Passive Income: What it is & How to Use it to Build Wealth
Passive income is generated with little effort to maintain it. Generally, this type of income is tied to a form of investing and continues to build for years.
It allows for an accumulation of wealth without a person’s direct involvement once the initial investment has been funded.
Rental properties, financial portfolios (stocks, bonds) or private business investments are capable of generating regular cash flow. Each build wealth using various tools from interest payments, dividends, or limited partner shares. And of course, the Internal Revenue Service (IRS) comes into play with a guideline that defines passive income for tax purposes.
Some passive investments pay immediately, most gain momentum over time. You can build an investment portfolio to create a diverse source of short-term cash flow while accumulating long-term investments. Before you dive into passive income investing, be sure you understand what’s involved.
3 Common Types of Passive Income
1. Rental Properties
Real estate continues to be a high-interest investment for passive income and substantial tax deductions to offset the tax liabilities. Single residential dwellings, townhouses, condominiums, or apartment buildings (multiple units) are ideal for generating steady income.
Most investors hire property managers or landlords to maintain the property. Their job is to keep the property in good condition (building equity), units occupied, manage rental agreements, or tenant issues.
Tax benefits allow the owner (investor) to deduct the cost of these services, mortgage loan interest and property taxes against the revenue (rent) collected without having to participate in the daily upkeep.
2. Private Business
Consider investing in a business by providing capital. Become a limited partner, and sit back, while the developer or entrepreneur works on generating passive income for you. The relationship as an investor and limited partner is linked to the amount of funding and the percentage of earnings. Usually, there’s a written agreement (contract) with the terms and conditions.
Depending structure of the company, your investment could pay dividends on a regular basis.
Technology has created massive opportunities for passive income with online apps, ebooks, services and other products. You invest in the project for a portion of the earnings or royalties produced from each sale and collect passive income. It’s a fact more and more business is being conducted online.
3. Investment Portfolios
Financial portfolios offer a variety of passive income ventures. Get your money working for you since you’ve spent a good portion of your life working to earn it. Stocks, bonds, and money market funds have proven to be good sources with high yields.
Let’s say you found the stock and purchased shares. Now you have to wait for them to perform. Yes, you need to monitor its performance periodically. The concept is to earn more money than you invested. If the stocks increase in value, you can sell for a profit.
- Do the research and buy performers (income earners).
- Select a productive and in-demand market segment with growth potential.
Buying bonds is a form of lending money in exchange for scheduled interest payments. Bonds mature over time, and the issuer must repay your principal investment at maturity. Do the research, since every investment has some level of risk.
- Purchase bonds from proven sources preventing any loss of your investment.
Annuities are insurance products that pay passive income monthly. There are precautions due to fees or upfront cost, but there also are benefits.
- Lifetime income streams or cash payouts aligned with schedules.
Although passive income may not involve daily management or business involvement, it does require some research and analysis about the market and the business risk. Look for cash flow and growth prospects without real-time involvement.
If you are considering opportunities for generating passive income, work with a financial advisor. They can answer your questions and provide helpful advice. Don't forget the upfront checks and balances help in choosing productive passive income investments.
By Christian Cordoba
CERTIFIED FINANCIAL PLANNER™
Founder, California Retirement Advisors
Investment advisory services offered through Mutual Advisors, LLC DBA California Retirement Advisors, a SEC registered investment adviser. Securities offered through Mutual Securities, Inc., member FINRA/SIPC. Mutual Securities, Inc. and Mutual Advisors, LLC are affiliated companies. CA Insurance license #0B09076. This content is developed from sources believed to be providing accurate information and provided by California Retirement Advisors. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. California Retirement Advisors, nor any of its members, are tax accountants or legal attorneys and do not provide tax or legal advice. For tax or legal advice, you should consult your tax or legal professional.