Creating passive income, not a passive activity
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.
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.
It’s easy to think as 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.
“Many people think that passive income is about getting something for nothing,” he says. “It has a ‘get-rich-quick’ appeal … but in the end, it still involves work. You just give the work upfront.”
If you’re thinking about creating a passive income stream, check out these five strategies and what it takes to be successful with them.
Selling information products
One popular strategy for passive income is establishing an information product, such as an e-book, audio course or DVD, then kicking back while cash rolls in from the sale of your product.
Information products can deliver an excellent income stream, but they’re hardly a passive activity, Tresidder notes.
“It takes a massive amount of effort to create the product,” he 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.
Make sure you’re earning a top rate on your savings.
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.”
To earn passive income from rental property, 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.
Now, the question becomes one of risk: Is there a market for your property? What if you get a deadbeat tenant who pays late or one who damages your property? Any of these factors could put a big dent in your passive income.
A personal loan can be used to improve a rental income property.
With affiliate marketing, website owners or bloggers promote a third party’s product by including a link to the product on their site. When a visitor clicks on the link and makes a purchase from the third party, the site owner earns a commission.
Affiliate marketing is considered passive because, in theory, you can earn money just by adding the link to your site. In reality, you won’t earn anything if you can’t attract readers to your site who will click on the link and buy something.
If you’re just starting out, you’ll have to take time to create content and build traffic.
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. 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, $25 is the minimum investment per loan.
- Analyze 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. 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.
Shareholders in companies with dividend-yielding stocks receive a payment at regular intervals from the company. 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.
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 an initial investment of a huge amount of time. 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.