What Is Passive Income? An Ultimate Guide with Examples

In our beginner’s guide, you’ll learn what passive income is, how to create it, and how other people make money from it. Passive income is frequently described as “making money while you sleep,” but there’s more to it.

If it were that simple, everyone would be counting dollars while also counting sheep. If you have enough money, you can invest in assets such as an Airbnb rental property, cryptocurrency, and stocks that generate income on their own. But what if you don’t have the necessary funds to get started?

Many creators and bloggers prefer to create their own assets. Larger assets, such as real estate, require investment capital that not everyone has, but creating assets yourself requires your time and effort as an investment in order to reap the benefits later.

If you’re willing to work for free while developing your passive income strategy, it can be a fantastic long-term revenue stream with consistent cash flow. Here’s a beginner’s guide to passive income.

What exactly is passive income?

Passive income is income that requires little effort to maintain. It could be from a rental property, the stock market, or a company in which you are not actively involved.

A more in-depth look at passive income

You are not exchanging your time for money with passive income, as you would at a 9-to-5 job. Instead, you’re creating or purchasing an asset that you can sell or generate revenue with, whether you’re at your desk or on a Maldives beach.

There are numerous passive income opportunities, such as writing a book, developing a course, investing in real estate, and running an affiliate marketing program.

However, none of these activities are as passive as people believe. You must first put in the effort, such as writing the book you intend to sell, filming the videos for your course, and selecting the assets you intend to purchase. And you have to do all of this while not being paid directly, in the hope that it will pay off months or years later.

Despite this, passive income can be a useful additional revenue stream (which is especially important in a shaky and recovering economy).

What are the various kinds of passive income?

Unearned income is classified into two types. Each one generates a different type of income and can be used separately or in tandem, depending on your financial objectives:

1. Creating. Money earned upfront for doing the work. Selling digital products, writing books, creating music, or creating another product that earns money are all examples of passive income.
2. Investing. Profits from asset investments. Dividend stocks, real estate investment trusts, renting out a spare room or leasing, interest, capital gains, peer lending, mutual funds, and royalties are common examples of initial investments.

What is the distinction between passive and active income?

The primary distinction between active and passive income is that active income is earned through labor or output. In contrast, passive income requires some initial effort.

Both types of income necessitate work; the only difference is when that work occurs. Someone who is paid by a brand to write blog content every month is earning money, whereas someone who writes 20 blog posts upfront for their own site and monetizes them with affiliate links is earning money passively.

Earned income is the traditional income model because it is less risky. The idea is straightforward: you do the work you know you’ll be paid for. Passive income is an excellent side hustle for creators and social media influencers who have full-time jobs or other obligations and want to continue building their brand.

Advantages of passive income

1. Increase your cash flow

The potential for wealth creation is undoubtedly the most appealing aspect of passive income. It can be used to diversify your wealth, accelerate early retirement, support a digital nomad lifestyle, and increase your net worth. Having multiple passive income streams also means you’re not reliant on a single one that could fail at any time.

2. Greater financial independence

Passive income is more than just making extra money. With enough income streams, you can earn enough to cover your living expenses without having to work or rely on others. It also allows you to spend your time however you want, whether it’s pursuing passion projects or starting a small business.

3. It alleviates stress and anxiety.

People experience significant stress when they do not have enough money to pay their bills. You can easily pay your bills with passive income without worrying about not having enough money. When you have passive income, you have the financial momentum to effectively manage yourself, your time, and your assets.

4. Allows you to live and work from any location.

When you are not dependent on a paycheck, you can live and work from anywhere. Passive income provides you with the flexibility that other methods of earning money do not. You can work from anywhere while maintaining your standard of living, allowing you to travel or do other things.

How much money can you make with passive income?

There is no upper or lower limit to the amount of passive income you can generate. It can range from a few pennies extra per month to hundreds of thousands of dollars per year, depending on the value and scalability of the product you’re selling.

For example, if you invest in an ETF that tracks the S&P 500, you can expect a 10.5% annual return. Residential rental properties have an average annual return of 7.5%, while industrial real estate investments have an average annual return of 9.5%. These are significantly higher returns than a high-yield savings account, which can earn up to 1.5% per year.

Passive income is another way for online content creators to make a living. 

In January, YouTuber and author Frankie Calkins earned $800 from passive income streams such as YouTube channel advertising, book sales, and affiliate marketing, while another person earned more than $100,000 from dropshipping ($6,000 on selling a plush elephant pillow for babies alone). One of Udemy’s top teachers earns $17,000 per month selling online courses.

