Unlike regular employment or investments that may require your active engagement, passive income strategies typically require minimal work to generate returns.
However, while producing passive income may sound effortless, these strategies are not without risk — or work. Many require investing your time and money up front.
We’ll help you determine how these strategies could potentially augment your earnings and fit with your risk tolerance, time horizon and financial goals.
Here are five passive income strategies to understand. As you consider these options, remember that it’s wise to incorporate multiple strategies to diversify your investment portfolio, as well as consider the possible tax implications:
Cash equivalents and deposits
Cash investments are short-term investments that offer a return on invested/deposited principal. These investments require little to no effort, making them an attractive passive income option. However, their returns are typically tied to the current interest rate environment and may fall short of other strategies given their generally lower risk.
Certain cash vehicles — like sweep accounts and high-interest checking or savings accounts — allow you to earn a return on your money while also allowing you to readily access it. This feature can make them beneficial accounts for emergency fund savings, transactional purposes such as paying bills, making purchases, or ongoing investments.
Here are a few examples:
- Sweep account: Regularly transfers a portion of your funds into a higher-interest account and offers a modest level of interest in return for making balances readily accessible.
- High-interest checking or savings account: Checking or savings accounts that offer higher rates than the industry average.
- Certificates of deposit: A high-interest rate deposit that typically offers a higher fixed return for leaving funds deposited for a specified term (for example, 6 months, 1 year, or 5 years).
- Treasury Bills (T-bills): A short-term, government-backed debt obligation that matures in one year or less.
Instead of buying stock in a company, you can lend money to a company, municipality, the U.S. government or governmental agency. In return, the issuer agrees to pay you a specified rate of interest over the life of the bond and repay the face value of the bond (the principal) when it reaches maturity. Bonds are typically less volatile than stocks and have a specified maturity and interest payments. However, they also generally receive a lower return than stocks and are exposed to risks such as interest rate risk, credit risk and prepayment risk.
- U.S. Treasury bonds: Bonds backed by the full faith and credit of the U.S. government, bonds are used to fund a portion of U.S. government spending.
- Corporate bonds: Companies may borrow from bond investors to fund business operations or expansions.
- Municipal bonds: State and local government entities issue bonds to raise funds for projects.
Certain companies return a portion of their profits to shareholders in the form of dividends. When you purchase stocks from these firms, you may receive quarterly payments from the company based on its net income and dividend policy.
Dividend paying stocks may yield more or less than bonds and come with considerably more market price risk as they lack a defined maturity. Keep in mind that a company can, at any time, cut or eliminate its dividend payout, reducing your passive income stream.
Real estate investment trusts (REITs)
Buying and managing real estate can require a lot of hands-on attention. Real estate investment trusts allow you to invest in large-scale income-producing real estate. They may be a good option if you’d like to benefit from the income that property can generate but reduce the associated stress.
REITs allow you to earn a share of the income produced through commercial properties without purchasing the real estate yourself. The potential downside of REITs includes the unpredictable nature of the real estate market and that a portion of distributions may be taxed as ordinary income. REITs come in two varieties: publicly traded REITs that buy and sell on an exchange like stocks, and non-traded REITs that have more restrictive liquidity considerations.
Investing in short- and long-term rental property, can generate potentially significant income. But it often requires more work and expense than other strategies, involving tenants, property taxes, and building maintenance and repairs.
If you’d rather start small with generating rental income, you may consider renting high-priced items you already own. Peer-to-peer rental websites now allow individuals to rent out their vehicles, equipment and other physical assets (even parking spaces). For example, boats, RVs, camera gear or power tools are just a small sample of goods that people contract out. However, you’ll want to account for your lost time in managing the leasing process, the wear and tear on your property and the possible tax implications if you ever wish to sell your rented property.
Determine how passive income can work for you
Passive income strategies can help you generate extra earnings while working and supplement your retirement income — but you’ll want to consult a professional on what is best for your unique situation. We can help you better understand these strategies and determine which fit within your overall financial strategy.