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What is Passive Income and How to Earn it

what is passive income

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Passive income often sounds like some magical thing reserved for the worlds wealthiest people. You know, CEOs and oil tycoons. In reality, that mindset couldn’t be more wrong. When it comes to passive income the mentality of “it all starts somewhere” is a better guide.

Separate from your regular earnings, passive income is money you earn with little to no effort usually done by completing a few (or more than a few) actions upfront and then reaping the rewards over time with little maintenance later. In a simple form, that means is your money is making money for you or you are making money while you sleep.

As you read this article, I want you to keep reminding yourself that the amount of money you get from passive vehicles does not matter. What matters is that passive income is passive income, and the goal is to increase the amount you earn from 0% to 0.1% to 0.2%, or $1 to $2 to $3 and so on. Also, this will be a long term effort to increase your wealth, not a get rich quick plan.

So what are these mythical passive income vehicles once thought to be reserved for the rich and famous? Let's take a look.

Savings Accounts

I know what you are thinking, “I already have a savings account.” But do you really? In 2019, the average savings rate for the common brick and mortar bank, think Bank of America, Citibank, Wells Fargo and those alike, is floating somewhere between 0.06% and 0.15% (nerdwallet.com). Meanwhile, some online banks offer much higher rates in the area between 2.10% and 2.25% (nerdwallet.com). I understand if you cringed a bit when I said the dreaded words “online bank” (ooooh scary), but this is 2019 and it’s time you open your eyes to the changing landscape.

It remains true that you shouldn’t toss your money into the first online bank that pops up at the top of a Google search. The advantage in that aspect remains with the local bank you can walk into and have confidence it’s a real and trustworthy bank. You will have to do a lot more homework in regard to online banks. Although, with a bit of effort you will find a huge financial reward. And let's be real, financial success is mostly gained by giving up an equally huge amount of hard work. To get you started, check out Marcus by Goldman Sachs Bank, Synchrony, and Ally. All three of those banks are FDIC members.

Certificate of Deposits (CDs)

Save MoneyThe average rates of CDs in 2019 is around 2.70% for a year or 3.10% (nerdwallet.com) for five years. CDs are similar to a savings account in the fact that they give you a guaranteed rate of return on your money without risk factors such as a sudden downturn in the economy or a volatile stock market. Although, CDs do come with more rules and restrictions. The most notable difference being if you want access to your money before its maturity date you will be hit with a penalty fee. With that being said, use a CD as a secondary vehicle for your cash after you have enough in your savings account for a rainy day. Typically, you should keep 6-8 months of reserve cash on hand for emergencies.

Let's take a brief pause.

I believe this is the drop-off point where most people start to say they don’t have “extra cash” and thus think passive income is for the rich. I understand, and this is where I will remind you about increasing your passive income from 0% to 0.1% and so on. You should, and I repeat you should have a savings account. If you do nothing else after reading this article other than opening a higher yielding savings account than the one you have now, consider it a success because you improved your passive income.

If you only have $100 in savings at any given time, you need to understand how important it is to earn $2 a year on your money vs. just 10 cents. I refuse to let you believe $2 isn't important when you only have $100 in savings. Use whatever scenario that will help you to realize that. $2 = one meal for your child or the difference between being able to pay your power bill and not. Whatever it takes, understand more is more. Simple as that. Now, let’s continue.

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Real Estate

We have entered the realm of higher difficulty in passive income vehicles. Remember, financial success takes extra effort. There are multiple ways to get into real estate and not all of them require a six-figure salary to enter.

Real Estate Investment Trust (REIT):

finance blogThere exist public and private trust open to investors. A REIT can be thought of as a pool of money that is gathered and used to invest in something that each contributor may not have been able to (or don’t want to) finance alone, and the investments are handled by a company whose main purpose is real estate investing. Some have high minimums, but a lot have low barriers to entry. Public REITs can be found using most investment services (TD Ameritrade, Robinhood, Merrill Edge, etc.) and investments can be made by purchasing individual shares.

Public shares give you the freedom to invest as little as you like and to retrieve your money whenever you like based on your brokerage account rules. Although, using this method you are also at the mercy of stock market volatility which means your holding could be down significantly at the time you want to retrieve it. My recommendation is to treat public shares the same as a private holding and only use cash that you don’t expect to need for at least the next 3-5 years.

Private REITs take a little more work to find and offer some advantages as well as disadvantages when compared to public REITs. After doing your research, it will help you decide which method is best for your situation. In the private sector, you will have limited access to your funds as most real estate investments have an expected investment horizon of 3-5 years. The advantage comes from being, mostly, separate from the daily volatility of the stock market.

