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Originally published on Bankrate.com by James Royal.
Passive income can be a great way to generate additional cash flow, and the economic upheaval caused in large part by the COVID-19 crisis is evidence of the value of multiple streams of income.
With the pandemic messing up the work situation of many Americans, passive income is helping you fill the void if you suddenly become unemployed or volunteer time for work.
Passive income can give you money even if you do your main job, or if you are able to build a solid stream of passive income, you may want to sit back and relax. In any case, a passive income gives you additional security.
And if you're worried about being able to save enough of your income to meet your age goals, building wealth through passive income could also be a strategy that might appeal to you.
What is passive income?
Passive income includes regular income from a source other than an employer or a contractor. The Internal Revenue Service (IRS) says passive income can come from two sources: rental property or a business that one does not actively participate in, such as a homeownership. B. Book fees paid or stock dividends.
"A lot of people think that passive income is about getting something for nothing," says Todd Tresidder, finance coach and retired hedge fund manager. “It has the appeal of getting rich quick … but in the end it's still about work. You just give the work in advance. "
In practice, you might do some or all of the work in advance, but passive income often requires additional work as well. You may need to keep your product updated or maintain your rental property well for the passive dollars to flow.
However, if you are committed to strategy, this can be a great way to generate income and create additional financial security for yourself along the way.
12 passive income ideas for building wealth
If you are thinking about creating a passive income stream, read these 12 strategies and learn what it takes to be successful with them while understanding the risks associated with each idea.
1. Selling information products
A popular passive income strategy is to set up an information product like an e-book or an audio or video course, and then sit back while the money flows from selling your product. Courses can be distributed and sold through websites such as Udemy, SkillShare, and Coursera.
Alternatively, you could consider a "freemium model" – build a following with free content and then charge for more detailed information or for those who want to know more. For example, language teachers and stock-picking advice can use this model. The free content serves as a demonstration of your expertise and can attract those looking to take it to the next level.
As a third alternative to this, you can use ads (or sponsors) to generate your income while providing information or content to a growing audience on a free platform like YouTube. Take your love for video games or music for example and turn it into content.
Opportunity: Information products can be an excellent source of income as you can easily make money after spending an initial amount of time.
Risk: “The development of the product requires an enormous amount of effort,” says Tresidder. “And to make good money with it, it has to be great. There's no place for rubbish out there. "
Tresidder says you need to build a strong platform, market your products, and plan more products if you are to be successful.
"A product is not a business if you are not really lucky," says Tresidder. "The best way to sell an existing product is to develop better products."
Once you master the business model, you can generate a good source of income, he says.
2. Rental income
Investing in rental properties is an effective way to generate passive income. But it often takes more work than people expect.
If you don't take the time to learn how to turn it into a profitable business, you could lose your investment and more, says John H. Graves, an accredited investment trustee (AIF) in the Los Angeles area and Author of The 7% Solution: You Can Afford a Comfortable Retirement. "
Opportunity: According to Graves, to get passive income from rental properties, you need to determine three things:
- How much return do you want on the investment.
- The total cost and cost of the property.
- The financial risks of owning the property.
For example, if your goal is to earn $ 10,000 per year in rental income and the property has a $ 2,000 monthly mortgage and an additional $ 300 per month for taxes and other expenses, you will need a monthly rent of $ 3,133 calculate to achieve your goal.
Risk: There are a few questions to consider: Is there a market for your property? What if you get a tenant paying late or damaging the property? What if you can't rent your property? Any of these factors could seriously affect your passive income.
And the pandemic has also brought new challenges. Due to the economic downturn, you may suddenly have tenants who can no longer pay their rent while you may still have your own mortgage to pay. Or, you may not be able to rent the home for as much as possible as incomes decline. You should weigh these risks and have contingency plans in place to protect yourself.
3. Affiliate Marketing
In affiliate marketing, website owners, social media influencers, or bloggers promote a third-party product by adding a link to the product on their website or social media account. Amazon is perhaps the best-known partner, but eBay, Awin and ShareASale are also some of the bigger names. And Instagram and TikTok have become huge platforms for those looking to build a fan base and promote products.
You can also create an email list to draw attention to your blog or to bring other people's attention to products and services they may want.
Opportunity: When a visitor clicks the link and makes a purchase from a third party, the website owner receives a commission. Commission can be anywhere from 3 to 7 percent, so it will likely require significant traffic to your website to generate serious income. But if you can grow your following or if you have a more lucrative niche (like software, financial services, or fitness), you can potentially make some serious coin.
Affiliate marketing is considered passive because in theory you can make money by adding a link on your website or social media account. In reality, you don't earn anything if you can't attract readers to your website to click the link and buy something.
Risk: When you're just starting out, you need to take the time to create content and build traffic. It can take time to build a fan base and you need to find the right formula to attract that audience. This process itself can take a while. Worse, when you've expended all that energy, your audience can potentially flee to the next popular influencer, trending, or social media platform.
