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What Is Passive Income? [Definition + Guide for 2022]

Passive Income and how to earn it.

Passive income is often described as “making money while you sleep,” but there’s more to it than that. 

If it really was that easy, everyone would be counting dollar bills while also counting sheep. If you have enough money, you can buy assets like an Airbnb rental property, cryptocurrency, and stocks that make money on autopilot. But what happens if you don’t have the funds to get started? 

The answer for many creators and bloggers is to make the assets themselves. Larger assets, like property, involve investment capital that not everyone has, but creating assets yourself requires your time and effort as investment, so you can reap the rewards later. 

If you’re willing to get paid absolutely nothing while you build up your passive income strategy, it can be an amazing long-term revenue stream and a consistent cash flow. Here’s a guide to passive income for beginners. 

What is passive income? 

Income that requires little effort to maintain is passive income. It can be additional income from a rental property, the stock market, or a company that you are not actively involved in. 

A deeper look at passive income

With passive income, you’re not exchanging your time for money like you might do at a 9-to-5 job. Instead, you’re creating or buying an asset that you can sell or generate revenue with, regardless of whether you’re at your desk or on a beach in the Maldives. 

There are plenty of passive income ideas, like writing a book, creating a course, investing in real estate, and running an affiliate marketing program. 

But none of these activities are as passive as people like to think. You have to put in the work upfront, like actually writing the book you’re going to sell, filming the videos for your course, and choosing the assets you’ll buy. And you have to do all of this without getting directly paid, in the hope that it will pay off for months or years afterward. 

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Despite this, passive income can be a nice additional revenue stream (something that’s never been more important in a shaky and recovering economy). 

What are the different types of passive income? 

Unearned income comes in two main forms. Each one provides a different way to generate income, and they can be used individually or in tandem, depending on your financial goals:

  1. Creating. Money earned from doing the work upfront. Examples of passive income include selling digital products, writing books, creating music, or making another product that earns cash. 
  2. Investing. Money earned from investing in assets. It usually requires an initial investment and can include dividend stocks, real estate investment trusts, renting out a spare room or leasing, interest, capital gains, peer lending, mutual funds, and royalties. 

What’s the difference between passive income and active income?

The main difference between active income and passive income is that active income is earned through effort or output. In contrast, passive income requires upfront work. 

Both types of income require work, it’s just a case of when that work happens. Someone paid by a brand to write blog content every month is generating earned income, while someone who writes 20 blog posts upfront for their own site and monetizes them with affiliate links is generating passive income. 

Earned income is the traditional income model because it doesn’t have as many risks. The concept is simple: you do the work you know you’ll get paid for. Passive income is a good side hustle for creators and social media influencers with full-time jobs or other responsibilities who want to continue building their brand. 

Benefits of passive income

1. Gain additional cash flow

Possible wealth creation is obviously the big draw of passive income. It can provide an alternative wealth option, accelerate early retirement, support a nomad lifestyle, and increase your net worth. Creating multiple passive income streams also means you’re not reliant on one that could fall through at any moment. 

2. More financial freedom

Passive income goes beyond just earning extra money. With enough streams of income, you can earn enough to pay for your living expenses without being employed or dependent on others. It also gives you flexibility to spend time as you like, be it pursuing passion projects or starting a small business. 

3. Reduces stress and anxiety

Not having enough money to pay the bills is a major cause of stress for people. With passive income, you can easily pay your bills without worrying about not having enough money. You have the financial momentum to manage yourself, your time, and your assets effectively when you have passive income.

4. Lets you live and work from anywhere

Living and working from anywhere is possible when you are not dependent on a paycheck. Passive income gives you the flexibility that other methods of earning money cannot provide. You can work from anywhere while still maintaining your standard of living, which means you can travel or do other stuff.

How much can you make from passive income? 

There’s really no upper or lower limit to how much passive income you can make. It can be anywhere from a few extra pennies a month to hundreds of thousands a 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 an average return of 10.5% per year. Residential rental properties have an average return of 7.5% each year, while industrial real estate investments can see a 9.5% return yearly, on average. These are much higher returns compared to a high-yield savings account, which can earn you up to 1.5% per year. 

Online content creators can earn a living through passive income, too. Personal finance YouTuber and author Frankie Calkins earned $800 in January from passive income streams, including YouTube channel advertising, book sales, and affiliate marketing, while another person made more than $100,000 from dropshipping ($6,000 alone on selling a plush elephant pillow for babies). One of Udemy’s highest-earning teachers makes $17,000 a month selling online courses.

