Recently we got a listener question for The Prosperity Podcast: “Is there really such a thing as passive income?” Yes, there is! True passive income isn’t quite as rare as Santa Claus or the Easter Bunny. However, as Spencer Shaw and Kim Butler discussed in this podcast episode, there can be a LOT of grey area between earning active income (such as a job) and completely passive income.
By definition, something that is “passive” would require little to no active work or time commitment. The IRS defines passive income as only coming from two sources: rental activity or “trade or business activities in which you do not materially participate.” However, many strategies thought of as “passive income” may indeed require some work, either intermittently or in the beginning. For instance, authors or songwriters may earn passive income royalties based on work done in the past. In this article, we’ll explore 15 ways to create passive income—and semi-passive income.
Making Passive Income a Reality
With interest rates still low, you need a substantial amount of money to generate an income in traditional safe money vehicles. At current bank CD rates of about 2%, it takes $5 million dollars to generate an annual interest-only income of only $100,000.
The good news? There are other options for passive or residual income which are not tied to market interest rates. Even better news? Some can be created with little or no money by utilizing time, talent, and a little know-how. And the best news is that you don’t need to quit working or turn 65 to benefit from these strategies. We believe it’s never too early to learn how to create cash flow! If you’d like to develop a passive income that makes work optional some day, you can start learning to create passive income now—with or without a large net worth.
Aside from typical low-return vehicles such as savings accounts, bank CDs and bonds, some examples of passive income—from the typical to the inventive—include:
#1: Stock or Cash Dividends from Public Companies.
A dividend is a sum of money (or sometimes shares of stock) paid regularly by a company to its shareholders out of its profits or reserves. Essentially a profit-sharing plan, dividends are typically distributed quarterly, but other arrangements (monthly or annually) are also common. Many companies have a long history of regular dividend payments to shareholders, though neither dividends nor the value of the stock are guaranteed.
#2: Insurance Policy Dividends.
Owners of participating whole life insurance policies may also receive dividends, which are paid annually on the policy anniversary. Early in the policy’s existence, owners often forgo receipt of these dividends, instead adding them to the policy’s cash value in the form of paid-up additions. The size of the dividend typically increases with the age of the policy, along with the policy size and cash value.
In the later years of a policy, policyholders may wish to receive these larger dividends as an annual income source. Policy dividends are not guaranteed but have proven to be historically reliable in the past.
We recently did an entire article on life insurance dividends. In “Understanding Life Insurance Dividends,” we articulate the differences between dividends (cash or stock) from publicly-traded companies and mutual life insurance companies.
#3: Immediate Annuities.
Annuities are contracts issued by insurance companies that deliver regular payments to the investor. Some people like to include them in an income portfolio, since they can deliver a reliable income stream you can’t outlive—although they are complex financial products with potential downsides as well.
If you are upwards of 75 years of age, a single premium immediate annuity (SPIA) is worth considering. They can be a good way to create passive income, for example, with a windfall from the sale of a home or business. A life insurance policy can also be converted into an annuity, which can make sense in your later years, especially if policy beneficiaries are financially independent or no longer living.
The downside of an annuity is that it is an irreversible step—so consider it carefully! The older you are when you begin an annuity, the better your rate of return will be, so this is a move best made when you are ready to turn an asset into a safe and stable cash flow.
Only purchase an annuity within an IRA if you are taking disbursements from your retirement account. Do NOT purchase a deferred annuity in any situation—they are typically expensive, riddled with rules, and not worth it! Reach out to us if you’d like to see what an immediate annuity would pay or compare it to other potential cash flow options.
#4: Rental real estate.
When income from rental real estate exceeds the costs of ownership and maintenance (such as mortgages or loans, taxes, and operating costs), the profits may provide a steady stream of cash flow. Investors who purchase wisely and pay their mortgage with rental income can end up with considerable cash flow and, eventually, a free-and-clear asset from a relatively modest initial investment for down payment and improvements. Real estate investments can also provide growth in equity over time, although we would caution you to make decisions based only on cash flow—not future potential appreciation.
However, unless you are a silent investment partner, rental real estate can be anything but passive in many situations. Scouting homes or apartments, purchasing and renovating them, then finding and managing tenants, maintenance and bookkeeping can be a full-time job, depending on how many units you have. Some people are well-equipped to be landlords and others don’t enjoy it or don’t have the time for it.
You can always hire a property manager, which will likely run you about 10% of the monthly rent. So make sure you have adequate cash flow in the deal to allow for a manager.
Some people invest in real estate through REITs. Our observation is that REITs can be volatile and have a history of rising and fall with the stock market, making them a poor asset for reliable cash flow.
#5: Bridge loans.
Private lending strategies allow investors to earn competitive interest rates by lending money to others who repay it with interest. Bridge loans are a common private lending strategy that offers a way to invest in real estate without “toilets, tenants or termites.”
Real estate bridge loans are short-term loans (generally three years or less) that provide temporary financing for properties while a property is being improved and/or until the owner (or lease-to-own buyer) is able to acquire permanent financing. Bridge loans can offer healthy returns and the security of having a real property (commercial or residential) as collateral.
Bridge loans can produce high single digit and even low double digit returns, but are not without risk. It is important to do your due diligence with any type of private lending. Bridge loans also require a minimum investment of $25k.
#6: Mineral rights leases.