4. Flip retail products
Use online sales platforms such as eBay or Amazon and sell products that you can find elsewhere at low prices. They will determine the difference between your buying and selling prices and potentially build a following of people who follow your deals.
Opportunity: You can take advantage of price differences between what you can find and what the average consumer can possibly find. This can work especially well when you have a point of contact to help you access discounted merchandise that few other people can find. Or you may find valuable goods that others have simply overlooked.
Risk: While selling can be done online anytime to make this strategy passive, you definitely need to hurry to find a reliable source of product. And you really need to know the market so that you're not buying too high a price. Otherwise, you may end up with products that nobody wants or that you have to drastically drop in price to sell.
5. Peer-to-Peer Lending
A peer-to-peer loan (P2P) is a personal loan made between you and a borrower and made possible through a third party provider such as Prosper or LendingClub. Other players include Funding Circle, which targets businesses and has higher credit limits, and Payoff, which targets better credit risks.
Opportunity: As a lender, you earn income by paying interest on the loans. However, since the loan is unsecured, you are at risk of default and you may be left with nothing.
To reduce this risk, there are two things you need to do:
- Diversify your loan portfolio by investing smaller amounts across multiple loans. At Prosper.com and LendingClub, the minimum investment per loan is $ 25.
- Analyze historical data on prospective borrowers to make informed decisions.
Risk: It takes time to master the P2P lending metrics. Hence, this is not entirely passive. You should examine your potential borrowers carefully. Since you are investing in multiple loans, you need to closely monitor the payments received. Whatever interest you do should be reinvested if you want to build income.
Economic recessions can also make high-yield personal loans a more likely candidate for default. If COVID-19 continues to weigh on the economy, these loans could go bad at higher-than-historic interest rates.
6. Dividend stocks
Shareholders of companies with shares entitled to dividends receive payments from the company at regular intervals. Companies pay cash dividends out of their profits quarterly, and all you have to do is own the stock. Dividends are paid per share. The more shares you own, the higher your payout.
Opportunity: Since the income from the stocks is not related to any activity other than initial financial investment, owning dividend-yielding stocks can be one of the most passive forms of making money. The money is simply deposited into your brokerage account.
Risk: The hard part is choosing the right stocks. Graves warns that too many newbies are entering the market without a thorough study of the company issuing the stock.
"You need to research each company's website and be familiar with the financial statements," says Graves. "You should spend two to three weeks researching each company."
However, there are ways to invest in dividend-yielding stocks without spending a lot of time valuing companies. Graves recommends using Exchange Traded Funds or ETFs. ETFs are mutual funds that hold assets like stocks, commodities, and bonds, but trade like stocks.
"ETFs are an ideal choice for beginners because they are easy to understand, highly liquid, inexpensive and, because they are far less expensive than mutual funds, offer far better potential returns," says Graves.
Another important risk is that stocks or ETFs can go down significantly in a short period of time, especially in times of uncertainty such as in 2020 when the coronavirus crisis shocked financial markets. Economic stress can also cause some companies to cut their dividends entirely, while diversified funds may feel less burdened.
Compare your investment options with Bankrate's brokerage reviews.
7. Create an app
Building an app could be a way to invest your time upfront and then get the reward over time. Your app might be a game or a game that allows mobile users to perform some hard-to-do functions. Once your app is public, users will download it and you can start generating income.
Opportunity: An app has a huge advantage when you can design something that will grab your audience's imagination. You need to think about the best way to generate sales with your app. For example, you can run in-app ads or otherwise have users pay a nominal fee to download the app.
As your app grows in popularity or you get feedback, you will likely need to add incremental features to keep the app relevant and popular.
Risk: Probably the biggest risk here is wasting your time. If you're spending little or no money on the project (or money that you would have spent on hardware anyway), you have little financial disadvantage here. It's a crowded market, however, and really successful apps need to offer users compelling value or experience. You should also make sure that when your app collects data, it complies with data protection laws, which differ around the world.
A REIT is a real estate investment trust, a quirky name for a company that owns and manages real estate. REITs have a special legal structure so that they pay little or no corporate tax when they pass most of their income on to shareholders.
Opportunity: You can buy REITs like any other company or any dividend stock on the stock market. They earn everything the REIT pays out as dividends, and the best REITs have a proven record of increasing their dividends annually, so you can get a growing stream of dividends over time.
Like dividend stocks, individual REITs can be riskier than owning an ETF made up of dozens of REIT stocks. A fund offers instant diversification and is usually much safer than buying individual stocks – and you still get a good payout.
Risk: Just like with dividend stocks, you need to be able to pick the good REITs, and that means analyzing each of the companies you might buy – a time-consuming process. And while it's a passive activity, you can lose a lot of money if you don't know what you are doing.
