The Big Picture On Types Of Passive Income
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- Passive income sources like rental properties, stock dividends, and royalties can provide financial stability but often require initial investment and strategic planning to ensure sustainability.
- Different types of passive income have varying levels of involvement; rental properties might demand active management, while dividends and royalties are more hands-off.
- Diversifying passive income streams minimizes risks and enhances long-term wealth accumulation, making it essential to understand each income type’s unique benefits and challenges.
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Going to work every day and getting a paycheck every two weeks? That’s active income.
Being self-employed? Freelance work and side gigs? All active income, too.
Active income is money you must work to earn on an ongoing basis. It’s trading time for money.
I don’t know about you, but I don’t want to do that for the rest of my life. Enter: passive income.
What Does Passive Income Mean?
Passive income is money that you earn without having to actively work for it. You earn it while sleeping, playing with your kids, relaxing on the beach, playing golf, sipping a nice cabernet, or doing whatever you’d rather do than work.
That sounds pretty terrific. So why isn’t everyone out-building passive income?
They are, sort of. When people save and invest for retirement, their nest egg usually includes stocks that pay dividends and perhaps bonds. Retirement income is passive income.
But retirement is a distant, nebulous idea for most people. They do it because everyone tells them they “should,” not because they’re trying to build passive income streams to change their lives here and now.
Also, most types of passive income require much upfront work. They require you to invest time and/or money up front, often with no immediate results.
Some Factors to Consider Before Starting
Before entering any passive income venture, study the fundamental elements impacting your success in generating hands-off earnings.
Consideration |
Description |
Risk Level |
Different passive income streams carry varying degrees of risk – from very low to extremely high |
Time to Profitability |
Most passive income ventures take 6-24 months before generating meaningful returns |
Maintenance Required |
While “passive,” most income streams need periodic monitoring and adjustment |
Initial Learning Curve |
Understanding your chosen passive income method requires education and research |
Scalability |
Some passive income sources can be multiplied easily, while others have natural limits |
Tax Implications |
Different forms of passive income are taxed at different rates and schedules |
Passive Income Types
Just because you understand the definition of passive income doesn’t mean you know how to create passive income.
While it comes in many shapes and sizes, the five passive income types cover most passive income sources. As a broad overview, the most common types of passive incomes include:
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- Dividends: Stocks tend to be better vehicles for appreciation than income, but some produce income (or “yield”) through regular dividends.
- Bonds: When you buy a bond, you effectively lend money and earn interest payments over its life, then get your original investment back at the end. Bonds tend to make better investments when inflation is low, and interest rates are high (which they haven’t been in this century).
- Business Income: You can also create cash flows of passive income by starting a business and then letting others manage it. However, business owners must still keep an eye on the business’s direction if they want it to survive and thrive in the long term.
- Rents & Rent Distributions: You already understand rental income from investment properties, but more on this shortly. They typically require a high initial investment, then serve as an ongoing passive income source after that. If you own fractional ownership in a group real estate investment, you collect regular distributions of rental income as well.
- Royalties: Artists often earn royalties from songs, books, art, and other creative works that more of us should be putting out into the world.
Of course, these aren’t the only types of passive income. Let’s explore these and other best sources of passive income.
Best Sources of Passive Income
So, how do you invest to start collecting these different types of passive income?
Start with these best sources of passive income.
High-Yield Stocks & Funds
You can buy dividend-paying stocks, mutual funds, and exchange-traded funds (ETFs) with a regular brokerage account. You can also buy publicly traded real estate investment trusts (REITs), which by law must pay out at least 90% of their annual profits to shareholders in the form of dividends.
Check out NOBL as a fund that includes all “dividend aristocrats”: companies that have raised their dividends yearly for at least the last 25 years. You can also look up “dividend achievers” who have raised their dividends for at least 10 years in a row. For more lists of high-yield dividend stocks, particularly undervalued stocks paying high dividends, check out Sure Dividend.
