For many people who want to be financially free, passive income is the ultimate goal. Passive income allows you the opportunity to do what you want to do without thinking of where your next pay check is coming from.
You hop on a flight to Spain or Tunisia or Thailand. You spend a month revelling by the sea and sand. You taste new foods. You discover new music. You spot wildlife you’ve never imagined. You have the time of your life.
You don’t check email the entire time. Heck, you don’t even post photos to Instagram or Facebook. You’re radically offline — like it’s 1974.
You return to the UK, check your bank account, and notice your balance has grown while you’ve been away. You’ve returned from your month-long trip with more money than you had when you started.
Sound like a dream or fantasy?
This can be your life — if you create self-sustaining passive income.
What is Passive Income?
Passive income is income received on a regular basis, that requires little effort from you to produce or maintain it. It is the money that flows into your pocket whilst you sleep, eat, vacation or just sit around watching TV. A stream of passive income essentially makes money for you without any effort.
When you’re collecting passive income, your money is grossly disproportionate to the time you spend working. Actually, “disproportionate” may not be the the right word: it’s un-proportionate. Your income is not correlated to your hours. You income is not depended on the hours you work.
At most jobs, regardless of whether you’re earning £8 per hour or £800 per hour, there’s a linear relationship between time and money. The more time you spend working, the more money you earn. For passive income, this relationship disappears.
With ‘working’ for money, also called active income, you are limited in your earning potential as you can only work so many hours each day. With passive income, money is not linked to the time you spend working. This is because passive income flows into your bank account without having to put any effort. You can achieve far more money passively than you can actively.
But always remember that by passive income, we don’t mean easy or quick. It just means you invest effort once and it continues to pay you without any further (or much more) effort afterwards.
How to create passive income?
Now that you realise that passive income is the key to living a financially free life, you need to create a stream of passive income.
There are a number of ways to create passive income. Some are:
- Rental income – These should ideally be from from properties that other people manage and repair – Remember, you want to do as little work as possible but still receive money. Use property crowd funding websites (Property Moose, The House Crowd) or REITS.
- Dividend paying stocks – Have a look at the idea behind my dividend growth portfolio to see how I collect passive income from dividend stocks. To see which stocks I have been buying, have a look at the ‘my journey‘ section of this website.
- From stocks that someone else manages – Use an online portfolio manager like Nutmeg.
- Royalties from books, music and other creative works.
- App Development – Create Apps for phones and tablets and see the royalties flow in.
- Rent space in your house – Read this article on how to make money from the space in your house to find out more.
- Rent your car parking space – Read my article on JustPark to see how this can be done. Although not entirely passive, this is to good an opportunity and income stream to not include in this list.
- Income from businesses you own but don’t have an active role in.
- Peer to Peer Lending – An easy way to make your money work harder is to improve the rate you get on your savings. The rates you get in typical bank high street bank accounts is very low at present and it would be better to instead spread your money out and put some in in P2P lenders. Have a look at my review of the p2p lender Fruitful.
- Owning vending machines, laundromats, arcade games and other hands-off enterprises with one or two employees.
- Bonds and bond ladders
- High Yielding current or savings account – Many current accounts dod not pay you interest in the present low interest rate environment. But Santander and Halifax provide current accounts that pay you interest monthly.
Whilst all the above are ideal going to create money for you with little to no work, you will have to put some work in at the beginning phase.
You see passive income isn’t ‘something-for-nothing’. This isn’t no lottery, and it’s definitely not a get-rich-quick scheme. You’ll be planting seeds today, so you can harvest freedom for the rest of your life.
With passive income, you do all the work upfront.
- For dividend paying stocks – you need to do work upfront to ensure you buy into the right stocks and at the right price.
- For property – you need to do work upfront to ensure you buy property in the right location, for the correct price and one that will provide you with positive income even if you outsource the repair and maintenance work on the property.
- Books- Someone can spend time initially writing a book. Once published, they never have to touch it again, and for that big upfront investment, gets to collect royalties for years.
The best passive income opportunities that will provide you with higher income over the long term might require you to invest more time upfront whilst not earning any money initially for this time. This may feel really bad at first as you don’t initially see the fruits of your labour and that is why many people shy away from passive income investments. (These people that shy away are ironically the people stuck in their 9-5 jobs for 40+ years – the people that actually need passive income the most).
To see how this initial effort for no reward works in practice, we look at Britons favourite passive income source, property for this example.
At the early stage, you are:
- Reading and learning about investments and businesses.
- Searching for properties.
- Analysing deals and looking at the financials to see if they make sense.
- Negotiating and closing deals.
- Repairing and renovating properties.
- Building your team — hiring property managers, contractors and other support staff. This is probably the most important step if you want to scale (grow bigger overtime). You don’t want to be getting calls about broken boilers. Hire someone to take those calls on your behalf. You want to keep the income stream as passive as possible.
After a few months of putting in the hard work upfront, you rent the property, and it feels like ecstasy- the hard work pays off. You get your first rental deposit and the money keeps rolling in.
At this point, you’ve experienced two phases:
- Initial: Work, but no income. This is where most people give up as they are short sighted as say they can’t work for free.
- Passive: This is when your rental cheques start flowing in. Your rental income comes in even if you put no work into the property. This is the reward for perseverance.
How to start earning passive income
To find the passive income opportunities that are right for you, you will want to consider the following things:
- What are you most interested in?
- What do you own or know that others might want to pay you for? You could write a book and earn royalties?
- Do you have any skills that you can use in the initial phase for any of the above mentioned opportunities?
- How much money do you have to start off with? If you have quite a bit of money, rental property and dividend paying stocks is the way to go. If you don’t have any money, the best opportunities are for you to write a book, rent our your car parking space or rent out some space in your house.
- How much initial effort you want to put in. – some passive income streams require a lot of upfront time like writing a book or purchasing a rental property (buy-to-let method as opposed to crowd funding which hardly requires time). Other opportunities requires little to no upfront time like stock/portfolio management that someone else manages or peer-to-peer lending.
Why passive income is cheaper and better than active income
Passive Income is income you receive for which you haven’t put effort in. Active income on the other hand is directly related to effort. With active income you normally receive income in proportion to the hours you work.
Active income has many disadvantages.
Active income (your usual salary) has a lot of associated costs that come with it. It costs your time and effort. But even more costly than these is the fact that you pay far higher taxes on active income than passive income. As you earn money actively from employment you need to pay income taxes and NICs. With passive income, you can avoid these as you can get dividends tax free in an ISA or you can get reliefs on taxes for your rental property. Read my article on how home owners can reduce their tax bill.
There is also no ‘associated costs’ with passive income. By this we mean that no transportation costs to and from work, no lunches with co-workers, no uniforms and no dry cleaning.
If you have multiple passive income streams you are not ties to a particular geographical area. You are no longer tied to a home the is near your workplace. You can take your pick and chose to live/work from Spain, Thailand or any other destination of choice.
The goal of passive income is to spend more time with friends and family or have the experiences you want. The goal of passive income is to let your money work for you.