Also a form of private lending, mineral rights leases are a secured debt product that pays a predetermined interest rate—usually in the high single digits—to investors. Mineral rights leases are secured by first position liens against specific assets such as oil and gas wells, mineral rights interests, and the working capital of the oil and gas business contracting with investors.
If you were thinking oil and gas were on their way out, our article “Is Oil and Gas Still a Good Investment?” might surprise you. Most investors are unaware that oil and gas still comprise 70% of the U.S. energy consumption. Additionally, the U.S. has become the leading producer of oil and gas in the world, much of which is exported. Mineral rights leases are an excellent way to turn the oil and gas boom in Texas into passive income.
The downside of mineral rights leases is that, like bridge loans, you need a lump sum to invest. If we can provide you with more education on how those work, contact us with your questions.
#7: Peer lending.
Peer-to-peer lending platforms such as Prosper and Lending Club help borrowers and lenders/investors alike obtain more favorable rates by eliminating banks as the middle man. One advantage of peer lending is that it does not require large lump sums to start. You could start building a peer lending portfolio with $500 or $1,000 and add to it as you are able. While not as lucrative for private lenders as it once was, peer lending is still delivering returns in the mid-to-upper single digits.
#8: Rent out your home.
Renting out a portion of your home or your vacation home when you’re not using it through a site like Airbnb.com, FlipKey.com or VRBO.com (vacation rental by owner) is a somewhat passive way to earn income. In some locations, you can hire managers who will market and handle housecleaning, making the income very passive. However, as with rental real estate, the less you manage yourself, the less you will make.
#9: Rent your vehicle or boat.
Many people are earning thousands each year by renting out their car, SUV or camper van—even just part-time. After all, vehicles are often underutilized assets, costing tens of thousands of dollars, but perhaps only used a few hours each week. Turo.com and GetAround.com are the leaders in the field. (Just make sure your vehicle is properly insured for such a venture!)
If you have a boat and live in a city where boating is popular, you can rent out your boat (or choose to captain it yourself) on BoatSetter.com.
A royalty is a payment made to the owner of a copyrighted work or patent, generally representing a percentage of the publisher’s or company’s profits. Sales of books, songs, and other works result in a residual income stream to the owner of the work. Authors and musicians can also self-publish their work to keep greater profits. (We have published most of our own books “in house” through Amazon.com’s CreateSpace and Kindle platforms.)
Obviously, royalties require plenty of work up front! But they can represent truly passive income after the initial work is completed.
#11: Franchising, Licensing and Fees.
Franchise and licensing fees, paid for the privilege of using a branded product or service, are another form of royalty. My husband’s financial software business generates licensing fees. We also license books and other educational content to other financial advisors and agents. Depending on the terms of their compensation agreements, brokers and sales representatives can receive a passive income from trail commissions or renewal fees even after they retire.
#12: Business Partnerships.
General or Limited Partnerships are business arrangements in which some of the participants are investors only. Limited partners generally do not have management responsibilities and are not responsible for the debt obligations of the business.
It is not unusual for your favorite local business owner with the restaurant or yoga studio to have a silent money partner. One partner manages and the other provides capital for either a share of the profits and/or an agreed-upon rate of return.
One common form of Business Partnerships that have proven to be lucrative is investing in oil and gas, something we have experience with ourselves.
#13: Network Marketing.
Although it’s not for everyone, network marketing is a popular way to add an stream of income IF you don’t mind putting in some work. Millions of networkers successfully generate a few hundred dollars a month to supplement their lifestyle. Many aspire to be “heavy hitters” who earn six figures or more in residual income, though such success stories are more the exception than the rule.
Network marketing can be a wonderful way to learn about business with low overhead and guidance from mentors—particularly if you use and enjoy the products. And who knows? You might love it and make it your career. Our friend Jordan Adler did and you might enjoy his story.
#14: Online business models.
In recent years, many people have turned to the internet to build extra income through strategies such as:
- affiliate marketing
- blogging (monetized through sponsors, ads, affiliate marketing or products), and
- information marketing in the form of ebooks, membership sites, or training courses offered independently through sites such as teachable.com.
The the world of online businesses, there is typically upfront effort required and no guarantees of income, yet, many success stories as well. Our Prosperity Podcast co-host, Spencer Shaw (also the host of the Business Growth Podcast) has had success with online businesses.
#15: “Classic” passive income business models.
Time-tested examples of passive income businesses in the real world include laundromats, ATM machines, and vending machines. After an initial outlay of cash (and perhaps the hiring of a key employee), owners can profit from these businesses with a minimum investment of time.
Next Steps to Create Passive Income
Often, the first step to future passive income is repositioning your money. As Garret Gunderson points out well in Killing Sacred Cows, most 401(k)s and other qualified plans ironically discourage or prevent investors from using retirement funds to build a cash flow business! While you can (for instance) purchase real estate inside of a self-directed IRA, the structure, taxation, regulations and restrictions of doing so aren’t attractive.
As a rule, establishing these streams of income is not as easy making a deposit into a savings account. But the potential returns from many passive income sources are far greater than those offered by more common interest-bearing financial instruments, particularly given current interest rates. With cash flow as the ultimate goal, it is wise to develop alternative passive income strategies before, or perhaps even instead of retirement.
The ultimate “win-win” is finding something you love to do that can generate at least semi-passive income. While most people are focused on “saving for retirement,” consider what you can start doing now that will generate cash flow for years to come!
Are you ready to create passive income? Contact us today to discuss how to position yourself for cash flow.