As a final thought, read up on the role of dividends for retiring early.
Rental Properties
You get the premise behind rental properties: you buy an investment property and collect rents on it forever after.
Many skeptics question passive rental income, as landlords must still advertise vacant units, screen rental applications, sign lease agreements, and collect rent. It’s a good thing SparkRental’s landlord software can do all those things for you (shameless plug!).
Landlords can alternatively rent out their properties as short-term rentals rather than to long-term tenants.
Rental properties produce ongoing income forever. You can raise rents over time, making properties a good hedge against inflation.
They also usually appreciate and come with dozens of rental property tax deductions, including paper expenses like property depreciation.
While a big down payment helps, you can explore ways to buy a rental property with no money down.
For that matter, these days, you don’t have to do any of the work of finding a property yourself. Buy fractional ownership in a rental property for $50 through Lofty or for $100 through Arrived.
And if you want to go a little bigger than a single-family rental, you can earn even higher returns on group investments in apartment buildings.
Distributions from Real Estate Syndications
Passive income opportunities from real estate go far beyond rental properties.
If you love the idea of portfolio income and capital gains building over time, consider investing in real estate syndications. In these, you buy fractional ownership in a commercial property, such as an apartment complex, and collect income distributions on a regular basis (monthly or quarterly) while you own an interest in the property. A property manager oversees the day-to-day operations of collecting rents and property maintenance, making it a truly passive investment.
You and all the other fractional owners get a hefty paycheck when it sells. Alternatively, some syndicators refinance the property after renovating it, returning some or all of your original investment back to you. But you keep your ownership interest, earning high returns on your remaining equity investment (or even infinite returns). Think of it like the BRRRR strategy but on steroids.
Between the distribution income and the capital gains payout at the end, syndications often pay 15-50% annualized returns. Check out our free class on real estate syndications for a breakdown of how they work.
Uh, 15-50% returns on a completely passive source of income? What’s the catch?
There are several reasons why not everyone and their mother is out there putting every penny into real estate syndications. First, many syndications only allow accredited investors. Second, most middle-class investors have never heard of them, and if they have, they don’t know how to find or vet syndicators. Finally, the minimum investment is usually $50-100K, similar to a down payment on a rental property.
Fortunately, there’s a way around all of those challenges: join an investment club. For example, our Co-Investing Club invests in group real estate investments every month, and members can invest as little as $5,000 per syndication deal rather than $50,000 or $100,000.
Crowdfunded REITs
You can still invest in real estate if you don’t want the headaches of owning properties directly. In fact, some real estate crowdfunding platforms allow you to invest with as little as $10. You can skip two lattes this week to get the extra cash needed to start investing in real estate.
Crowdfunded REITs work similarly to publicly traded REITs in representing pooled real estate funds that own various residential and commercial properties or sometimes debt secured against real estate. But rather than buying and selling shares instantly on stock exchanges, you buy shares directly from the crowdfunding platform. That eliminates the stock market’s volatility and makes shares hard to sell. Most crowdfunding platforms expect you to leave your money invested for at least five years.
Check out Fundrise, a reputable platform for residential and apartment buildings, and Streitwise for commercial properties.
Crowdfunded Loans Secured by Real Estate
You can also invest money toward loans secured by real property.
My favorite of these is Groundfloor, a hard money lender that issues short-term loans. These are purchase-rehab loans for real estate investors, usually 6-18 months in length. After the borrower finishes renovating the property, they sell it as a flip or refinance it using the BRRRR strategy.
Since 2013, Groundfloor has consistently returned around 10% on average across their loans. If you prefer liquidity over returns, try their Stairs fund instead: you earn 4-6% returns and can pull out your money at any time with no penalty. Or try their competitor Concreit, which uses the same model of a pooled fund of short-term loans. You collect weekly interest income, all completely passive.
Crowdfunded real estate loans offer one more option for passive streams of income from real estate.
