Please note that this article is not intended to provide investment advice. As always, consult with personal finance professionals and do your own due diligence before investing.
Have you ever heard the phrase “making money in your sleep”? Well that’s exactly what passive income is.
The dictionary definition of passive income is: earnings from a rental property, limited partnership, or other enterprise in which a person is not actively involved.
Conversely, active income refers to income received for performing a service. Wages, tips, salaries, commissions, and income from businesses in which there is material participation are examples of active income.
Most people earn active income from their W-2 jobs where they are trading their time in exchange for an hourly wage or a salary.
The problem with active income is that your time is a limited resource and when you’re not working, you’re not earning. It is difficult if not impossible to create a life where you have time and financial freedom relying solely on an active income source. You work hard for the money you earn, it should work hard for you in return by generating passive income.
Why do you need passive income?
- Peace of Mind: a supplemental stream of income can provide you with the peace of mind to know that if an unexpected expense occurs you have the ability to cover it. A supplemental stream of passive income could also be used to save for a fun family trip, a new car or anything else you may be saving for!
- Achieve your financial goals faster: Relying solely on your W-2 income to achieve financial independence or fund your retirement plan may be a long, hard road. Why? Your income is limited to the number of hours you work and is generally capped by a fixed annual salary. The right passive income stream doesn’t require you to lift a finger and a passive income stream from something like real estate may also provide some excellent tax benefits.
- Freedom from exchanging your time for money: Time is a non-renewable resource, and while I hope you have a job that you love spending time at, I personally would rather be spending my time with the people I love. Let your hard earned money go to work for you! Over time, you may find that your passive income provides you enough income to seriously subsidize or replace your W-2 income. A passive income stream can provide you with something money can’t buy: more time!
How Do I Earn Passive Income?
There are many ways to create passive income streams:
- Some stocks and bonds provide a form of passive income when they pay dividends
- Certain types of online businesses can provide passive income such as digital courses
- Owning equity in a business that someone else manages may provide you with passive income
Of course, my favorite way to earn passive income is to invest in real estate. One of the main reasons why many people shy away from real estate investing is the assumption that making money from investment properties requires lots of time, effort, energy, and hard work — and this is not entirely true.
There are several ways to invest in real estate that do not require you to be hands on, for example in a syndication, passive investors (also known as limited partners) contribute capital to real estate investments in exchange for a return on their investment. As a passive investor, you can reap the benefits of appreciation of the asset, tax benefits such as depreciation and ongoing rental income, while someone else manages the tenants and toilets. Its the best of both worlds! We have dedicated an entire post to this investment vehicle here.
There are other ways passively invest in real estate as well, we will cover the pros and cons of those strategies in an upcoming post!