7 Forms of Passive Income Explained
Most people picture passive income as money flowing in while they sleep, but several of these seven income streams quietly demand more attention than a regular job. Knowing the difference before you commit can save you a lot of costly…
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Passive income is money that continues to come in because of work you did in the past, investments you made, or systems you previously set in place. This type of income doesn’t require the same amount of daily work as a traditional job. However, the word “passive” can be slightly misleading. Not all of this money will continue to flow if you’re spending your days laid up on a beach in Cancun. Some passive income streams still need money, maintenance, or another type of attention. The distinguishing factor is that the income is not tied to the number of hours someone works. Here are seven common forms of passive income with an explanation for each.
1. Dividend Stocks
Certain stocks with certain companies, called dividend stocks, distribute a portion of their earnings to shareholders. These payments are called dividends and tend to be paid quarterly (schedule can vary based on company). The amount shareholders get varies substantially based on a handful of factors: the company in question, how many shares are owned, and the dividend paid per share. Dividends are not guaranteed. Even if you purchased a stock with dividends, the company is allowed to reduce or eliminate them due to changes in their financial situation.
2. Real Estate Rentals
Rental income is fairly obvious. It’s any money paid by tenants to a landlord for the right to live in or use property. It can pretty much come any type of property; you could rent out space in your storeroom if you wanted to. But the most common rental sources are houses, apartments, commercial buildings, vacation homes, or individual rooms in a house. The property owner gets regular rent, generally on a monthly basis. Rental income is considered passive, but it can involve a decent amount of time and energy. Landlords are still responsible for maintaining the property and must cover things like repairs, insurance, and taxes. If the roof starts leaking, the landlord is the one who has to get it fixed.
3. Digital Products
Digital products are any items that can be bought over the internet and delivered electronically. Examples include eBooks, online courses, printable planners, photographs, templates, and software. The beauty of digital products, and where the passive income aspect comes into play, is their repeatability. Unlike with physical objects, the same digital file can be sold repeatedly without the creator needing to make a new copy for every customer. If you write an eBook and 75 people buy it, you only wrote the book once, while you received payment for 75 books. However, many writers would also argue that this isn’t true passive income because they tend to continually spend time and money marketing the book. Updates and customer service can also require ongoing attention.
4. Royalties
Royalties are a little like rent payments for creative work. These payments are made to the owner of intellectual property when someone else uses it. Authors might receive royalties from book sales, musicians can earn them when their songs are downloaded or played, and inventors collect them when companies license their creations. Royalty payments are normally based on a prearranged agreement. The documentation details how much the owner gets for each use and under what circumstances. This type of income can continue for years. The amount one gets from royalties varies greatly depending on how often the work is purchased, performed, streamed, or licensed.
5. Peer-to-Peer Lending
Peer-to-peer lending is an interesting concept. It allows regular people to lend money to borrowers through an online platform. Instead of borrowing through a traditional bank, an individual can log on to one of these platforms and borrow money from a stranger. The borrower repays the loan over a set period of time, with interest, and a portion of that interest goes into the lender’s pocket (the other part is kept by the operating platform). Of course, this is a basic explanation, and fee structures can vary.
The payments can generate a recurring source of income while the loan is being paid off. However, there is the risk that a borrower will make late payments or stop making payments entirely. While the specific platforms exist to help protect against this, things can get messy while the situation plays out and investors can lose some or even all of the money they put into a loan.
6. Real Estate Investment Trusts
A real estate investment trust, or REIT for short, is a company that owns income-producing real estate. They may have apartment complexes, hotels, offices, shopping centers, warehouses, hospitals, or other types of property. Like with a stock, investors can buy shares of the REIT, meaning they can potentially earn dividend income without going out and personally buying a building themselves. REIT values can go up and down based on property performance, interest rates, and the current market. Worth noting: REITs generally have to distribute at least 90% of their taxable income to shareholders each year to qualify for REIT tax treatment.
7. High-Yield Savings Accounts
High-yield savings accounts pay interest on money deposited with a bank or credit union. Interest rates vary by institution. Your money simply sitting in a particular account can generate income, no extra work required. This is the ideal place for emergency funds or any money you want to be able to access quickly. Instead of sitting in a checking account earning nothing, it can just as easily be transferred to a high-yield savings account, giving you a bit of passive income.
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