Bonds
I don’t love bonds personally, given their performance compared to stocks over the last few decades. However, they have their place in retirement planning, particularly for older adults with lower risk tolerance.
Even so, I find ways to replace bonds with real estate in my investment portfolio. I earn higher returns, both on active real estate activities (such as rental investing) and indirect ownership. Beyond the better returns, I also hedge against inflation while scoring great tax breaks. In fact, “active participation” as a landlord lets you deduct paper losses on rental activities from your taxable income up to $25,000 per year.
Business Income
Yes, businesses require an enormous upfront work investment to start and grow. As a founder of SparkRental, I should know it’s been exhausting!
But at a certain point, founders can start delegating the work of managing and growing their business. They can hire managers to take over most of the day-to-day business activities.
Consider online businesses and digital products for their low overhead and quick setup. You can explore information products, such as online courses. Or you can flip retail products, or earn money referring people to affiliate partners. In fact, affiliate links are the easiest way to start earning extra income from an online business.
There are endless business models, and not all of them require your active participation every day. To continue the affiliate marketer example, you could hire a writer to produce your blog content while earning affiliate revenue or selling digital assets through that content.
Just know that you typically work twice as hard as employees work in the upfront time investment of getting a business off the ground.
Alternative Types of Passive Income
You can get as creative as you want in exploring passive income ideas.
Different types of passive income could include advertising on your car or buying and installing vending machines or laundry machines. It could also mean creating intellectual property such as art, stock photos, or music and earning residual income from royalties from it.
Do some research on the good ol’ interwebs for more niche ideas for the best sources of passive income. The more diverse your types of income, the greater your financial security. One income stream might suffer due to a market correction or change in the economy, but your other financial investments can keep pumping income to you month in and month out.
Thinking About Time & Money Differently
With active income, you get immediate gratification: earning money immediately in exchange for labor.
This is how most of us think about money. Our parents raised us to think this way:
“If you do more chores you’ll earn more money.”
And then your first five jobs also reinforced this message:
“If you pick up the Saturday shift you’ll earn more money.”
We talk about this at length, including how parents can raise their kids to be good entrepreneurs rather than good employees. It starts with teaching your kids to think differently about money.
With passive income, you have to invest money, time, or both before seeing any results. At first, passive income requires more work than active income.
Fun hand-drawn graph courtesy of AffordAnything.com
See all that investment of time put in before the money starts coming in?
Yeah… most people aren’t all about that.
The graph above looks nothing like the traditional relationship between time and money. Passive income is about breaking out of that “time = money” mindset. The thinking goes more like this:
“If I spend the next 60 days scouting for potential rental investments, making offers, settling on a property, and placing a good long-term tenant in my new rental, I’ll earn $400/month in income for the rest of my life.”
If you put in money and effort up front for some time, you can stop working and continue earning money.
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Stacking Different Types of Passive Income
One of the many problems with active income is that it comes with a limit: your time. You can only work so many hours in a given week.
There’s no such limit on passive income. You can own as many stocks or bonds or rental properties as you can afford, and every source of investment income you own makes it that much easier to buy the next one.
Thus, you can stack different forms of passive income up indefinitely. Have you ever heard the expression “The first million is the hardest”? Passive income is precisely why. As you build wealth and assets, more of your income comes from passive activities and investments rather than active work. Your income increasingly becomes independent from your work, and the sky’s the limit on how much you can earn when your monthly income is untethered from your time.
“So you’re saying I put in a flurry of work & money on one passive income stream, let that start earning money, then put in another flurry of work & money on the next, and just keep going like that forever?”
No one said forever.
Financial Independence: Replacing Your Salary
You reach financial independence when you can cover your living expenses with your passive income from investments. In other words, working becomes optional — you can retire if you like, regardless of your age.
The lower your living expenses, the easier to cover them with passive income. But as intuitive as that sounds, most people don’t realize how “keeping up with the Joneses” hurts their finances.
