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Personal Finance

What Is Passive Income?

If you've ever thought that working for a living involves just a little too much work, passive income might be something for you to explore. Passive income refers to any earnings you receive without always being actively involved in the endeavor that generates it. For example, you could actively earn money by hand-lettering signs. But you might passively earn income by turning your handwriting into a computer font and collecting sales or royalties.

Passive income encompasses many types of investments and business arrangements. Some passive income opportunities require quite a bit of upfront work, while other forms are simpler. And though every opportunity might not be the right fit for you, if you'd like to diversify your sources of income or make some additional money without taking on a second job, passive income might be just the thing.

How Does Passive Income Work?

Passive income is exactly what it sounds like: It's income you generate that does not require your daily active involvement. Think of the interest you earn on a savings account. You collect money—in this case, a very small amount of interest—in exchange for simply parking your funds at the bank.

Not all forms of passive income are quite this passive, of course; some require a significant investment of your time and resources, at least upfront. What makes passive income different is, unlike regular employment or contract work, you're not being paid based on the amount of work you do or how much time you put in. You might create passive income by investing in the stock market, for example, or renting out your home or car, collecting book royalties, licensing a patent or designing and selling an app—the list is long.

Earning passive income can be a great way to supplement your income, whether you use it to make a few extra dollars here and there or invest significant time and money to build a major income stream. Although just about anyone might welcome a little extra money, for independent contractors with sporadic income, stay-at-home parents, full-time students and retirees, passive income can be especially valuable.

How to Create Passive Income

The best way to create passive income is to assess your interests, talents and resources, and choose opportunities that suit you. There are many opportunities to make money working from home, and you don't have to limit yourself to just one. In fact, developing a few sources of passive income will improve your chances of success.

If your available time and money are limited, look for low-impact opportunities that are easy to start:

  • Build an investment fund. Learn about basic investment strategies and economic trends or find a good financial advisor to guide you. Stocks that pay dividends are often good sources of passive income. Starting small? Consider an app like Acorns, where you can invest as little as $1 a month and use the "change" you get from rounded-up transactions to start a nest egg.
  • Rent out your garage or spare vehicle. You don't have to have a home to rent—or even a room. You can rent out your car on a platform like Turo or rent your garage on sites like Neighbor.com.
  • Leverage cash back credit cards. Here, you'll have to spend money to make money. But if you have cash back credit cards and enough discipline to pay off your balance every month, you can charge your everyday expenses on your card and collect the rewards dollars as passive income without paying high interest on a balance.
  • Declutter and sell items online. Depending on what lurks in your closets, you may be able to generate a bit of spending money—or funds to invest.

Feeling a little more ambitious? These ideas require quite a bit more time and/or money, but offer a higher potential upside as well:

  • Write a book, design an app or license your intellectual property. You'll need skill, talent, expertise or inventiveness—along with the time and focus to bring your idea to fruition. But you don't have to be a proven genius to succeed. Have you devised a solution to a common problem? Are you an expert who can share your knowledge in an e-book on Amazon or a video course for a platform like Coursera? You may be able to sell or license your idea for ongoing profits.
  • Try affiliate marketing. If you've cultivated an audience on social media—or elsewhere, for that matter—you can market other companies' goods and services using affiliate links. You'll receive a commission for every completed purchase that comes in through your link, sometimes even if the items purchased aren't the ones you originally promoted. Creating the content needed to build a social media following is definitely more active than passive, though, and only you know if you have an inner influencer ready to be unleashed.
  • Buy a rental property. Although this option requires real capital, it can create wealth in two ways: by generating monthly income and building equity in your property. Purchase a home in your favorite vacation destination and you'll create a built-in travel opportunity whenever your place isn't rented out on Airbnb or Vrbo.
  • Be a "silent" investor in a business. Being an entrepreneur is anything but passive. However, becoming a silent business partner by investing in a friend's or business associate's venture can allow you to participate in a growing business without contributing a lot of sweat equity. Just make sure you're not dependent on this income for your livelihood, as investments in startups and other ventures typically carry significant risk.

Is Passive Income Taxable?

Like nearly every type of income, passive income is taxable. Exactly how it is taxed depends on a variety of factors. Investment income, for example, may be calculated and taxed differently from passive business income, property rental proceeds or cash back credit card rewards.

The most important takeaway now: Find out what your potential tax liability is before you pursue—and especially before you spend—any passive income. Since there are no automatic payroll deductions associated with this type of income, you want to know in advance how much of your earnings you should set aside for taxes and what documentation you will need at filing time.

Income Independence Is Its Own Reward

Cultivating passive income takes some active research and, often, more than a little work. But the payoff can be significant. Having a stream of income that's not dependent on employment or contracting can be a hedge against lean economic times or help enrich your retirement. Whether you generate a little passive income or a lot, the security of having more than one source of money is in itself a reward.

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