REIT dividends aren't protected from tough economic times either. If the REIT isn't generating enough income, it will likely have to cut its dividend or eliminate it entirely. So your passive income can be hit exactly when you want it most.
9. A bond ladder
A bond ladder is a series of bonds that mature at different times over a period of years. You can reduce the reinvestment risk through the staggered terms. This is the risk of tying up your money when bonds offer low interest payments.
Opportunity: A bond ladder is a classic passive investment that has appealed to retirees and near-retirees for decades. You can sit back and collect your interest payments. When the bond matures, you extend the ladder and roll that principal into a new series of bonds. For example, you can start with bonds of one year, three years, five years, and seven years.
In a year in which the first bond matures, bonds with a term of two, four and six years remain. You can use the proceeds of the recently matured bond to buy another year or get a longer term, e.g. B. an eight-year bond.
Risk: A bond ladder removes one of the main risks of buying bonds – the risk of having to buy a new bond when your bond matures when interest rates may not be cheap.
Bonds also come with other risks. While government bonds are backed by the federal government, corporate bonds are not, so you could lose your capital. And you want to own many bonds to diversify your risk and eliminate the risk of a single bond affecting your overall portfolio.
Because of these concerns, many investors turn to bond ETFs, which provide a diversified bond fund that you can build on a ladder to eliminate the risk of a single bond affecting your returns.
10. Invest in a high-yield CD or savings account
Investing in a high yield certificate of deposit (CD) or savings account with an online bank can provide you with a passive income while getting one of the highest interest rates in the country. You don't even have to leave your home to make money.
Opportunity: To get the most from your CD, the quickest way to find the best CD rates in the country or the best savings accounts. In general, it is much more beneficial to go with an online bank than your local bank, as you can choose the top price available in the country. And you'll still get a guaranteed return on investment of up to $ 250,000 if your financial institution is backed by the FDIC.
Risk: As long as your bank is supported by the FDIC and is within limits, your capital is safe. So investing in a CD or savings account is as safe a return as you can find. While these accounts are safe, they are even less returned today than they were before. And since the Federal Reserve is aiming for 2 percent inflation, you're likely to lose inflation, at least in the short term. However, a CD or savings account is better than a cash account or a non-interest bearing checking account that gives you roughly zero.
11. Rent out your home at short notice
This no-nonsense strategy takes the space that you aren't using anyway and turns it into a way to make money. If you're going away for the summer, or need to be out of town for a while, or just want to travel, consider renting out your current space while you are away.
Opportunity: You can list your space on any number of websites like Airbnb and set the rental terms yourself. Get a check for your efforts with minimal overhead, especially if you're renting out to a tenant who may be on site for a few months.
Risk: You don't have many financial disadvantages here, although leaving strangers in your home is a risk that is atypical of most passive investments. For example, tenants can deface or even destroy your property or even steal valuables.
12. Advertise on your car
You may be able to make some extra cash just by driving your car around town. Contact a specialist advertising agency who will assess your driving habits, including where you drive and how many miles. If you agree with any of their advertisers, the agency will "wrap" your car with the ads for free. Agencies are looking for newer cars, and drivers should have a clean driving record.
Opportunity: While you have to get out and drive, this is a great way to make hundreds a month with little or no additional cost if you've already covered miles anyway. Drivers can be paid miles away.
Risk: If this idea looks interesting, take special care to find a legitimate operation to work with. Many scammers have set up scams in this area to get you out of thousands.
How many sources of income should you have?
There is no "one size fits all" advice when it comes to generating income streams. How many sources of income you have depends on where you are financially and what financial goals you have for the future. But having at least a few is a good start.
“You will catch more fish with multiple lines in the water,” said Greg McBride, CFA, financial analyst at Bankrate. "In addition to income from your human capital, rentals, income-generating securities, and business ventures are great ways to diversify your sources of income."
Of course, you want to make sure that you don't lose focus on your other streams as you seek out a new passive income stream. So, you want to balance your efforts and make sure you pick the best opportunities for your time.
Minimize your taxes on passive income
A passive income can be a great strategy for generating extra income, but you also generate a tax liability for your efforts. But you can also reduce the tax bite and prepare for your future by starting your own business and opening a retirement account. However, this strategy doesn't work for all of these passive strategies and you must be a legitimate company to qualify.
- Register with the IRS and receive a tax identification number for your company.
- Then contact a broker who can open a self-employed retirement account such as Charles Schwab or Fidelity.
- Determine what type of retirement account is best for your needs.
Two of the most popular options are the Solo 401 (k) and the SEP IRA. If you keep the money in a traditional 401 (k) or SEP IRA, you can get a tax break on this year's taxes. The Solo 401 (k) is great as it allows you to store up to 100 percent of your income in the account up to the annual maximum. In the SEP IRA, you can only make a contribution of 25 percent.
If you want to go down this route, compare the differences between the two account types.
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