For every dollar you want to spend with retirement income, you need to save and invest $25 if you follow the 4% Rule. Think about that for a second — for every $100/month extra that you spend, you need another $30,000 in savings to reach financial independence.
Beyond simply being easier to cover with passive income, lower living expenses also help you lift your savings rate. The lower the percentage of your income that you spend, the more you can save and invest to generate more passive income.
And the more passive income you earn, the more you can reinvest to keep snowballing your income.
Boost Your Savings Rate, Avoid Lifestyle Creep
Start looking for the greatest opportunities to save money. Most people spend 70% of their income on just three expenses: housing, transportation, and food. Because housing is the most expensive, start by asking:
“How can I reduce or eliminate my housing expenses?”
You could rent out a spare bedroom in your home to a housemate. Even better, you could segment off part of your home to be self-contained and rent it either short-term (e.g., on Airbnb) or long-term as an income suite.
For a truly powerful solution, you could house hack a multifamily property. This form of house hacking involves buying a multi-unit building, moving into one of the units, and leasing out the other(s) to pay the mortgage, repairs, and other housing expenses. If you don’t think it’s possible, read how one ordinary insurance underwriter house hacked a suburban duplex.
Alternatively, try out these ideas to house hack a single-family home, from renting storage space to ADUs to even hosting a foreign exchange student.
As you save and invest more money and start building passive income — and as you earn more money from your job — freeze your living expenses to avoid lifestyle creep. Invest the extra money you save each month.
The alternative is to continue to run on the financial treadmill, working hard every month only to stay in the same place.
Do you want to spend the rest of your life trading hours for dollars? If your priority is driving a fancy SUV, going on regular shopping sprees, eating out frequently, and so forth, there’s nothing wrong with that, but understand that it comes at a cost. You will likely have to keep working for a long time to come because you spend most of the money you bring in each month.
Tax and Legal Matters You Should Know
I know someone who started earning rental income and was surprised by a massive tax bill. Don’t worry; I can help you avoid that situation.
Most passive income streams get taxed differently than your regular paycheck. For example, rental income usually gets taxed at your ordinary income rate, but you can offset it with numerous deductions like mortgage interest, property taxes, depreciation, etc.
Similarly, not all dividends face the same tax treatment. Let’s say you earn $5,000 in qualified dividends from long-term stock holdings. If you’re in the 22% tax bracket, you’ll only pay 15% on these dividends instead of your regular 22% rate. That’s more money staying in your pocket.
Business entities matter too. Setting up an LLC for your rental properties or online business can provide liability protection and potentially better tax treatment. Some investors use S-corporations to save on self-employment taxes, though this requires careful planning with your tax advisor.
State taxes vary wildly. Some states tax passive income at the same rate as regular income, while others offer special treatment for certain types of passive income. For instance, some states have lower tax rates for retirement income, including passive streams like dividends.
Risk Protection Strategies That Actually Work
Even “passive” income requires active risk management to protect your wealth.
Diversification is pretty much like a three-bedroom rental property. If one tenant moves out, you still have rent coming in from the other two units. The same principle applies across all passive income streams. For instance, owning rental properties in different neighborhoods of a growing metro area means you’re not overly exposed to any single market’s downturn.
In dividend investing, spreading $100,000 across different sectors proves this point perfectly. During the COVID-19 market crash, while many retail businesses cut dividends, healthcare and consumer staples companies kept paying—and in some cases even raised—their dividends. That’s diversification doing its job.
Insurance plays a bigger role than most realize. Beyond basic landlord policies for rental properties, consider an umbrella policy to protect your assets from lawsuits. Also, set up regular monitoring systems. Even passive income needs checking – just not daily.
Schedule quarterly reviews of your investments’ performance, annual insurance policy updates, and regular market research to stay ahead of trends that could impact your income streams.