Revenue is entirely dependent on how much time, effort, and resources you put into developing it, the scalability of your product, the price you charge for it, and the level of demand for it.

Is passive income subject to taxation?

The Internal Revenue Service (IRS), like any other government agency, has something to say about passive and residual income.

You must still understand and follow local income tax laws, including the following: 

• Understand how the IRS classifies passive income. Passive income is defined as “net rental income” or “income from a business in which the taxpayer does not participate materially.”
• Understand what constitutes “material participation.” The IRS has a set of guidelines for determining “material participation,” or whether someone has actively participated in business or other income-producing activity.
• Understand when passive income is taxable. Hint: It is always. It is usually taxed at the same rate as salaries, but the IRS may treat it differently.

Disclaimer: This is not intended to be financial or tax advice. It is best to consult with an accountant about your specific situation.

What types of passive income exist?

There are numerous passive income opportunities available to you:

1. Own a business
2. Rental earnings
3. Private capital
4. The stock exchange
5. Peer-to-peer financing
6. Buy a business

Depending on how you set it up, owning a business can be a passive activity. For instance, if you work as a freelance writer, you are exchanging time for money, which is not a passive activity.

If you’re a creator, you can earn passive income through digital products and affiliate partnerships. By allowing other companies to use their work, artists and musicians can earn royalties. You could also buy an existing business with monthly revenue and earn money quickly.

Rental earnings

Real estate is the most common source of passive income. It frequently entails purchasing property and renting it to a tenant. Some argue that being a landlord is not passive because you must maintain and upgrade the property.

However, you could always hire a property manager to look after the property. Alternatively, spend a few hours per month dealing with tenant requests and concerns. The most time is spent on rental income turnover, or when one tenant moves out and another moves in. This typically takes 30 to 40 hours.

Private capital

Private equity is any money invested directly in a company, contributed to venture capital, or invested in real estate. These investments are frequently regarded as high-risk, with high capital requirements. Private equity investments are frequently held for up to ten years by investors. However, if you’re looking for a long-term investment, they can be a good source of passive income.

The stock exchange

The stock market is one of the most straightforward ways to generate passive income. Companies re-distribute earnings to shareholders in the form of dividends as they generate profits. 

You can invest in a variety of dividend-paying assets, including:

1. Dividend paying stocks
2. Property investment trusts (REIT)
3. Index mutual funds
4. ETFs that pay out dividends (ETFs)

Investing in dividend-paying assets is straightforward. Sign up for an advisory or brokerage service (such as Charles Schwab or TD Ameritrade), deposit funds into the account, and purchase one of the assets listed above.

Peer-to-peer financing

P2P lending connects individual lenders and borrowers without the use of a bank. Borrowers can get quick loans at low interest rates. The interest rate varies according to the borrower’s credit score. If you fund a loan on a platform such as Prosper, you will receive monthly payments from the borrower until the principal and loan interest are paid off.

Begin now to generate passive income.

There’s a good chance you already have assets that can be used to generate passive income—or, at the very least, a skill or talent that can be used to earn extra money. But keep in mind that passive income is anything but. There is a significant upfront workload involved in defining your asset, creating or purchasing it, and passively managing it.

You can earn more in the long run with little to no effort if you set up passive income investments, whether they involve contributing to a new business venture or purchasing income-producing securities.

FAQ on passive income

How can a beginner generate passive income?

The early stages of generating passive income are the most difficult because you will be investing the majority of your time and energy. Coming up with a marketable idea, planning it, and actually creating it are all part of creating your asset upfront. If you want to invest, you must first save money to purchase an asset, such as real estate or stocks, and then manage the investment after it is purchased.

Can you make a living off of passive income?

You can retire early and live on passive income if you manage your money well. Without doing any active work, some of Udemy’s highest paid course creators earn $17,000 per month. If investors invest in dividend stocks over time, they can also live on their investment through real estate, peer-to-peer lending, and IRA or 401(k).

How can I generate passive income?

1. Purchase a rental property.
2. Make and sell digital goods.
3. You can rent out your home.
4. Learn to be an affiliate marketer.
5. Begin a blog or a YouTube channel.
6. Invest in the stock exchange.
7. Turn yourself into a peer-to-peer lender.

What is the distinction between passive and unearned income?

Earned income from rents, royalties, and contributions to limited partnerships are examples of passive income. Inheritance money, gambling winnings, taxable interest income, ordinary dividends, annuities, and capital gain distributions are examples of unearned income.