Investment Groups and Crowd Funding:

If executed correctly with due caution, both investment groups and crowdfunding can be excellent ways to pool money together to invest in a real estate property that would have been near impossible for the average investor to invest in alone. Investment groups can be started by anyone, and the key to success is working with partners you trust and developing robust guidelines that you will adhere to no matter the nature of the working relationships. Avoiding the horror stories of working with family and friends should be an essential goal when establishing rules and responsibilities. Exit strategies should be clear and agreed on by the collective group because they can be an effective way to end a professional partnership while maintaining a personal one.

It is also possible to work with people who you have no personal relationships, and many online resources exist in facilitating those introductions. As with any other business venture, make sure you should do your due diligence to before making any serious commitments with people you don’t know or trust just yet.

Once a solid group is formed, as well as the supporting team members such as realtors, accountants, and others, finding and investing in a property will be a difficult task. Although, if your group consist of people who have bought real estate before, such as their own house, sticking to a solid plan should provide good results as the actual process of buying a property is rather common. Certain complexities will arise in the form of transferring ownership to the company, but with a solid strategy, you will be on your way to earning passive real estate income that can add another step on your stairway to financial success.

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Crowdfunding is relatively new and is rightfully so in the realm of being a skeptical route. Still, the possibility exists for it to be a successful venture toward earning passive income. Websites like Fundrise or Groundfloor are gaining popularity because they expand to non-accredited investors, which basically means there are lower minimum investment options. Tread carefully, but with optimism. I would suggest as you expand your passive investment portfolio you start with the safer alternatives and then move on to the route with more risk involved.

Traditional Rental Property and Airbnb:

These options should be more familiar, but a good reminder never hurts. If you inherited property from family, or have a vacation house you never use, then you should think about renting the space out. If you think time can’t be spared to do so, then you should look at property management services. They will cost money to use but letting them take a small cut of the profits is better than having no profits at all.

Airbnb has become a highly regarded and recognized platform for travelers to rent rooms and houses. If you have a spare house or room, consider looking into Airbnb. Protect yourself by establishing ground rules you are comfortable with, such as the deposit, cleaning fee, and pets and this could be a profitable passive income vehicle.

Other Investment Accounts

Peer-to-peer Lending:Finance Blog

Another form of investing that is relatively new, peer-to-peer lending is a significant change in the way that average people get a loan for a various number of needs. In the old days you only had a few options, borrow money from family and friends or a big financial institution. I’m excluding payday loans and pawn shops because those were always outside the box and inefficient ways to get a loan.

In modern times, the landscape is changing, and different companies have risen in many forms to be able to facilitate loans. These loans can be rather large and will continue to close the gap of what a traditional bank can offer compared to other companies. In the case of peer-to-peer lending, investors crowdfund their money to offer up as a loan to somebody who needs it. Investors earn interest on that loan just as a bank would.

The benefits of peer-to-peer lending are that you don’t have to offer up a huge sum of money to a single person or business which would create a high risk for you. Instead, you can create an account and fund it with $1000 for example, and then loan out $25 to 40 different borrowers. Your return on investment will depend on the number of those loans that default and the average interest rate for all of the loans.

This is another method where you should tread carefully. Upon further research, you will find that peer-to-peer lending is not very tax efficient, so this should not be your go-to for passive income. If you already have a diversified passive income portfolio, peer-to-peer lending can add another layer to further diversify your risk if used correctly.

Standard Brokerage/Investment Account with Dividend Paying Stocks

Earn MoneyInvesting in stocks and bonds is a risky business, there is no way around that fact. Even so, when done correctly, the rewards can be extremely lucrative. In the case of looking for passive income, dividend-paying stocks can provide a steady income if you are able to ignore the noise of the market. Buying stocks of good companies that have a proven track record of paying dividends can provide steady passive income if you buy and hold for an extended time, think 10-15 years and beyond. Search for so-called “dividend aristocrats” that have increased their dividend annually over the last 25 years.

Alternatively, safer options include investing in a low fee index fund or a trusted Exchange Traded Fund (ETF). Both funds will come with a price, but the funds take care of the day to day actions that will allow you to reap the reward of passive income. Holding onto these assets over a long period of time can add passive income to your wallet but is not for the faint of heart because the price can drop significantly in a short amount of time. It will take a steady hand to avoid selling your positions because of a significant loss in value.

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