Frequently Asked Questions About Passive Income
Here are the real answers to questions you’re probably asking about passive income – no sugar coating, just straight talk from someone who’s seen what works and what doesn’t.
How truly “passive” is passive income?
Nothing is completely hands-off. Even dividend stocks require occasional portfolio rebalancing. The key is that you’re not trading hours for dollars directly. Most passive income sources need a few monthly maintenance hours rather than daily active work.
How much money do I need to start earning passive income?
You can start with as little as $10 in some crowdfunding platforms or a few hundred dollars in dividend-paying ETFs. The real question is how much you need to generate meaningful income. Generally, expect to need $25 in investments for every $1 in annual passive income using the 4% rule.
What’s the fastest way to start earning passive income?
Despite what social media influencers claim, there’s no overnight path to significant passive income. The fastest legitimate route usually involves creating digital products or starting affiliate marketing, but even these typically take 6-12 months to generate meaningful income.
Can I lose money with passive income investments?
Absolutely. Any investment carrying return potential also carries risk. Rental properties can sit vacant, stocks can cut dividends, and businesses can fail. That’s why starting small, diversifying, and understanding your risk tolerance is crucial.
Do I need to quit my job to build passive income?
Not at all. In fact, keeping your job while building passive income streams is usually smarter. Your regular paycheck provides stability and capital to invest in building passive income sources. Most successful passive income earners started while working full-time.
How do I know which passive income strategy is right for me?
Consider your available time, money, skills, and risk tolerance. Creating digital products might work best if you have more time than money. If you have significant savings but limited
Tying Passive Income Types Together
Knowing the definition of passive income doesn’t help you if you don’t act to begin building different types of passive income.
Start thinking about your “escape the rat race” number. How much passive income do you need to cover your monthly expenses?
In other words, what will it take to reach financial independence?
Find ways to spend less and funnel more money toward your passive income investments. Start investing in dividend-paying stocks, rental properties, or other types of passive income. But in the beginning, just focus on one type of passive income strategy rather than getting overwhelmed by many types.
Ashley and Kevin Thompson reached financial independence in six years, all while traveling the world. At first, it took an incredible amount of discipline, living on a fraction of their income. Later, it got easier as they started earning more and more passive income from their rental properties. Today they have $60,000/year in passive income from their rentals, and growing.♦
What does passive income mean to you? What are your favorite passive income types?
Great intro to passive income! Very accessible (and even entertaining 🙂
Thanks Theo! We do what we can to keep things lively around here!
Ha! Love the graphs
Wish I could claim credit for them – shout out to Paula Pant of AffordAnything!
Great article, helped me understand passive income.
Thanks Betty! (And I can’t believe it took me so long to reply to you. Shame on me!)
I have a friend living in Colorado.. He is disabled and receives section eight housing. He would like to move to. Reno NV. I have a large mobil home, about 1600 sf. That I would like to share . Would I be able to offer him section 8 as a landlord?
I’d call up the local Section 8 housing office and talk to them about their requirements. I suspect you’ll have trouble if the home still has its wheels and could still be moved easily.
Best of luck!
Far too people bother to think about replacing their active income with passive income. Great introduction piece on it, and to the whole concept of financial independence!
This article is great. Passive income explained in the most simple way. Thanks a tonne Brian.
Glad it was helpful Alan!
I really love the concept of passive income, actually apartment rentals are a bit too passive. The way I see it, I’m either going to invest in the stock market to try to earn a decent return, or I’m going to find some unique opportunity and make something happen. Your blog is really good at helping people to understand these types of financial concepts, and for that I’m grateful.
That’s why I like to diversify and spread my money among many different types of investments!
Very interesting topic. Thanks for sharing.
Glad you enjoyed it Malce!
This hit me to the core, “Knowing the passive income definition doesn’t help you if you don’t act to begin building different types of passive income. ” haha! I guess the most difficult part is when to start.
Absolutely Hunter. Action is the most important part!