Revenue is entirely dependent on how much time, effort, and resources you put into building it, the scalability of your product, how much you’re selling it for, and how big the demand is for it. 

Is passive income taxed?

Like with anything money related, the Internal Revenue Service (IRS) has something to say about passive and residual income.You still need to understand and abide by local income tax laws:

  • Know how the IRS defines passive income. Passive income is defined as either “net rental income” or “income from a business in which the taxpayer does not materially participate.”
  • Know what counts as “material participation.” The IRS has a set of guidelines for what it calls “material participation” that determines whether someone has actively participated in business or other income-producing activity.
  • Know when passive income is taxable. Hint: It always is. It’s usually taxed at the same rate as salaries, but it can receive different treatment from the IRS.

Disclaimer: This is by no means financial or tax advice. It’s best to consult an accountant to discuss your individual case. 

What are examples of passive income?

There are various passive income opportunities you can take advantage of: 

  • Owning businesses 
  • Rental income
  • Private equity 
  • Stock market
  • Peer-to-peer lending

Owning businesses

Owning a business could be a passive activity, depending on how you set it up. For example, if you’re a freelance writer, you’re trading time for money, which isn’t a passive activity. 

If you’re a creator, on the other hand, you can earn passive income off of digital products and affiliate partnerships. Artists and musicians can earn royalties by letting other companies use their work. You could also buy an existing business with monthly revenue and earn money with little effort.

Rental income

The most common form of passive income comes from real estate. It often involves buying property and renting it out to a tenant. Some would argue that being a landlord isn’t passive, because you have to maintain and upgrade the property. 

But, you could always hire a property manager to take care of the property. Or spend a few hours per month managing tenant requests and concerns. The biggest time investment with rental income is during turnover, or when one tenant moves out and another moves in. This often takes between 30 and 40 hours.

Private equity

Private equity refers to any money you directly invest into a company, contribute to venture capital, or invest in real estate. These investments are often seen as risky and most require high capital requirements. Investors often hold private equity investments for up to 10 years. But, they can be a good source of passive income if you’re looking for a long-term investment.

Stock market

The stock market is one of the simplest ways to create passive income. As companies generate profits, they re-distribute earnings back to investors in the form of dividends. You can invest in various dividend-producing assets such as:

  • Dividend stocks
  • Real estate investment trusts (REIT)
  • Index funds
  • Dividend exchange-traded funds (ETFs)

Investing in assets that yield dividends is simple. Sign up for an advisory or brokerage service (like Charles Schwab or TD Ameritrade), add money to the account, and buy one of the assets above. 

Peer-to-peer lending

Peer-to-peer (P2P) lending connects individual lenders and borrowers without going through a bank. It allows borrowers to get quick loans at a low cost. Interest rates vary depending on the borrower’s credit score. If you fund a loan on a platform like Prosper, for example, you’ll receive monthly payments from the borrower until the principal and loan interest is paid off.

Start now and generate passive income

There’s a good chance you already have assets you can use to create passive income—or, at the very least, have a skill or talent that can make extra cash. Remember though, passive income definitely isn’t passive. There’s a hefty upfront workload that involves defining your asset, creating or buying it, and passively managing it. 

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


Passive income FAQ

How can a beginner make passive income?

The initial stages of generating passive income are the hardest, because that’s when you’ll be investing the majority of your time and energy. Creating your asset upfront involves coming up with a marketable idea, planning it, and actually creating it. If you’re investing, you need to save up money to invest in an asset, like real estate or stocks, then manage the investment after purchase.

Can you live on passive income?

If you manage your money well, you can retire early and live on passive income. Some of Udemy’s highest paid course creators earn $17,000 per month without doing active work. Investors can also live on their investment through real estate, P2P lending, and IRA or 401(k) if they invest in dividend stocks over time.

How can I build passive income?

  1. Invest in a rental property.
  2. Create and sell digital products.
  3. Rent out your house.
  4. Become an affiliate marketer.
  5. Start a blog or YouTube channel.
  6. Invest in the stock market. 
  7. Become a peer-to-peer lender.

What is the difference between passive income and unearned income?

Passive income includes earned income from rents, royalties, and contributions to limited partnerships. Unearned income includes things like inheritance money, gambling winnings, taxable interest income, ordinary dividends, annuities, and capital gain distributions.
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