doesn't always mean “effortless." Some initial work or investment is typically required. But once set up, these income streams can flow with minimal ongoing effort.
1. Rent out real estate
This is the classic passive income generator. Buy an income property, find tenants and charge enough rent to pay your carrying costs and a tidy profit. Of course, you'll need a hefty down payment at the outset to purchase the property, and there are ongoing expenses for maintenance. And it's not without risk: For example, tenants can damage your property, and you might have periods between tenants when you'll need to find a different source of income to pay your carrying costs. On the plus side, you can deduct mortgage interest and other expenses from your rental income at tax time.
If you can't afford a rental property, you may be able to rent part of your property—even, say, a parking space you don't use—or get a roommate to bring in passive income.
READ MORE: The Smart Way to Make Your Vacation Home into an Income Stream
2. Invest in dividend stocks
Some stocks pay out a slice of company profits to investors on a regular basis. These payments are called dividends and are another example of passive income.
To access dividend income, you'll need money to invest, as well as time to research stocks to make sure the company provides consistently high dividend payments. You can also invest in dividend exchange-traded funds (ETFs), which combine a basket of dividend-paying stocks into one equity product. By diversifying your investment in this way, you lower the risk of seeing your dividend payments decline, even if some of the companies in the ETF slash their dividends due to sinking revenues.
Dividend income is usually taxed at a lower rate than ordinary income, making it a tax-efficient option.
READ MORE: How Can I Build Wealth?
3. Earn income from savings interest
This form of passive income probably has the lowest barrier to entry, as you can begin collecting interest on any amount of savings with almost no time commitment involved. In short, you earn money by lending your cash through various financial products, such as high yield savings accounts, certificates of deposit (CDs), bonds and money market accounts.
When comparing your options, be sure to consider the interest rate, how the yields are calculated, whether there are account minimums or restrictions on withdrawals, and any account or transaction fees. The yields you earn are typically taxed as ordinary income, although some products like municipal bonds may offer tax advantages—as do tax-advantaged accounts.
READ MORE: High Yield Savings Account: What It Is and How It Works
4. Engage in affiliate marketing
If you're an online content creator, you may be able to promote other people's products and earn a commission on sales. You do this by embedding affiliate links in blog posts, videos or other forms of social media you create.
While you don't need much of an initial investment to engage in affiliate marketing, it does require ongoing content creation and promotion—which takes considerable time and effort. So, this isn't truly “passive" income unless you were already spending your time creating content and looking for a way to leverage that activity into a stream of income.
5. Collect royalties
Intellectual properties (such as books, music or patents) that you create can generate ongoing royalty payments for their use. These types of passive income clearly require significant up-front effort and expertise, but for the fortunate few they can provide long-term, hands-off earnings.
6. Create and sell digital products
Monetize individual skills to design templates, develop online courses or create an app. Once created, these digital products can be sold repeatedly with little additional effort. The initial time investment can be significant, but ongoing work is minimal. Just keep in mind that the online marketplace is saturated with such products already, so it may not be easy to find prospective buyers.
More Passive Income Tips
Here's some advice to keep in mind as you start to generate passive income:
- Diversify. Don't put all your eggs in one passive income basket. Mix it up to spread your risk and increase your chances of success.
- Be patient. Rome wasn't built in a day, and neither is a robust passive income stream. Give your ventures time to develop and generate returns, and your investments and savings time to benefit from compound growth.
- Choose financial products carefully. Consider factors like risk, return, liquidity and tax implications. Higher returns often come with higher risk, so make sure you understand what you're investing in.
- Keep learning. The world of passive income is always evolving. Stay informed about new opportunities and strategies.
- Mind the taxman. Different passive income streams have different tax implications. Consider consulting with a tax professional to optimize your strategy.
The Bottom Line: Passive Income as a Financial Booster
Passive income isn't a magic bullet, but it can be a smart way to supplement your income, providing an extra push toward your financial goals. Whether you're saving for a down payment, building your retirement nest egg, or just wanting a bit more financial breathing room, passive income can help you fatten your wallet without necessarily fattening your to-do list.
Looking for other ways to grow your wealth? Check out these tips to improve your net worth.
